Forecasts & Trends : Economy

Economic Recovery vs. Rising Unemployment

Gary D. Halbert — Tue, 27 Oct 2009 21:28:00 GMT

IN THIS ISSUE:

Overview of Recent US Economic Trends
Snapshot of the Latest Economic Data
Fed's "Beige Book" Sees Modest Improvement
Unemployment: The 800-Pound Gorilla in the Room
Conclusions - Storm Clouds on the Horizon

Eyes around the world are intently focused on this Thursday's advance estimate of 3Q GDP in the US. Everyone is anxiously awaiting the report which will signal whether or not the US economy moved into positive territory in the July-September quarter. Pre-report GDP estimates are all over the board, ranging from -1% to +3% or more. I can't recall another quarterly GDP report that was this uncertain in terms of pre-report estimates than this one.

As I have reported over the last couple of months, most economic reports of late have suggested that the US economy is coming out of the recession a little sooner than many of us expected earlier this year. In the pages that follow, we will review the latest economic reports in the hopes of giving us a little more insight as to what we may learn on Thursday with the release of the 3Q "advance" GDP estimate.

While the GDP report on Thursday is generally expected to be positive, we all know that the unemployment rate continues to rise, now at 9.8%, and likely headed even higher just ahead.

While most economists concur that the jobless rate will move even higher for at least several more months, recent data paint a grim picture for the likelihood of the unemployment rate falling significantly anytime soon.

And the truth is, the real unemployment rate in the US is now at 17%, if the government reported all of the people who are out of work and those who are having to work part-time because they can't find a full-time job. This week, I will give you all of the unemployment numbers, not just the official unemployment rate which now stands at 9.8% and rising.

Finally, most forecasters believe the economy will rebound, at least modestly in 2010, and I don't disagree. Yet few are offering forecasts beyond 2010 because no one knows what will happen if President Obama doubles the national debt in the next 5+ years. All I can say is that I don't believe this liberal experiment will end pretty, and I will have more to say about it in the weeks and months ahead.

Overview of US Economic Trends

Global attention will be intently focused on Thursday's 3Q GDP report as it is widely expected to show that the US economy emerged from the worst recession since the Great Depression. As noted above, not all pre-report GDP estimates are positive, but most are as I will discuss below.

But before we get to the latest estimates for Thursday's GDP report, let's quickly review the quarterly GDP data for 2008 and the first half of 2009. Here are the official annualized numbers:

1Q 08	2Q 08	3Q 08	4Q 08	1Q 09	2Q 09
-0.7%	+1.5%	-2.7%	-5.4%	-6.4%	-0.7%

On September 30, the Commerce Department released its third and final GDP report for the 2Q, showing the economy contracted at an annual rate of -0.7%, as compared to its prior estimate of -1.0%

As you can see, the worst of the recent economic slump occurred in the last half of 2008 and the first quarter of this year as the housing/credit crisis played out. But it should also be pointed out that the US economy was already slowing down its growth rate even before the latest recession. GDP growth was only 2.7% in 2006 and 2.1% in 2007 (annual rates).

Most economists agree that apprx. 3% annualized growth in GDP represents the average rate of growth in the US economy in the post-WWII era. Periods of growth below 3% represent "below-trend" time windows, while periods above 3% indicate "above-trend" examples. Clearly, the US economy has been growing at below-trend rates for the last several years.

With that perspective, let's look at the latest economic reports.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Snapshot of the Latest Economic Data

The consensus view based on recent economic and financial data is that the US economy is coming out of the credit crisis and recession. The National Association for Business Economics (NABE) recently surveyed leading economists, and over 80% believe the recession is over and an expansion has begun, but they expect the economic recovery will be slow as worries over unemployment and high federal debt persist.

"The survey found that the vast majority of business economists believe that the recession has ended but that the economic recovery is likely to be more moderate than those typically experienced following steep declines," said NABE President-elect Lynn Reaser, chief economist at Point Loma Nazarene University.

Most of the forecasters surveyed had upgraded their economic outlook for the next several quarters, but cautioned that unemployment rates and the federal deficit are expected to remain high through the next year. On balance, the economists now expect the economy, as measured by GDP, to advance at a 2.9% pace in the second half of 2009, after falling for four straight quarters for the first time in more than 50 years. On average, they expect GDP to gain 3% in 2010. I wish I were so optimistic.

The best news in recent months has been in the Index of Leading Economic Indicators (LEI), which has long been one of my favorite economic benchmarks. The LEI has risen for six consecutive months, with a strong increase of 1.0% in September, following +0.6% in August.

The LEI rise over the last six consecutive months, alone, would suggest - with the benefit of hindsight - that the recession was coming to an end. The six-month rise in the LEI gives credence to positive forecasts for the 3Q GDP number and perhaps the 4Q as well. Beyond that, it is anyone's guess.

For the benefit of our many newer readers, the Index of Leading Economic Indicators is, for the most part, a compendium of economic indicators: new orders, jobless claims, money supply, average workweek, building permits, and stock prices. The LEI is maintained and reported by the Conference Board (www.conference-board.org).

Consumer confidence is arguably the next major indicator of the direction of the economy, since consumer spending accounts for roughly 70% of GDP. Since rising sharply in April-May-June, the Consumer Confidence Index has gone basically sideways since then.

The other widely followed measure of consumer confidence is the University of Michigan Consumer Sentiment Index. After reaching a new recent high of 73.5 in September, the UM Consumer Sentiment Index fell to 69.4 earlier this month as announced on October 16.

Consumer spending is generally gauged by two economic reports, both of which are generated by the Commerce Department. One is the monthly retail sales report which dipped slightly in September. However, if we revise this retail sales report to exclude auto sales (which plunged last month due to the end of the "cash-for-clunkers" rebate program in August), retail sales actually increased marginally (+0.5%) in September, following a 2.2% gain in August.

The other widely followed indicator of consumer spending is the Commerce Department's "personal consumption expenditures" (PCE) measure, which is a part of the quarterly GDP reports. Americans increased PCE by 0.6% in the 1Q, only to see it decline by 0.9% in the 2Q. We will get our first look at 3Q PCE on Thursday with the latest GDP report.

Regardless of which report we use to gauge retail sales, the results are not eye-popping. Yes, consumer spending is finally on the rise in the wake of the recession, but we are far from out of the woods.

On the manufacturing front, things continue to improve at least modestly. The ISM Index basically was flat in September at 52.6. Industrial production rose 0.7% in September. The factory operating rate rose to 70.5% in September from 69.9% in August. Construction spending rose 0.8% in August (latest data available). The ISM Services Index rose to 50.9 in September, another indication that the recession may be ending.

And finally, on the housing front, there was more encouraging news last Friday. The National Association of Realtors reported that sales of existing homes rose 9.4% in September. The inventory of existing homes on the market declined slightly last month, and the decrease in home sale prices was somewhat less than was expected.

Fed's "Beige Book" Sees Modest Improvement

The Federal Reserve publishes an economic report eight times per year (roughly every six weeks) that is based on surveys conducted by the Fed's 12 regional banks that continually collect economic data within their respective regions. This periodic economic report is called the Fed's "Beige Book," and the latest report was released last Wednesday.

Basically, the latest Beige Book indicated that the US economy is continuing to improve, albeit very modestly, in most (but not all) regions of the country. The survey indicates that the economy, while gaining momentum, has yet to overcome weaknesses in bank lending and employment. According to the report, unemployment continued to rise last month in 23 US states, giving the Fed additional reasons to hold the main interest rate at a record low to stoke a recovery.

In particular, Federal Reserve district banks identified commercial real estate as the weakest part of the economy, while most saw "stabilization or modest improvements" in areas including housing and manufacturing. All 12 district banks reported a weak or declining commercial real estate market. You may recall that I wrote about the problems in commercial real estate in great detail in my September 29 E-Letter, so my readers should not be surprised.

While the latest Beige Book tried to present a guardedly optimistic outlook for continued economic recovery, it included several prominent caveats, such as: "Reports of gains in economic activity generally outnumber declines, but virtually every reference to improvement was qualified as either small or scattered." The report also demonstrated how heavily many businesses are relying on government spending in the face of huge contractions in the private sector.

Unemployment: The 800-Pound Gorilla in the Room

It is widely estimated that over 7 million jobs have been lost since the recession began in late 2007. The unemployment rate rose to 9.8% in September, with the "official" number of job losses at 263,000 last month. That is the highest unemployment rate since June 1983.

Most forecasters expect the US unemployment rate to continue to climb until sometime in mid-2010 when the rate is expected to peak somewhere north of 10%.

As many of you know, the official Labor Department unemployment rate is quite misleading in several ways. While it is useful as an indication of the trend in the unemployment rate, it actually understates the real percentage of Americans who are out of work.

The official unemployment rate that is announced every month does not include: 1) workers who have had to settle for part-time jobs because they can't find full-time jobs; and 2) Americans who have given up looking for a job.

If laid-off workers who have settled for part-time work or have given up looking for new jobs are included, the true unemployment rate rose to 17% in September. Here is the actual data from the Labor Department:

Table A-12.

Alternative measures of labor underutilization
Seasonally adjusted rates as of September 2009:

U-1 Persons unemployed 15 weeks or longer, as a percent of the civilian labor force	5.4%
U-2 Job losers and persons who completed temporary jobs, as a percent of the civilian labor force	6.8%
U-3 Total unemployed, as a percent of the civilian labor force (official unemployment rate)	9.8%
U-4 Total unemployed plus discouraged workers, as a percent of the civilian labor force plus discouraged workers	10.2%
U-5 Total unemployed, plus discouraged workers, plus all other marginally attached workers, as a percent of the civilian labor force plus all marginally attached workers	11.1%
U-6 Total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally attached workers	17.0%
NOTE: Marginally attached workers are persons who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the recent past. Discouraged workers, a subset of the marginally attached, have given a job-market related reason for not looking currently for a job. Persons employed part time for economic reasons are those who want and are available for full-time work but have had to settle for a part-time schedule. For more information, see "BLS introduces new range of alternative unemployment measures," in the October 1995 issue of the Monthly Labor Review. Updated population controls are introduced annually with the release of January data. (Source: Bureau of Labor Statistics Economic News Release - October 2, 2009)

All told, 15.1 million Americans (17%) are now out of work, the Department said. And an estimated 7.2 million jobs have been eliminated since the recession began in December 2007.

The Labor Department said 571,000 of the unemployed dropped out of the work force last month, presumably out of frustration over the lack of jobs. That sent the so-called "participation rate," or the percentage of the population either not working or looking for work, to a 23-year low. The unemployment rate would have topped 10% if the labor force hadn't shrunk again in September.

Older, laid-off workers are dropping out and requesting Social Security at a faster-than-expected pace, according to government officials. The Social Security Administration reported earlier this month that applications for retirement benefits are 23% higher than last year, while disability claims have risen by about 20%.

Meanwhile, the number of people out of work for six months or longer jumped to a record 5.4 million in September, and they now make up almost 36% of the unemployed, also a record. Making matters worse, weekly wages fell $1.54 to $616.11 in September, according to the Labor Department. Also, the average hourly work week fell back to a record low of 33 hours in September.

Unemployment to Remain High for Years to Come,
Even if the Economic Recovery Gets Stronger

With the unemployment rate so much higher than most expected, and headed higher still, more and more analysts are trying to determine how much job creation will be required to bring us down to 5% unemployment. Many economists and analysts consider that 5% unemployment is the equivalent of "full employment," since there will always be some percentage of the working population that is unemployed at any given time.

The job creation numbers required to get us from the current 9.8% unemployment to 5% unemployment, at this point, are simply staggering. And they are likely to get even worse, since we are likely headed for at least 10% unemployment in the months ahead.

As noted above, well over seven million jobs have been eliminated since late 2007. Most economists agree that most of these jobs have been eliminated permanently. Also as noted above, there are now 15.1 million Americans (17%) who were out of work, or forced to work part-time, as of the end of September.

In addition to the 15.1 million Americans who are out of work, most economists agree that apprx. 1 million new people enter the US job market every year (high school and college grads, legal immigrants, etc.). So not only does the economy need to grow by enough to re-employ 15 million unemployed, it also must create another 1 million jobs each year to provide for new entrants to the labor force.

With 15 million out of work already, and with the labor force expanding by more than 1 million new workers annually, economists Joseph Seneca and James Hughes of Rutgers estimate that even the robust job growth of the 1990s (2.4 million new jobs a year) wouldn't reduce today's 9.8% unemployment to 5% until 2017.

We increasingly hear about the so-called "jobless recovery" that we are likely facing. With the economy still losing over 250,000 jobs per month, it is a real stretch to assume that we will get anywhere near the 1990s pace of adding an average of 200,000 jobs per month (2.4 million annually). For example, the Business Roundtable, a group of CEOs from large corporations, said earlier this month that only 13% of its members expect to increase hiring over the next six months.

As these numbers continue to sink in, we are hearing new calls for more federal aid to state governments, a further extension of unemployment insurance (now up to 79 weeks) and a tax credit for companies that create new jobs. One such proposal would give employers a $7,000 tax credit for each additional worker hired (over some base period).

The W.E. Upjohn Institute for Employment Research thinks such a credit might create two million jobs. Sounds good on paper, perhaps, but the budgetary cost to the government would likely be $40 billion annually or higher.

As you will likely recall, President Obama rammed through his massive $787 billion "stimulus package" back in February, largely on the promise that it would create jobs. What he didn't tell us was that most of the money would not be spent this year, and that much of the money would go for pork-barrel spending programs over the next few years that won't create large numbers of jobs in the first place.

Supporters of the stimulus argue that without it, unemployment would be even worse than it is now and suggest that the stimulus spending in 2010 and 2011 will boost the economic recovery significantly. That remains to be seen, of course. I tend to doubt it.

Conclusions - Storm Clouds on the Horizon

Economic and financial reports continue to support the idea that we have seen the worst of the economic recession and the credit crisis, as I have suggested in recent weeks. Most estimates suggest that the economy, as measured by GDP, will show a positive number for the first time in over a year with this Thursday's advance 3Q GDP report.

Pre-report estimates are all over the board, and some analysts believe the report could show 3Q growth of 3% or more. Of course, we must all keep in mind that year-over-year comparisons of 3Q 2009 to last year's 3Q should make this year look pretty darned good in any event.

But the bigger problem is that unemployment continues to rise and is likely to do so until at least sometime in the first half of 2010, reaching well over 10% in the official number. As I have explained in detail above, the official unemployment rate significantly understates the real unemployment rate, which is now at 17%, as admitted by the Labor Department.

Despite the continuing unemployment trend, most forecasters believe that the US economy came out of the recession in the 3Q. Likewise, most mainstream forecasters believe that 2010 will be a year with at least modestly higher growth rates. Most estimates I read suggest the US economy will grow by 1.5%-3% in GDP next year. That remains to be seen, however.

Yet the most interesting thing for me is that we are seeing very few forecasts for 2011 and beyond. Usually, forecasters are more than happy to provide multi-year economic projections, so why not now? The reason is, in my opinion, that no one has a clue what the long-term effects will be as a result of President Obama's plans to run trillion-dollar deficits for the next several years at least and double the national debt in possibly the next five years.

The US dollar continues to fall as I discussed in detail last week. While I don't believe the dollar will be replaced as the world's "reserve currency" in the near-term, the long-term prospects for the dollar are questionable at best, especially if Obama doubles the national debt over the next 5-plus years. At some point, foreigners who buy our massive debt may decide to stop buying dollars, or worst case, begin to unload dollars.

If that were to happen, the implications for the US financial markets would be enormous. That could cause a financial crisis that dwarfs the one we've just been through. Maybe we do see an economic recovery in 2010 as most economists predict. But I want to go on record in predicting a "double-dip recession" in 2011 and perhaps beyond, especially if the dollar accelerates its decline. Space does not allow me to go into my reasons for this prediction this week, but I will be writing more about it in the weeks and months ahead.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Stocks Up 60% - Now What?

If the current troubling economic forecast doesn't call for a defensive investment approach, I don't know what does. Stocks have exploded since the March lows, with the S&P 500 Index up almost 60%. Now, more than ever, you may want to consider active management strategies that can move to cash or hedge long positions should stocks switch direction just ahead.

We recently sponsored live webinars featuring two of our recommended Investment Advisors. The overwhelming response we received shows us that investors are beginning to realize that the market can't continue to go up forever, and that market euphoria will run into economic reality at some point.

Increasingly, sophisticated investors are increasingly turning to professional money managers that can take advantage of whatever remains of the stock market upside, but that also have the ability to move to cash, or hedge long positions, when the current bull market rally plays out.

Fortunately, we recorded both of these webinars and have placed them on our website. I urge you to check out both the Potomac Fund Management and Niemann Capital Management webinars. Both of these Advisors have actual track records going back well over a decade, so they are not recent entrants in the field of active money management. Click on the following links to learn more about how these professional money managers add value to their clients' investments.

Potomac Fund Management Webinar

Niemann Capital Management Webinar

If you would like to discuss either of these managers, or learn more about our other actively managed investment programs, feel free to call one of our Investment Consultants at 800-348-3601 or send an e-mail to info@halbertwealth.com. We look forward to hearing from you!

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Why Government Health Care Keeps Falling in the Polls
http://online.wsj.com/article/SB10001424052748704335904574495131591949574.html

Is the healthcare "public option" really back?
http://www.realclearpolitics.com/articles/2009/10/27/if_public_option_is_really_back_why_such_a_heavy_lift_98890.html

The Dethroning of King Dollar (an interesting read)
http://www.weeklystandard.com/Content/Public/Articles/000/000/017/124jwyuq.asp?pg=1

The Economy & the Commercial Real Estate Bust

Gary D. Halbert — Wed, 30 Sep 2009 00:43:00 GMT

In This Issue:

The Economy Continues to Improve Slowly
Plunge in Commercial Real Estate Values
More Trouble Ahead for the Banks
Glut of Commercial Mortgage-Backed Securities
Personal: Thinking Wrong, But Getting It Right

Introduction

There is broad agreement that we have seen the worst of the recession, and that GDP will show a positive gain for the 3Q when we get the first government estimate in late October. Most pre-report GDP estimates I have seen are in the +2 to +3% range for the 3Q. The actual number remains to be seen, of course.

There is also a growing agreement that we have seen the worst of the housing bust, as sales of new and existing homes rose briskly for the four months ended in July; however sales of existing homes unexpectedly fell slightly in August as reported last week.

Yet while the economy appears to be on the mend, at least for a while, and the housing market seems to be recovering, there is another serious threat to the economy and the credit markets just ahead - the continuing commercial real estate bust which is still getting worse.

This week, we will take a brief look at the latest economic reports, most of which are encouraging, and then I will summarize the very troubling situation in US commercial real estate. This problem has led numerous analysts to predict that the commercial real estate may well be the next shoe to drop in the credit crunch.

The Economy Continues to Improve Slowly

As noted above, most forecasters believe the US economy has expanded at healthy rate in the 3Q which officially ends tomorrow. If so, that will be a welcome relief following GDP declines of -6.4% in the 1Q and -1.0% (annual rates) in the 2Q.

The Index of Leading Economic Indicators (LEI) rose 0.6% in August, marketing the sixth consecutive monthly increase. This is perhaps our best indication that growth in the 3Q and the 4Q will be positive and could surprise on the upside, which is not surprising following the worst recession since the Great Depression.

Most analysts that I follow closely believe, however, that the economic recovery in 2010 will be rather anemic with GDP growth at or below 3% on average. Such estimates could prove too rosy, depending on what happens in the huge commercial real estate sector (details to follow).

Consumer confidence improved significantly in August after falling slightly in June and July. The Consumer Confidence Index rose to its highest level (54.1) since the recession began. The improvement continued into September with the University of Michigan Consumer Sentiment Index climbing to a new recent high of 70.2.

Higher confidence resulted in a nice rise in retail sales in August, up 2.7%. Unfortunately, durable goods orders, which were expected to have risen in August, fell 2.7% last month, following the big increase of 4.8% in July.

On the manufacturing front, the ISM Index rose to 54.1 in August, up from a revised 47.4 in July. Industrial production rose 0.8% in August, following a 1.3% gain in July. Factory orders were up 1.3% in July (latest data available). The factory operating rate rose to 69.6% in August.

As noted above, existing home sales dipped slightly in August following four consecutive monthly increases. New home sales in August were up fractionally (0.7%), well below expectations, following the 9.6% jump in July, the highest in almost a year.

Of course, any analysis of the overall economy would be remiss not to point out that, while things are improving on most fronts, the unemployment rate continues to rise - up to 9.7% in August from 9.4% in July - and will almost certainly continue higher for several more months at least.

Overall, it appears clear that the recession will end this year, and it is quite possible that we will see positive growth in GDP in the 3Q and 4Q. Most of the estimates I read for the 2Q are in the +2-3% range; most of the guesses I read for the 4Q are in the +3-4% range, which remains to be seen, especially in light of the potentially dangerous situation in the commercial real estate markets.

Plunge in Commercial Real Estate Values

US commercial real estate, valued at some $3.5 trillion, has experienced a 39% decline in prices on average from the peak in late 2007, according to the MITCenter for Real Estate.

This current drop is considerably worse than the 27% commercial real estate decline associated with the savings and loan crisis of the late '80s and early '90s. You will recall that the S&L crisis precipitated the government-run Resolution Trust Corporation and the resulting seizures and auctions of hundreds S&Ls around the country.

The same conditions that caused the residential housing bubble, including the Fed's easy credit, lax lending standards and booming mortgage-backed securities underwriting on Wall Street, also drove commercial real estate overvaluation.

Recently, MIT reported that commercial real estate prices plunged 18% in the second quarter, which was the largest quarterly drop in the 25 years since MIT first published its Commercial Real Estate Price Index. MIT also reports that most commercial properties bought or refinanced in the last five years are now upside down on their loans, with current property prices having fallen below the finance or purchase price. Real Capital Analytics reports that owners have lost their entire down payments on about $1.3 trillion worth of property.

According to several sources, nearly half of all the commercial real estate mortgage loans in the US are coming due within the next five years. Deutsche Bank, for example, believes that 65% or more of these loans will fail to qualify for refinancing. Existing high vacancy rates will continue or worsen as long as the unemployment rate continues to rise.

We are hearing more and more talk about the plunge in commercial real estate values these days because commercial real estate value trends tend to lag the overall economy. There are many reasons for this - too many in fact that it is impossible to cover them in this short space.

Susan Smith, who is the director of PricewaterhouseCoopers' real estate advisory practice notes: "The biggest problem is that commercial real estate lags what happens in the economy. Companies are looking for ways to cut costs, many are continuing to reduce workers and are continuing to reduce their space needs." As a result, commercial rental rates have taken a nosedive in most markets.

Ms. Smith and her team at PricewaterhouseCoopers conduct surveys each year of the commercial real estate market, and their latest survey concludes that the rise in vacancy rates and the plunge in rental rate are far from over and may well extend into 2011. Office rents in New York and San Francisco may drop 20% in 2010 alone, the survey found.

The National Association of Realtors projects that retail vacancy rates will increase from 11.7% in the 2Q of 2009 to at least 12.9% in the same period of 2010, the highest vacancy rates since 1991. Likewise, NAR projects that office building vacancy rates will rise from 15.5% to at least 18.8% by this time next year.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

More Trouble Ahead for the Banks

All of the above suggests the following: many of the banks that made commercial real estate have only realized a fraction of their losses. And as those losses continue to mount, we're likely to see more and more bank failures. Commercial real estate loans are not just concentrated among the nations largest banks; these loans are widely made by regional banks and even smaller banks.

Of the largest banks, San Francisco-based Wells Fargo has the largest share of the apprx. $3.5 trillion commercial debt securities, reportedly with 16.5% of its $821 billion loan portfolio invested. JPMorgan Chase is reportedly a distant second with 5.4% of its portfolio invested in commercial loans, followed by Citigroup with 3.4%.

However, smaller banks - 92 of which have already folded this year as of mid-September, according to the FDIC, compared to 25 last year - are even more at risk because they will likely have a harder time accessing the crucial capital to offset rising defaults on commercial real estate loans, according to the TARP-inspired Congressional Oversight Panel's August Oversight Report. The Oversight Panel noted:

"Unlike large banks that can sustain a certain number of defaults, even of large commercial loans, smaller banks may have far more difficulty in absorbing more than a few large loan losses. The FDIC's statement that ‘banks have been able to raise capital without having to sell bad assets through the LLP' may not reflect the reality for these banks."

Indeed, the number of smaller banks expected to be seized by the FDIC is forecast to accelerate later this year and next year. The FDIC's "problem list," of banks that run a higher risk of failure, grew to 416 in the 2Q, up from 305 in the 1Q. That's the highest number since the 2Q of 1994, following the S&L crisis, when there were 434 banks on the list.

As noted above, the S&L crisis resulted in a 27% decline in commercial real estate around the country. This time around the losses are even greater (39% so far) because the apprx. $3.5 trillion is over three times what it was during the early 1990s - meaning the potential for losses is steeper than ever before.

Glut of Commercial Mortgage-Backed Securities

Federal Reserve and Treasury officials are scrambling to prevent the commercial real estate sector from delivering another knockout punch to the US economy just as it struggles to get up off the mat. Yet their efforts could be undermined by a surge in foreclosures of commercial property carrying mortgages that were packaged and sold by Wall Street as bonds. These loans are known as Commercial Mortgage-Backed Securities (CMBS).

As discussed above, many US banks have high exposure to commercial real estate debt that they initiated through their own internal loans. In addition, many banks also bought CMBS and now have additional default risks that I will discuss in more detail as we go along.

Similar mortgage-backed securities (Sub-prime, Alt A, etc.) created out of home loans played a huge role in undoing that sector and triggering the global economic recession and credit crisis. Most sources estimate that there is around $700-$900 billion of CMBS outstanding at this time. These complicated products are being tested for the first time by the massive downturn real estate values discussed above, and so far the outcome so far hasn't been pretty.

A typical CMBS is stuffed with mortgages on a diverse group of properties, often fewer than 100, with loans ranging from a couple of million dollars to more than $100 million. A CMBS servicer, which is usually a large financial institution like Wells Fargo or JPMorgan Chase, collects monthly payments from the borrowers and passes the money on to the institutional investors that buy the securities.

The CMBS sector is suffering from two major problems, which, according to credit rater Realpoint LLC, sent its delinquency rate to 3.14% in July, more than six times the level a year earlier. One is major problem is that many of these mortgages were simply poorly underwritten. In the era of looser credit in recent years, Wall Street's CMBS machine lent owners money on the assumption that occupancy and rents of their office buildings, hotels, stores or other commercial property would keep rising. In fact, the opposite has happened. The result is that a growing number of properties aren't generating enough cash to make principal and interest payments.

The other major problem is the growing inability of property owners to refinance loans bundled into CMBS when these loans mature. By the end of 2012, some $153 billion in loans that make up CMBS are coming due, and close to $100 billion of that will face difficulty getting refinanced, according to Deutsche Bank. Unfortunately, other sources estimate that twice that many CMBS loans will come due between now and 2012; and double the amount that will be difficult or impossible to refinance.

Even though the cash flows of many of these properties are enough to pay interest and principal on the debt, their values have fallen so far that borrowers won't be able to extend existing mortgages or replace them with new debt. That means losses not only to the property owners but also to those who bought CMBS - including hedge funds, pension funds, mutual funds and other financial institutions - thus exacerbating the economic downturn.

Many banks that hold traditional commercial real estate loans have chosen to extend the maturities and/or renegotiate the terms (this is one reason we haven't heard too much about it until recently). Banks have had a strong incentive to refinance because relaxed accounting standards have enabled them to avoid marking the value of the loans down.

Until now, banks have been able to keep a lid on commercial-real-estate losses by extending debt when it has matured as long as the underlying properties are generating enough cash to pay debt service. Unfortunately, CMBS are held by scores of investors, and the servicers of CMBS loans have limited flexibility to extend or restructure troubled loans like banks do.

Mounting foreclosures in the CMBS sector will likely depress values even further as property is dumped on the market. And this, in turn, will likely put pressure on banks to write down the myriad of commercial loans on their books, thereby exacerbating the problem.

The $64 Question: Why Are Bank Stocks Soaring?

At this point, the logical question to ask is, how is it that we have this enormous commercial debt problem, yet bank stocks have been on a tear for the last couple of months? Frankly, I think most bank shares are wildly overbought at this point, but then I'm not a stock picker.

Some of the largest US-based multinational banks saw their share prices plunge to the level of "penny stocks" over the last year. CitiGroup at one point fell to below $1 per share (97¢) on March 5. Yet shares of these mega-banks have rebounded significantly in recent months, albeit from the lowest levels ever recorded for many of the largest banks. In other words, they were due for a significant rebound.

Another reason the large money center banks have seen their shares soar is the widespread belief that President Obama will not allow any of the major financial institutions fail on his watch. The turmoil that erupted after the Lehman failure will not be allowed to happen again, so investors have more confidence in the large bank stocks. The recent spike in bank stocks has also helped the regional bank stocks which, in most cases have seen their share prices rise as well.

None of this, however, makes the commercial real estate debt problem go away, and it will get worse before it gets better. There is virtually no market for CMBS. Potentially hundreds of billions in commercial mortgage loans will not be able to be refinanced over the next couple of years. I fully expect this to weigh heavily on the banks - small and large - in the weeks and months ahead.

If I had very large profits in banks stocks over the last 2-3 months, I would be taking money off the table. But again, I'm not a stock picker.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Thinking Wrong, But Getting It Right

If you have been reading this E-Letter all year, you know that my calls on the economy and the stock market have been off the mark for the most part. Earlier this year, I expected the economy would remain in negative GDP territory all year and not recover until sometime next year. I expected consumer confidence to stay in the dumps pretty much all year.

Despite my forecast, the economy did begin to rebound during the summer, and it now looks reasonable to expect positive growth in the 3Q and 4Q, assuming there are no more big negative surprises. Just how negative the commercial real estate debt problem will be remains to be seen.

In a similar vein, I did not see the recent surge in the stock markets coming. Of course, I don't know anyone else who predicted stocks would spike 50% higher back in March either. Back in early March when the Dow had literally collapsed to 6500, I did feel that the panic was probably over. Yet I never would have imagined that the Dow and other major market indexes would soar over 50% in relatively short order. But they have.

I openly admit to those misgivings to make the following point. I don't manage any of my own money that is in the stock market or in bonds. I haven't made a personal trade in years. I figured out a long time ago that I am too emotional to do it myself.

If I had been managing my own money in stocks or mutual funds, I would probably have bailed out sometime late last year or early this year, as millions of investors did. Given my views of the economy and the stock markets earlier this year, I can all but assure you I would not have jumped back in when the markets turned up in late March and April.

I would still be on the sidelines like millions of other investors, and I would have missed out on the huge gains that followed. By the way, estimates are that there is still $3-$4 trillion in money that bailed out that is still sitting on the sidelines in money market funds, T-bills, etc.

But since almost all of the money I have in the stock markets is managed by professionals, I have been able to participate in this recovery.

If you have read these letters for long, you know that my firm is in the business of finding successful professional money managers to recommend to our clients. As a long-time critic of Wall Street's "buy-and-hold" mantra, I have always preferred "active" or "tactical" money management strategies that have the ability to move to cash (money market) or "hedge" long positions during down periods.

The reality is that my equity managers lost far less than the market during the bear market that began in late 2007, and they have been able to participate in the bull market that began earlier this year. (As always, past performance is no guarantee of future returns.)

My goal has always been to avoid the 40-50% losses that often occur during bear markets. Remember, if you lose 50%, you must make 100% just to get back to breakeven.

If avoiding big losses is a big concern to you, then maybe it's time to checkout some of the active managers I recommend. Hopefully, you read my E-Letter two weeks ago on the Columbus High-Yield Bond Program.

Please feel free to give one of our Investment Consultants a call at 800-348-3601 or click on the following link to complete one of our online request forms. If more convenient, drop us an e-mail at info@halbertwealth.com or visit our website at www.halbertwealth.com to learn more about our actively managed investment strategies.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Healthcare: Doubling Down on a Flawed Model (read this)
http://online.wsj.com/article/SB10001424052970204488304574426872264215790.html

Second Stimulus - Good Money After Bad

Gary D. Halbert — Tue, 21 Jul 2009 21:20:00 GMT

IN THIS ISSUE:

The Latest Assessment of the US Economy
The Real Unemployment Rate is 16.5%, Not 9.5%
Nine Reasons the Economy is Not Getting Better
Where I Disagree With Mr. Zuckerman
Conclusions -- "The New Normal"

Introduction

Over the last few weeks, most polls have shifted to indicate that a majority of Americans now believe President Obama's massive $787 billion stimulus package that he signed into law on February 17 has been a failure in terms of restarting the economy. I could not agree more. Rather than making the money available to immediate job-creating projects and programs, Obama and the Democrats in Congress loaded the stimulus up with pork-barrel projects that will take years to come about, and the recession will likely be over well before that.

I warned about this repeatedly in my February 10, 17 and 24 E-Letters. I was not a fan of the massive $787 billion stimulus package, but most of my best sources agreed that the government needed to step in with some kind of stimulus to at least partially fill the gap left by the marked slowdown in consumer spending. But the $787 billion spending package, which was spread out over 3-4 years, was not what we needed to jump-start the economy. It is now estimated that only about 10% of the stimulus money has been spent at this point. No wonder unemployment is 9.5% and rising fast.

Now we have widespread talk in Washington and elsewhere of a second huge stimulus package. Oh, but this time the politicos in Washington claim that they've learned their lesson, and a second stimulus will be focused only on "shovel-ready" programs that will create new jobs right away. To that I say (as my kids often do): yeah, right! I have a different suggestion: forget a second stimulus and redirect the remaining 90% of the $787 billion first stimulus to projects that will create jobs now. And include a payroll tax holiday for six months or so to boot.

In addition to the second stimulus issue, we will touch several other bases in this week's E-Letter. We will begin with the latest economic reports which remain mixed to negative. The theme of "green shoots" and an economic recovery that became popular in April and May has since turned more negative in June and so far in July. Consumer confidence is falling once again as it increasingly becomes clear that this recession will not be over anytime soon, and that the recovery will almost certainly be tepid over the next couple of years.

Following that discussion, we will look at a recent article which details why the real unemployment rate in the US is much, much worse than the monthly Labor Department reports depict. Most of you, I suspect, are aware of this, but the report I will share with you below puts the situation in much clearer terms, and explains why the economic recovery is likely doomed to be lackluster over the next couple of years or longer.

While this definitely won't be one of my more upbeat E-Letters, the circumstances are what they are and you need to know about it, especially as you try to manage your money and plan for retirement in this very challenging environment. Let's get started.

The Latest Assessment of the US Economy

On June 25, the Commerce Department released its final report on 1Q GDP at -5.5% (annual rate). That was slightly less negative than the prior estimate of -5.7%. The 1Q decline followed the 6.3% decline in the 4Q of 2008. Most analysts now expect that GDP will be negative for the 2Q as well, but not nearly as bad as the 1Q. A good number of analysts and economists continue to believe GDP will return to mildly positive territory by the 3Q, but that remains to be seen.

The Index of Leading Economic Indicators (LEI) rose for the third month in a row in June, up 0.7% following the rise of 1.2% in May. This is encouraging and seems to confirm that we have seen the worst of the recession and the credit crisis, but it does not suggest that this deep recession is over yet. Retail sales also increased modestly in June, up 0.6% following a gain of 0.5% in May, a sign that things are improving but we are not nearly out of the woods yet.

Unfortunately, the Consumer Confidence Index fell from 54.8 in May to 49.3 in June. The index had risen for three months in a row until the June decline. The University of Michigan Consumer Sentiment Index fell from 70.8 in June to 64.6 so far in July. I believe it is clear that consumers are coming to realize that this recession, while we've likely seen the worst of it, is not going away anytime soon.

As we will discuss in detail below, the unemployment rate surged to 9.5% in June, above expectations. Most analysts, including President Obama, now predict that the unemployment rate will go above 10% in the months ahead and will not likely peak until sometime in the second half of 2010. As we will explore later on, the "headline" unemployment rate published by the Labor Department significantly understates the true level of unemployment.

Factory orders and durable goods orders both rose for the second month in a row in May (latest data available). The ISM Manufacturing Index rose modestly in June to 44.8, up from 42.8 in May. Remember, any ISM number below 50 indicates recession. Industrial production fell by 0.4% in June, and the factory operating rate (capacity utilization) continued to fall in June to only 68.3%, down 13.6% over the last 12 months.

Sales of new and existing homes appear to be bottoming out with a very modest rise in May/June. Housing starts actually rose slightly in May/June as well. Unfortunately, the home foreclosure rate continues to soar, rising 4.6% in June and 33% over the last 12 months. The housing crisis is still far from over.

While it is encouraging that we have had some positive economic reports over the last several weeks, most economists continue to lower their forecasts for the last half of the year. I continue to believe that this recession will last longer than the current consensus predicts.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

The Real Unemployment Rate is 16.5%, Not 9.5%

I have known for more than two decades that the official Labor Department "unemployment rate" significantly understates the number of Americans who are out of work each month. Most likely, many of you are also aware of this longstanding disparity. A number of other official government reports contain similar disparities. But since the markets react to these government reports as if they are accurate, I report them in these pages accordingly.

With that in mind, I was pleasantly surprised to read an article last week by the Editor-in-Chief of U.S. News & World Report, Mort Zuckerman, that very accurately described the fallacies in the Labor Department's monthly unemployment report. I don't think I have ever seen these fallacies reported so accurately and concisely in one place. Mr. Zuckerman also reveals what he sees for the future of the US economy and the jobs market in the years to come.

So, I will reprint it for you below. While I don't agree with Mr. Zuckerman's conclusions as to what should be done now, I trust you will find the following of great interest.

QUOTE:

Nine Reasons the Economy is Not Getting Better
Jobs data paint a discouraging picture of more pain to come
By Mortimer Zuckerman
Posted July 13, 2009

We are now looking at unemployment numbers that undermine any confidence that we might be nearing the bottom of the recession. The appropriate metaphor is not the green shoots of new growth. A better image is to look at the true total of jobless people as a prudent navigator looks at an iceberg.

What we see on the surface is disconcerting enough. The estimate from the Bureau of Labor Statistics of job losses for June is 467,000. That increases by 7.2 million the number of unemployed since the start of the recession. The cumulative job losses over the past six months have been greater than for any other half-year period since World War II, including demobilization. What's more, the job losses are now equal to the net job gains over the previous nine years, making this the only recession since the Great Depression to wipe out all employment growth from the previous business cycle.

That's bad enough. But here are nine reasons we are in even more trouble than the 9.5 percent unemployment rate indicates.

One. June's total included 185,000 people who were assumed to be at work, many of whom probably were not. The government could not identify them; it made an assumption about trends. But many of the mythical jobs are in industries that have absolutely no job creation: finance, for example. When the official numbers are adjusted over the next several months, look to some of the 185,000 boosting the unemployment totals.

Two. More companies are asking employees to take unpaid leave. These people don't count on the unemployment roll.

Three. No fewer than 1.4 million people wanted or were available for work in the past 12 months. They were not counted. Why? Because they hadn't searched for work in the four weeks preceding the survey. The assumption is that they had found work or don't want it, but there are other explanations: school attendance, family responsibilities, sheer exhaustion.

Four. The number of workers taking part-time jobs because of the slack economy, a kind of stealth underemployment, has doubled in this recession to about 9 million, or 5.8 percent of the workforce. Add those whose hours have been cut to those who cannot find a full-time job, and the total of unemployed and underemployed rises to 16.5 percent, putting the number of involuntarily idle workers in the range of an overwhelming 25 million. [Emphasis added, GDH.]

Five. The inside numbers are just as bad. The average workweek for production and nonsupervisory private-sector employees, around 80 percent of the workforce, dropped to 33 hours. That's 48 minutes a week less than before the recession began, the lowest level of activity since the government began tracking such data 45 years ago. Full-time workers are being downgraded to part time as businesses slash labor costs to remain above water and factories operate at only 65 percent of capacity. If American workers were still putting in those extra 48 minutes a week now, 3.3 million fewer employees could perform the same aggregate amount of work. With a longer workweek, the unemployment rate would reach 11.7 percent, not the official 9.5 percent (which in turn dramatically exceeds the 8 percent rate projected by the Obama administration).

Six. The average length of official unemployment increased to 24.5 weeks. This is the longest term since the government started to track these data in 1948. The number of long-term unemployed (those out of a job for 27 weeks or more) has now jumped to 4.4 million, an all-time high.

Seven. The average worker saw no wage gains in June, with average compensation running flat at $18.53 an hour.

Eight. The jobs report is even uglier when you consider that the sector producing goods is losing the most jobs—223,000 in the last report alone.

Nine.The prospects for job creation are equally distressing. The likelihood is that when economic activity picks up, employers will first choose to increase hours for existing workers and bring part-time workers to full-time status.

Many unemployed workers looking for jobs once the recovery begins will discover that jobs as good as the ones they lost are almost impossible to find because more layoffs in this recession have been permanent and not temporary. Instead of shrinking operations, companies have closed whole business units or made sweeping structural changes in the way they conduct their business.

For example, General Motors and Chrysler shut down hundreds of dealerships and reduced brands; Citigroup and Bank of America cut tens of thousands of jobs and exited many parts of the world of finance. In other words, we could face a very low upswing in terms of the creation of new jobs, and we may be facing a much higher level of joblessness on an ongoing basis. Job losses may last well into 2010 to hit an unemployment peak close to 11 percent. And then joblessness may be sustained for an extended period.

Can we find comfort in knowing that employment has long been considered a lagging indicator? It is conventionally seen as having limited predictive power because employment reflects decisions taken earlier in the business cycle. But today is different. Unemployment has doubled from 4.8 to 9.5 percent in just 16 months, a record rate so fast it may influence future economic behaviors and outlooks.

Bear in mind that the lackluster increase in inventories suggests that there's little prospect in the pipeline of real growth in consumption, investment, and exports. So the terrible state of the labor market is likely to be a strong head wind against consumer spending for a long time as wages and overall income growth are decelerating and households, within a fairly short period, will have received their full portion of the [$787 billion] stimulus package.

How could this happen when Washington has thrown trillions of dollars into the pot, including the famous $787 billion in spending that was supposed to yield $1.50 in growth for every dollar spent? For a start, too much of the money went to transfer payments—Medicaid, jobless benefits, and the like - that do nothing for jobs and growth. The spending that creates new jobs is new spending, particularly on infrastructure. It amounts to less than 10 percent of the stimulus package today.

Second, the stimulus package may have been well intentioned, but it was [arguably!] too small and [definitely!] too badly constructed to get money into the economy fast enough to replace lost consumer and business spending and to slow unemployment. Workers' pessimism is justified: About 40 percent believe the recession will continue for another full year. As paychecks shrink and disappear, consumers are more hesitant to spend and won't lead the economy out of the doldrums quickly enough.

It may have made him unpopular in parts of the Obama administration, but Vice President Joe Biden told it as it is when he said the administration misread how bad the economy was. The administration inherited the problem, but then it failed to understand how ineffective its solution would be. The program was supposed to be about jobs, jobs, and jobs. It wasn't. The recovery act may have been a single piece of legislation, but it included thousands of funding schemes for tens of thousands of projects, and those programs are stuck in the bureaucracy as the government releases the funds with typical inefficiency. [Emphasis added, GDH.]

An additional $150 billion, which was allocated to state coffers so as to continue existing programs like Medicaid, did not add new jobs. Hundreds of billions of dollars were set aside for tax cuts and for new benefits for the poor and the unemployed, and that did not add new jobs. Now state budgets are drowning in red ink as jobless claims and Medicaid bills climb.

Next year, state budgets will have depleted their initial rescue dollars. Absent another rescue plan, they will have no choice but to slash spending or raise taxes, or both. The complete state and local government sector, which makes up about 15 percent of the economy, is beginning the worst contraction in postwar history in the face of a [combined state] deficit gap of $166 billion for fiscal year 2010, according to the Center on Budget and Policy Priorities, and a cumulative gap of $350 billion in fiscal year 2011.

Similarly, households overburdened with historic levels of debt will be saving more. The savings rate has already jumped from zero in 2007 to almost 7 percent of after-tax income now, and it is still rising. Every dollar of saving comes out of consumption. Because consumer spending is the economy's main driver, we are going to have a [continued] weak consumer sector, and many businesses simply won't have the means or the need to hire employees.

In the aftermath of the 1990-1991 recession, Americans bought houses, cars, and other expensive goods. This time, the combination of a weak job picture and a severe credit crunch means that people won't be able to get the financing for big expenditures, and those who can borrow will be reluctant to do so.

In recent times, Americans found myriad ways to fuel spending, even as incomes stagnated: borrowing against the once rising price of their homes and tapping plentiful credit cards. No longer. The paycheck has returned as the primary source of spending, and pay is eroding even for those who have jobs. This process is nowhere near complete, and, until it is, the economy will barely grow, if at all, and may well oscillate between sluggish growth and modest decline for the next several years until the rebalancing of the excessive debt has been completed. Until then, the private economy will be deprived of adequate profits and cash flow, and businesses will not start to hire. Nor will they race to make capital expenditures when they have vast idle capacity.

In other words, there are many more reasons today to expect the downturn to continue than to expect a turnaround. Consumer spending and residential investment could be even weaker than most estimates, and, as the level of fiscal stimulus begins its decline in the second half of 2010, we may be facing an even more difficult future. [Emphasis added, GDH.]

No wonder poll after poll shows a steady erosion of confidence in the stimulus measures. One survey even showed 45 percent believe the limited [stimulus] results suggest they should simply be abandoned midway. The disappointment is understandable - but that would only make things worse. So what kind of second-act stimulus program should we look for? This time, it should not be an excuse to pass a lot of programs like those in the first stimulus package that do not really have the kind of multiplier effect on job creation and on economic growth that was intended.

In any event, given the trends, it is absolutely critical that the Obama administration not play politics with the issue but really begin to prepare a second stimulus program, so that if the economy does take a major downturn, it will be possible this time to provide much more rapid government support to infrastructure spending that will maximize the creation of jobs. The time to get ready is now.
END QUOTE

Where I Disagree With Mr. Zuckerman

It is now clear that President Obama's initial $787 billion stimulus package was badly misguided. We can agree or disagree on whether it should have been passed in the first place. But what is not in question any longer is that the bulk of the near-$1 trillion spending package was made up of pork-barrel spending that will be years in creating any meaningful jobs.

Now, Mr. Zuckerman and others are calling for another large stimulus package. Who knows how large the next one will be, but I would guess that it will be at least another $500 billion to $1 trillion. The new stimulus we're hearing about will, they say, somehow be successful in creating large numbers of jobs in the near-term. But why in the world should we believe that? I certainly do not.

My suggestion is as follows. As reported widely, only apprx. 10% ($60-$70 billion) of the $787 billion stimulus package has actually been spent thus far. How about we reallocate the remaining $700+ billion from long-term liberal spending programs to job-creating programs in the short-term, and forget about a second stimulus program?

Of course, this is just wishful thinking on my part -- it will probably never happen, unfortunately. If the economy continues to languish, as I expect it will for another year or two, there will very likely be another stimulus package that will likely add another trillion or so to our already bulging national debt.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions -- "The New Normal"

It is becoming increasingly clear to economists, market analysts and investors that the US economy is not going to come roaring back from this severe recession and credit crisis anytime soon. In light of the sharp increase in the personal saving rate, consumer spending no longer accounts for 70-72% of GDP and is not likely to do so for the foreseeable future as Americans are increasingly paying down debt (deleveraging) and hoping they can hang onto their jobs.

We are not going back anytime soon to the go-go days of the late 1990s when tech stocks exploded and we saw the greatest stock bull market in history when equity gains fueled record large consumer spending. Likewise, we are not going back to the real estate/refinance boom of the 2000s when home prices exploded and consumer spending hit even new record highs anytime soon.

I agree with Mr. Zuckerman that the most likely scenario when we finally come out of this recession is a "range-bound" economy that fluctuates back and forth from slightly negative growth to slightly positive growth for the next several years. Analysts are increasingly referring to this scenario as "The New Normal."

Meanwhile, President Obama is spending trillions after trillions that we do not have on big government programs that may or may not work, but will certainly increase government control in our lives and our pocketbooks (ie- higher taxes). Another huge new stimulus package may be just around the corner, along with nationalized healthcare at an estimated cost of $1.5 trillion (and we all know how good the government is at estimating costs). Never mind that we have a massive Social Security and Medicare crisis facing us in the next 5-10 years.

I don't pretend to know exactly where all of this is headed, but I cannot see it ending pretty on any front. The stock markets have rallied a fair amount since the March lows, which is not surprising given how hard they plunged since this recession began in late 2007. Maybe the March lows were the bottom, maybe not.

It has long been argued that stocks tend to lead the end of major recessions by 6-9 months. In the past, this has been true on numerous occasions. But as Mr. Zuckerman opined above, things are very different this time around. The "New Normal" is definitely new and is anything but normal.

If we are destined for an extended period of "range-bound" economic growth as I believe, that very likely means an extended broad trading rage in stocks, and probably bonds as well. All of this suggests, more than ever, that you need some alternative investment strategies that can move among different market sectors and can move to the safety of cash (or hedge long positions) when market conditions turn ugly.

If you agree, you know where to find us: 800-348-3601 or www.halbertwealth.com.

Wishing you a great summer,

Gary D. Halbert

SPECIAL ARTICLES

The Squandered Stimulus
http://www.realclearpolitics.com/articles/2009/07/20/the_squandered_stimulus.html

Obama's Summer of Discontent
http://www.commentarymagazine.com/viewarticle.cfm/obama-s-summer-of-discontent-15208

Why Toxic Assets Are So Hard to Clean Up
http://online.wsj.com/article/SB124804469056163533.html

Have We Turned The Corner On The Recession?

Gary D. Halbert — Tue, 31 Mar 2009 20:31:08 GMT

IN THIS ISSUE:

Finally a Little Good News for the Economy
Geithner's Latest Toxic Asset Bank Bailout
Does the PPIP Have Any Chance of Working?
Fed to Buy $300 Billion in Treasuries & a Lot More
CBO Assessment of Obama's Record 2010 Budget
Conclusions, Market Implications & What to Do Now

Introduction

Some weeks, it's tough to find a good topic to write about. Then other weeks, I'm overwhelmed with all there is to write about, as is the case this week. So, we'll touch several bases in this week's E-Letter. We'll begin with the latest economic news, some of which was surprisingly positive (especially housing). Unfortunately, the latest good news does not necessarily mean we've seen the bottom of the recession or the bear market.

On Monday of last week, Treasury Secretary Geithner announced the much-awaited new plan to take toxic assets off the books of troubled banks. The plan is called the Public-Private Investment Program. Under this new program, the government along with private investors would buy up toxic assets by way of auctions to get these loans off the banks' books. But will the plan work? I'm not optimistic. We'll discuss this in some detail as we go along.

As if the Obama administration is not spending enough already, the Fed recently announced that it will print and spend over $1 trillion in the months ahead to buy at least $300 billion in direct purchases of Treasury securities and at least another $750 billion for purchasing more toxic assets from banks and other sources. Where will it end? No one knows.

In my March 10 E-Letter, I predicted that President Obama's $3.55 trillion federal budget for fiscal 2010 would result in a deficit of more than $2 trillion, as opposed to the administration's estimate of $1.75 trillion. Turns out I was wrong – the Congressional Budget Office predicted last week that Obama's 2010 budget deficit will hit $2.3 trillion. Wow, this will be bad! The CBO agrees with me that Obama's economic assumptions are too optimistic.

Following those discussions, I will give you my latest thoughts on where we stand in the big picture. With the latest smattering of good news on the economy and the nice rebound in the stock markets, some analysts are concluding that we've turned the corner on the recession and the financial crisis. I think it's premature to make that call, and I will not be surprised if we see another downward leg before long. In fact, it may have already begun. Let's get started.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Finally a Little Good News for the Economy

As everyone reading this is all too aware, the economic news so far this year has been horrible. Rarely has any good news been seen in recent months. But there was some good news last week, and it came in a very good spot – housing. Existing home sales in February unexpectedly rose by 5.3% above January levels to an annual rate of 4.72 million units. It was the largest monthly jump since 2003; still, sales were down almost 5% below yearago levels.

The increase in sales of existing homes was strongest in the West and in Florida, one of the worst hit markets. February sales of existing homes in Florida rose 20%. Florida Realtors also reported a 15% gain in statewide sales of existing condominiums in February, continuing a trend in recent months for higher statewide sales of both the existing home and existing condo markets compared to yearago levels.

The median sales price for existing homes nationwide rose to $165,400 in February, the first monthly increase in over a year, but it remains 15.5% below yearago levels. Unfortunately, the inventory of unsold existing homes rose again in February, despite the improved sales figures, thus putting the backlog at an estimated 9.7 months supply at the current sales pace.

New homes sales also increased by 4.7% in February to an annual rate of 337,000 units. Economists had expected new home sales to decline to a rate of 300,000 annualized units, so this was welcome news. While the unexpected rise in new home sales might be seen as a positive movement for the beleaguered housing market, the February rate for new home construction is still the second-lowest reading since the last recession in 2002. The median price of a purchased new home fell to $200,900 in February, down over 18% from a year ago.

Housing starts jumped well above expectations in February, rising 22% over January levels. Rising housing starts might not sound like a good thing, as that could mean even more homes on the market, but reportedly over 80% of the February construction starts were for apartment complexes, not new single family homes. Also, building permits climbed in February for the first time in over a year.

On another front, durable goods orders rose a surprising 3.4% in February following six consecutive monthly declines. This news was bittersweet because the Commerce Department revised January durable goods orders further downward from -5.2% to -7.3%.

Elsewhere, the economic news continued to disappoint. Last Thursday, the government reported that 4Q GDP fell at an annual rate of -6.3%, down from -6.2% as reported last month. Consumer confidence continued to plunge in February to only 25.0, a new record low, down from 37.4 in January. However, the latest Rasmussen tracking poll shows that consumer confidence has rebounded a bit in March.

The Index of Leading Economic Indicators fell 0.4% in February. The LEI has fallen very sharply since the last peak in July 2007. The unemployment rate jumped to 8.1% in February from 7.6% in January. The consensus is for a rise to 8.5% in March and at least 9% by yearend. These are just a few of the negative reports we've seen over the last month.

In summary, while we've seen a few positive reports on the economy and the housing sector in particular over the last month, we are far from out of the woods on the recession and the financial crisis. Now, let's move on to the latest bank bailout proposed by Treasury Secretary Timothy Geithner.

Geithner's Latest Toxic Asset Bank Bailout

After Treasury Secretary Geithner announced his new Public-Private Investment Program (“PPIP”) on Monday of last week, the Dow Jones promptly rallied over 500 points. That followed a rally of almost 1,000 points since the low in early March. The Dow and the S&P 500 bounced just over 20% from their recent lows – that is until the latest near 5% downward reversal over the last two trading sessions (Friday and Monday). While the equity markets clearly liked the government's latest bank bailout plan, serious questions remain – such as, will it work, and will private investor groups want to get in bed with the government, which threatened to impose a 90% tax on AIG executive bonuses?

We'll get to those questions and others as we go along, but first let's examine how the Public-Private Investment Program is supposedly designed to work. In an online article in FORTUNE, CNNMoney.com's Jon Birger provided the following summary on how the PPIP is expected to work as follows:

“The [PPIP] plan tries to fix the banking crisis by encouraging the very behavior that got us into this mess in the first place -- using buckets full of leverage to buy mortgages, asset-backed securities and other so-called toxic assets. Moreover, it requires the participation of the very folks -- Wall Street bankers and investors -- whom officials in Washington have spent the last two months threatening and vilifying.

At its core, the Public-Private Investment Program (PPIP) harkens back to what the original bank bailout bill was supposed to do when it was first passed by Congress last fall: remove toxic assets from bank balance sheets, thereby freeing up more money for lending. The mechanics of the program would operate somewhat differently for stand-alone loans than for debt securities (basically bundles of loans packaged as asset-backed or mortgage-backed securities), but the general approach is the same. The government will match, dollar for dollar, any private-sector funds put towards buying these toxic assets.

And if that weren't incentive enough, the government will also facilitate cheap loans -- think of them as FDIC-guaranteed margin loans -- to private investors who will be able to leverage their distressed-debt purchases six to one.

Here's how it might work: Say a bank has a pool of residential mortgages with a $100,000 face value that are deemed good risks by the FDIC. The pool is then auctioned off, and in this example, the winning bid is $84,000. Of that, the government puts up $6,000, the private investor another $6,000, and the remaining $72,000 is financed via a FDIC-guaranteed margin loan.

The goal is to jump start the market for toxic debt and put the prices of these loans more in line with the underlying interest payments (which in some cases have declined far less than the market valuation of the loans or debt securities). Theoretically, once the PPIPs start buying and selling this stuff, the valuations will become clearer, opening the door to other private investors who may see opportunity but have shied away up until now due to the lack of price transparency.

That's the upside. The potential downside is what happens if prices continue to fall. And if you think taxpayers are mad now, just wait till they find out that, on account of government-sponsored leverage, a further 15% decline in the debt markets caused them to lose 100% of their investment in PPIPs. Says Tom Atteberry, co-manager of the FPA New Income bond fund: ‘I do see some irony in the fact that the proposed government solution to the problem looks a lot like a hedge fund and a primary broker -- with the primary broker being the federal government.'

There's also a question of whether Wall Street money managers will play ball with a government that has been bad-mouthing them and threatening them with confiscatory taxes. ‘If they go ahead with the 90% tax, nobody is going to want to work with the government,' says a top mortgage-fund manager, referring to the bill passed by the U.S. House of Representatives that would slap a 90% tax on bonuses paid to employees of bailed-out financial companies. ‘It's a deal killer,' says Rick Hughes, co-president of Portfolio Management Consultants, which directs $70 billion in institutional and retail accounts.

Even if the bonus tax isn't implemented, the mortgage-fund manager worries what might happen if PPIP works too well. He envisions a scenario in which money managers are hauled before Congress and accused of making millions on the backs of taxpayers. ‘I'd rather be attacked by a pack of wild dogs,' he says. There are other, more conventional ways that government involvement could discourage money managers from participating.

FPA's Atteberry notes that under the Treasury Department proposal, the FDIC would provide oversight to the PPIP funds. Atteberry says that if he were putting his firm's capital at risk, he'd want to know more about what ‘oversight' entails. For instance, will political considerations prevent investors from foreclosing on certain homeowners or force them to offer generous loan modifications? Says Atteberry, ‘Those are details you need to flesh out if you want to get private investors to come on board.'

Of course, it could be that some on Wall Street -- hedge fund managers in particular -- are so desperate for any source of income, they'll gladly accept these risks.

Prime brokers are extending less credit to hedge funds and investors are pulling out their money. So if the government now wants to become hedge funds' new BFF -- their new prime broker as well as their biggest investor -- why quibble about the details? ‘The reality is that a lot of hedge funds really don't have a business model any more,' says veteran Wall Street strategist Ed Yardeni. ‘The government is basically putting Wall Street back in business with a whole new business model, which is to take all the toxic assets, repackage them and re-sell them at a discount.'

‘Wall Street is getting paid to re-arrange the deck chairs on the Titanic -- but hopefully with a better outcome.'”

Many thanks to Jon Birger of CNNMoney.com for that summary. Obviously, there are still many unanswered questions about the Public-Private Investment Program. Geithner's roll out of the program last week was very short on details, and many private investors are going to be very wary of getting in bed with the government to buy up these toxic assets, even if the discounts are very attractive.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Does the PPIP Have Any Chance of Working?

If President Obama wants this plan to have any chance of working, he needs to make sure the Senate does not go along with the House in passing the 90% retroactive income tax on the AIG executives that received big bonuses. Hedge funds, private equity funds and the like will not want to pony up money to buy toxic assets if they fear that the government will change the rules on profit sharing in these PPIP transactions.

I have read several articles recently that indicated the Treasury was already planning to recoup the AIG bonuses by subtracting that amount from the next round of bailout money AIG will need. That would have been an easy way to get the money back and put the onus on top AIG management to claw back the bonuses. But the Democrats in the House couldn't resist the opportunity to grandstand in front of the American people with an illegal, retroactive 90% income tax on the AIG bonus money.

Political commentator Dick Morris has an interesting take on the PPIP. Morris believes strongly that President Obama wants the PPIP to fail. Morris is convinced that, while Obama says publicly that he does not want to nationalize the big banks, privately Obama and Rahm Emanuel would very much like to see the government take over these large money center banks that have taken bailout money.

Morris argues that this is precisely why the president has been lambasting Wall Street and the big banks for weeks now, in the hope that private investors will not jump into the PPIP with both feet. Morris also believes that this is why Obama packaged the PPIP as Geithner's plan, not his own, so that if it fails he won't get the blame. If it does fail, Morris predicts that Obama will then nationalize the troubled banks. I sincerely hope this assessment is wrong!

As noted earlier, the stock markets reacted extremely strongly following Geithner's announcement of the Public-Private Investment Program. If it is to have any chance of working, he needs to get the details out fast, including assurances that the government won't change the rules in the middle of the game. We'll see.

Fed To Buy $300 Billion in Treasuries & a Lot More

The Fed Open Market Committee met on March 17-18, and the policymakers approved some bold new (yet troublesome) actions. Citing that the economy continues to worsen and the credit markets are still dysfunctional, the FOMC voted unanimously to authorize the Fed to make direct Treasury security purchases of $300 billion over the next six months, with a suggestion that much more could be authorized later on if needed.

This move is controversial because the Fed will have to print the $300 billion to pay for the purchases of Treasury securities. Many fear that this action (and likely more to come) will further sew the seeds of significantly higher inflation when we emerge from this recession. But as I have written often in recent letters, the Fed is scared to death of deflation and will do whatever they feel is required to avert a debt deflation in the economy.

At the same FOMC meeting, Bernanke & Company also voted to double the Fed's purchases of mortgage-backed securities and take on more agency debt. That means the Fed will purchase another $750 billion in toxic mortgage-related securities this year. Between the Treasury purchases and the additional mortgage-related securities – all of which they will have to print money for - the Fed's balance sheet liabilities will skyrocket to well above $3 trillion this year.

Here are excerpts from the March 17-18 FOMC official statement:

“In these [bad economic] circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve's balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities… and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets.”

Following this announcement, yields on 10-year Treasury notes plummeted in the largest one-day decline on record to near 2.5%, down from above 3% just two days before. Stocks also rallied on March 18 and since then (at least until the last two days), a clear indication that many investors approve of the Fed's unprecedented actions in buying Treasury debt directly and doubling its purchases of toxic assets.

But it should also be noted that the US dollar plunged on the news that the Fed would be buying $300 billion in Treasuries and another $750 billion in toxic assets, and the implication that those numbers may well go even higher later this year. Keep in mind that these numbers are in addition to the $2+ trillion budget deficit we will have in fiscal 2010 (more on that below) and well over $1 trillion in each of the next several years.

Given the staggering size of these numbers, I don't see the US dollar going anywhere but down over the next several years. Maybe that's why China is threatening to stop buying US Treasuries and calling for a serious discussion of a new world currency at the upcoming G-20 Summit on April 2. I will discuss this issue more in coming weeks.

CBO Assessment of Obama's Record 2010 Budget

In my March 10 E-Letter, I discussed President Obama's record $3.55 trillion budget for fiscal 2010, with its projected budget deficit of a record $1.75 trillion. I also discussed why I believe the deficit next year will be well north of $2 trillion. Last week, the supposedly non-partisan (but Democrat controlled) Congressional Budget Office (CBO) released its own analysis of President Obama's proposed budget for 2010 and the next 10 years.

The CBO estimates the 2010 budget deficit at $2.3 trillion; the budget deficits for 2009-2011 at almost $5 trillion; with deficits of $1 trillion or more each year thereafter to 2019, and concludes that Obama's budgets would add $9 trillion to the national debt over that 10-year period, if enacted.

If you recall, I noted in my March 10 letter that I believe the Obama administration used economic assumptions that were too optimistic. I pointed out that Obama's projections for GDP growth were too rosy. Likewise, I noted that his assumptions for unemployment were considerably too low. I concluded that discussion by saying: But it will not surprise me if the deficit is $2 trillion or more in 2010. Now the Democrat controlled CBO agrees with me!

Interestingly, Obama has routinely criticized George W. Bush for out-of-control spending, which is a well-deserved criticism. In Bush's eight years, he – with the help of Congress – added almost $5 trillion to the national debt. Obama's budgets would add almost twice that amount - $9 trillion - according to the CBO.

I think most people reading this would agree that a 2010 budget deficit of $2.3 trillion is simply way too much, even in this economic and financial crisis. While Obama says his budget is necessary to get the economy out of the ditch, it could make things worse by ruining America's credit standing in the world. Unfortunately, it looks like he has the votes to get most of his budget passed.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions, Market Implications & What To Do Now

The 20% bounce in the stock markets and the latest smattering of good news on the economy have led some analysts to conclude that the worst of the recession and the credit crisis are behind us. That could be, but the forecasters I respect believe we will see at least another 1-2 quarters when GDP will fall 6-7% or possibly more. So, I am not convinced we've seen the worst of the recession or the credit crisis. I hope I am wrong.

The good news (if we can call it that) is that the US was the first major economy to go into recession; it has suffered a more severe contraction than most other sizable economies, with the notable exception of Japan; and it would therefore be reasonable to assume the US will be one of the first major economies to turn the corner.

Yet in many ways, calling the bottom in the recession misses the point. Unlike past recessions that were followed by a strong recovery, I believe (and my best sources agree) that we face at least a couple of years of very slow growth when this recession ends. Yes, the government and the Fed are spending trillions like drunken sailors, but this economic and financial crisis is likely to put a damper on growth for at least several more years.

With that backdrop, investors have to consider the likelihood (or unlikelihood) that the US equity markets bottomed in early March. With the major market indexes having plunged over 50% from their peak in late 2007 to early March, it is easy to assume that we've seen the bottom. I, on the other hand, am not so convinced.

But that, too, misses the point in my opinion. Whether the bottom is in or not, I fully expect the equity markets to at least retest the lows seen early this month when the Dow fell to 6,500 and the S&P 500 fell to 675. And there is no guarantee that those lows will hold. Therefore, if you are looking to exit failed buy-and-hold positions in stocks, and move to more defensive strategies, I would suggest doing so now.

My greatest concern at this point is that the new Public-Private Investment Program may not work. As I have written in several recent letters, it is clear that relatively little of Obama's $787 billion stimulus plan will be spent this year when it is needed most. Thus, that means that it is even more critical that the PPIP get started quickly and that it succeeds. As noted earlier, there is no assurance that it will get up and running quickly, or that it will succeed (or if President Obama is fully behind it).

If the PPIP does not succeed, I would expect the US equity markets to plunge once again, and if so, buy-and-hold strategies will get hammered again.

If you have been considering alternatives to the buy-and-hold strategy for a portion of your equity portfolio, such as the active management programs I recommend – which can move to cash and/or hedge long positions - now may the time to get such strategies in place.

Remember, it does not matter where you live; we have hundreds of clients all across America.

Finally, we hosted our second Webinar with Scotia Partners on March 25. I'm very pleased to report that almost 300 of you registered for this opportunity to learn more about Scotia's very successful investment program. If you missed it, you can watch and listen to the full Webinar discussion (including all charts) at www.halbertwealth.com.

Hoping we can help you in these tough times,

Gary D. Halbert

SPECIAL ARTICLES:

Obama Budget - $9.3 Trillion in Deficits says CBO
http://news.yahoo.com/s/ap/20090320/ap_on_go_pr_wh/obama_budget

Obama Sticker Shock (more CBO budget analysis)
http://online.wsj.com/article/SB123776518094909023.html

Uncle Sam's Hedge Fund (the Geithner bank bailout plan)
http://www.realclearpolitics.com/articles/2009/03/uncle_sams_hedge_fund.html

Obama's Tax Policy: None Dare Call It Welfare

Gary D. Halbert — Tue, 13 Jan 2009 18:54:31 GMT

IN THIS ISSUE:

Obama Pushes His Stimulus Plan
Dick Morris -- Tax Exempt Tyranny?
More On Obama's Plan From Peter Ferrara
It Depends Upon Your Definition Of "Tax Cut"

Introduction

I had originally planned to write about the Bernie Madoff scandal this week. In fact, I had already written the E-Letter that described how Madoff swindled investors out of tens of billions of dollars in a giant Ponzi scheme. Maybe I'll send that one to you next week.

But just in the last few days, we have learned the details of President-elect Obama's massive income tax overhaul, and the plan is much worse than we had anticipated. And you need to know about it ASAP, since it will negatively affect most of you who read this E-Letter on a regular basis.

Obama's liberal tax plan would give annual tax rebates to millions of Americans who already pay no income taxes whatsoever. Giving government tax rebate checks to those who already pay zero income taxes is nothing short of expanding the welfare state (or socialism as I prefer to call it).

Worst of all, if Obama gets his massive tax plan approved, it will mean that a majority of Americans will pay little or no income taxes, while the so-called "wealthy" will foot the rest of the bill. If we reach such a point, there will be little to no chance of true tax reform for the foreseeable future.

While the "rich" can afford to pay higher income taxes, it is this same group that creates most of the new jobs in this country. As we have seen often in the past, when the government unduly taxes the "rich," job creation grinds to a halt. We can hardly risk that in the current economic recession and credit crisis.

To get you the information you need to know, I have reprinted two articles below that are right on point. The first is from political writer Dick Morris who was a top advisor to Bill Clinton, who has since converted to a conservative. The second is from Peter Ferrara who is director of budget and entitlement policy at the Institute for Policy Innovation and general counsel for the American Civil Rights Union.

Together, these two articles expose the fallacies of Obama's proposed tax policies. Please read what follows closely. If Obama gets his way (and he probably will), it will affect us in profound ways, which is part of his grand plan. Hint: it will affect your pocketbook!

QUOTE:
"Obama Stimulus Fosters Tax-Exempt Tyranny
by Dick Morris & (wife) Eileen McGann

It now looks like half of President-elect Barack Obama's stimulus package will take the form of "tax cuts" for 95 percent of all Americans. Yet this wouldn't boost the economy as much as trigger a massive, unhealthy shift in American politics.

Under Obama's plan, the majority of American voters would pay no federal income taxes but would get money from the government instead. That is, these "refundable tax credits" are basically welfare checks -- and Obama's plan would leave the most of us collecting, not paying.

A $200 billion giveaway won't do much to get a $14 trillion economy rolling again. But the plan would leave any future taxpayer revolt no hope of majority support.

Today, the bottom 50 percent of U.S. taxpayers pays a total of $30.6 billion in federal income taxes on a combined income of about $1 trillion. So about 3 percent of all federal income-tax payments come from the poorest half of the country. (The top 1 percent pays 40 percent; the top 25 percent pay 85 percent of the federal income tax.)

Obama's plan -- he'd give all couples a $1,000 refundable tax credit and all single people $500 -- would funnel more than $50 billion to the lowest half of the country, thereby completely wiping out their total federal tax liability. In most cases, it would trigger a "refund" welfare check.

In one stroke, this would transform the majority of voters from taxpayers into tax eaters, and leave an increasingly small minority to pay the bill. Regardless of whether this is good economics, it is very dangerous politics.

Essentially, it would put those who actually pay the taxes that fund our government into much the same situation as landlords in New York City: hopelessly outvoted by their tenants, who use their political clout to limit rents and landlords' profits.

Since Ronald Reagan, the anti-tax movement has been based on a blue-collar revolt against high taxes; it would lose that constituency under the Obama plan. Taxpayers would be politically helpless and the tax-eating majority would have free reign to impose any levies it wished.

Almost all of the 68 million tax filers in the country's bottom economic half would get checks from Washington at tax time. Some would be among the 22 million who get money from the Earned Income Tax Credit. Others would get a $500 check through the (Bush-passed) Child Tax Credit -- and all would get funds through the new Obama tax credit.

Welfare no longer would be only for the poor because the majority of the voters would depend on government handouts. This very system is what makes European social democracies so resistant to change.

In 1980, the bottom 50 percent of the nation paid 7 percent of the national tax bill, after refund and credits. It now pays 3 percent; under Obama's plan, it would pay less than nothing (that is, it would net a profit from the IRS). In 1980, the top 1 percent paid 19 percent of the income-tax burden; now, it's 40 percent. Taxes have become the province of only the rich.

Of course, the shift in tax burden also mirrors the incredible increase in incomes of the wealthy during the past 30 years: The top 1 percent earned only 8 percent of the total national income in 1980; now, it earns 22 percent. And the poorest half has seen its share of national income fall from 17 percent in 1980 to only 12.5 percent today.

So it is both fair and sensible to give the poor a tax break and to draw the bulk of federal revenues from the rich. But to exempt the bottom half -- a majority of the voters -- from paying any taxes and to award them refund checks instead would dangerously alter the fundamental balance of national politics. For the economically well off, it effectively could become taxation without representation, which, as the founders of our nation warned, leads to tyranny." END QUOTE

I trust that most of my readers can fully understand the implications for high net worth investors if Obama gets his way, as looks increasingly likely. Now let's take it a step further with another thought-provoking article from Peter Ferrara, another high-level source. Read closely.

QUOTE:
"The Tax Cut Mirage
by Peter Ferrara

Obama Eyes $310 Billion in Tax Cuts" the headline blares. The Obama team comes to town to start the new year, and the run-up to his inauguration, with this announcement. How sly.

This Obama tax cut package is to be part of the broader stimulus package now estimated to cost $775 billion. The problem is that there are tax cuts and there are tax cuts, and there are other things Obama calls tax cuts that are not even tax cuts. The "tax cuts" Obama is proposing for his stimulus package, like the rest of his stimulus package, are not going to stimulate anything.

Tax cuts do not stimulate the economy by "putting money in people's pockets" which they can then spend, as even some Republicans, including George Bush, mistakenly say. That's an old-fashioned Keynesian strategy, and, if it worked, the same result could be achieved by sending out increased welfare checks, which also puts money in people's pockets, which they can spend. But it doesn't work, because it doesn't do anything to change the basic incentives governing the economy, and because just borrowing money and then sending it out to people, in "tax rebate" checks or welfare checks, doesn't add anything to the economy on net.

Tax cuts stimulate the economy when they involve reductions in tax rates. The reduction in rates improves incentives for savings, investment, business creation and expansion, job creation, entrepreneurship, and work, by allowing people to keep a greater percentage of the reward produced by these activities. This improves the economy not just by the dollar amount of the tax cut. The improved incentives affect every economic decision and every dollar in the entire economy. The astoundingly successful Reagan tax cuts in the 1980s, as well as the astoundingly successful Kennedy tax cuts of the 1960s, were both based on reducing tax rates, and were successful for these reasons.

But the Obama tax cut package studiously avoids any reductions in tax rates anywhere. The centerpiece of the plan is a $500 per worker tax credit, estimated to cost $150 billion. The government will just borrow $150 billion from the private economy to give away in these tax credits, so there will be no net gain to the economy. Nor will there be any improved incentives to save, or invest, or start or expand a business, or hire new workers. The credit does not even provide increased incentives to work, because once the worker is over a very low income threshold of about $8,000 per year, the amount of the credit does not increase for increased work and income.

Notice that these arguments apply even for workers who do pay considerable income taxes. Suppose you work and earn enough to pay $5,000 per year in income taxes. The Obama tax credit will reduce your income taxes by $500. In this case, the credit is a real tax cut. But it still will not stimulate the economy for the reasons stated above, it does not add to the economy on net and it does not improve incentives. It is a Keynesian tax cut, not a supply-side tax cut, because it is a flat cash rebate, effectively the same as more government spending, not a reduction in rates.

Keynesians think that the way to increase economic growth is to increase deficits and government spending. We tried that in the 1970s, and we got inflation along with ever worsening recessions. We tried it in the 1930s, and we got the Great Depression lasting for over 10 years. It doesn't work.

Indeed, the Wall Street Journal news story on the Obama tax package says regarding this $500 per worker tax credit, "This part of the plan is similar to a bipartisan initiative launched in early 2008, which sent out checks worth $131 billion." Precisely. Bush and the Democrats joined together a year ago to agree on a stimulus package sending out $131 billion in "tax rebates" to workers all across the country. Those tax rebates were very similar to Obama's tax credits today. They involved no reduction in tax rates, or improved incentives anywhere. They were based on a Keynesian rationale, just like Obama's tax credits -- stimulate the economy by increasing government deficits and providing cash rebates for people to spend.

And, of course, that tax rebate stimulus package from a year ago didn't work. The economy continued to worsen throughout the year, and financial markets collapsed in the fall. Henry Paulson was back in September asking for another $700 billion, to save the economy supposedly from complete collapse, and another Depression.

Then there is the part of the Obama tax cut that is not a tax cut. The bottom 40% of income earners do not pay income taxes on net. The $500 per worker Obama income tax credit will consequently not reduce income taxes for these workers. It will involve instead another check going from other taxpayers to these workers, which is actually just increased government spending, indeed, increased welfare.

Indeed, another part of the Obama tax cut plan is even more overt. Obama proposes to include in that plan an increase in the scandal-ridden Earned Income Tax Credit (EITC). The EITC goes to the lowest income workers, who do not pay federal income taxes, and it is universally recognized as a welfare program. In this, as in other provisions of the overall stimulus package, Obama and the Democrats are effectively arguing that they are going to stimulate the economy by increasing welfare. Reagan and the Republicans stimulated the economy by cutting marginal tax rates, providing incentives to save, invest, produce, start and expand businesses, and create jobs (as Kennedy and the Democrats did in the 1960s). Now Obama and the Democrats claim they are going to do the same by increasing welfare and government spending.

Obama tries to argue that his $500 per worker income tax credit is a tax cut even for workers who do not pay income taxes because these workers still pay payroll taxes for Social Security and Medicare. But the only connection between this tax credit and payroll taxes is purely rhetorical. If Obama wants to claim credit for a cut in payroll taxes, then he can propose a cut in payroll taxes. Then Obama can tell us how much sooner the Social Security trust funds will run out and leave the program bankrupt because of his tax credit. The answer in regard to Obama's $500 per worker credit is zero, because that credit does not involve a reduction in payroll taxes of any sort; it is an income tax credit, not a payroll tax cut.

Another component of the Obama $310 billion "tax cut" package is a proposal for a one-year tax credit of $3,000 to businesses for each new job created, costing a pricey $40 billion to $50 billion. Congress already adopted a similar plan proposed by former Sen. Dan Quayle back in the 1980s, called the Targeted Jobs Tax Credit (TJTC). Over the years this has been changed into the Work Opportunity Tax Credit (WOTC), which provides $2,400 for each new adult worker hired, $4,800 for hiring a disabled veteran, and $9,600 for hiring welfare recipients, high risk youths, and qualified ex-felons. It is unclear whether Obama is aware of this history, but his tax credit is not going to produce any more hiring than the already existing WOTC.

Studies of these tax credits over the years have concluded that the credits have mostly gone for workers that would have been hired anyway, with little if any net new jobs created. And this does not include the jobs lost from the private sector when the government borrowed the additional funds to cover the tax credits. Steve Entin of the Institute for Research on the Economics of Taxation argues that such a tax credit is unlikely to stimulate much employment when the economy is down and businesses are not expanding. "Given the current degree of uncertainty about where the economy is headed," he writes, "the credit is not likely to achieve much for many months, until we are already on the upturn, at which time it would not be needed."

Other provisions of the overall stimulus package follow on the theme of stimulating the economy through increased welfare and government spending. The plan includes major expansions of unemployment compensation, including extending unemployment insurance to part-time workers. It also includes increased Medicaid coverage, and subsidies for employers continuing health insurance for laid off workers. Another $140 billion to $200 billion would go for aid to states to be spent on Medicaid and education. The government's borrowing hundreds of billions for such spending is not going to stimulate anything. It may produce a drag on the economy by increasing dependency.

Then there is another couple of hundred billion for increased spending on infrastructure, including building and renovating roads, highways, bridges, and schools, and making government buildings more energy efficient. Such infrastructure spending was the central strategy Japan used to counter its severe economic downturn of the 1990s, which nevertheless continued for over 10 years. In the U.S., these infrastructure projects take years to get up and running, and are often bogged down by lawsuits relating to the environment and other factors, leaving such projects unsuited for short-term stimulus spending. In any event, again, government borrowing of hundreds of billions for such increased spending would not add anything to the economy on net.

The Wall Street Journal reports Obama transition spokeswoman Stephanie Cutter as saying, "We're working with Congress to develop a tax cut package based on a simple principle: What will have the biggest and most immediate impact on creating private sector jobs and strengthening the middle class? We're guided by what works, not by any ideology or special interests."

This propaganda spin is exactly the opposite of what Obama is doing. Obama is studiously avoiding exactly what would work, with the biggest and most immediate impact, because he is so ideologically opposed to the pro-growth, free-market policies that would produce that result. Instead, his ideology is leading him to exactly what will not work to promote an economic recovery, increased welfare, government spending, and trillion dollar deficits. Here is what would work.

The Republicans should advance a proposal that would sharply reduce the 25% income tax rate that applies to the middle class to 15%. This would leave 90% of workers with a flat rate tax of 15%, or even less. Such reduced tax rates would provide real incentives to stimulate the economy, as discussed above. A bill providing for this should be introduced as soon as possible, to get the debate going. This proposal serves as an alternative to the rest of the Obama tax plan to be introduced later, as well as the stimulus package. Senate Minority Leader Mitch McConnell raised precisely this proposal last Sunday. Bravo.

Other proposals would promote economic recovery and growth even more. Most urgent, in terms of producing the biggest and most immediate pro-growth impact, is to reduce the outdated and uncompetitive federal corporate tax rate of 35% at least to 25%, if not the 19% recently adopted by Germany and Canada. The Bush tax cuts for capital gains and dividends should be made permanent. Also urgent would be to adopt immediate expensing, meaning deductions, for investment in capital equipment, rather than depreciation, which drags the deductions out over many years. This would have the same effect as a rate reduction for investors, by increasing the percentage of the reward that such investors could keep. A true economic boom would be created if Congress also reduced the top marginal income tax rate to 25%.

But McCain proposed most of these ideas, and Obama ridiculed them, and Obama won. So Republicans should not expect to be able to advance such ideas effectively in Congress right now, especially since they are in such a distinct minority. Conservative commentators can and should promote these ideas as the real effective and practical ways to promote economic growth and get America booming again, and Republicans can run on them in future races. But the one idea that Republicans can effectively advance right now politically is the middle class income tax rate reduction discussed above.

Another urgent, pro-growth reform is deregulation to allow drilling for oil and natural gas, offshore and onshore in ANWR and elsewhere, and renewed expansion of nuclear power production. This would promote economic growth both by reviving a powerful energy industry in America, and by providing low cost, reliable supplies of energy to the rest of the economy. Removing any regulatory barriers to development and production of alternative energy would be very helpful as well. But an alternative energy industry built on massive government subsidies would be a net drag on the economy.

Republicans and conservatives should be careful to note that the inherently powerful American economy retains natural tendencies to recover. They should not preclude that possibility in criticizing the Obama/Democrat stimulus package. Economic growth may well return later this year regardless of what Obama and the Democrats do.

But neither can we allow Obama to pose unchallenged as proposing enormous tax cuts when they are mostly a mirage, or worse, actually increased government spending and welfare, rather than tax cuts. We must start aggressively advancing that argument now, and the case more generally against Keynesian government spending and enormous deficits as the keys to recovery, and aggressively offer instead the real policies that would restore growth and prosperity, and set off a new economic boom." END QUOTE

[Peter Ferrara is director of budget and entitlement policy at the Institute for Policy Innovation and general counsel for the American Civil Rights Union. He formerly served in President Reagan's White House Office of Policy Development, and as Associate Deputy Attorney General of the United States under the first President Bush. He is a graduate of Harvard College and Harvard Law School.]

Conclusions

President-elect Obama's tax cut proposal has been criticized by many conservatives (and even some moderates and liberals) for being misleading because he says that it will benefit 95% of American households. Supporters, however, claim that the promise is legitimate and even some objective, third-party analysis has supported its merits. So who's telling the truth?

That's a very good question. I find it interesting that anyone can come to the conclusion that an income tax cut will benefit 95% of American households when the non-partisan TaxPolicyCenter estimates that approximately 38% of income tax filers pay no tax at all! To make Obama's statement true, you have to resort to an old Democratic tradition and ask what the meaning of ‘tax cut' is.

The secret of how the common-sense definition of reducing income taxes somehow morphs into a plan that benefits individuals who currently pay no income tax is a tale of political slight of hand at the highest level. After all, how can you reduce the income tax bite for someone who already pays NO income taxes? It sounds impossible, doesn't it? If your tax rate is effectively zero, then it would seem that you are already benefiting from the master design of a progressive tax system that increases rates as incomes go higher, right?

Wrong! (At least according to Obama and Congressional Democrats)

In today's world of political spin, a tax cut proposal need not apply only to those with income tax rates above zero. Instead, today's definition of a tax cut can include allowing those who already pay no income taxes to receive a check from the government. Let me make it clear, I'm not talking about getting a refund of all of the income tax withheld from pay. No, we're talking about receiving a government check over and above all of the withholding. In effect, it amounts to a negative tax rate for those who qualify, which is reportedly going to be over 50% of American households.

This negative tax rate is officially deemed to be a "refund," since certain tax credits are deemed to be "refundable," meaning that they are payable even if the filer's total tax bill is zero. Excuse me, but a "refund" used to be defined as a return of something that you had paid in. But that's not the case in the fairy tale world of Washington, DC. In Obama's plan, you can get something called a refund even though it really represents a check from the government drawn from all those unfortunate souls who actually had to pay income taxes. Can you say WELFARE?

Thus, in today's political world, we need to alter our common-sense definitions of some key terms, as follows:

Tax cut = Receipt of other people's tax money (but don't call it welfare or redistribution of wealth)

Refund = Check from the government that may or may not include any money you have actually paid in.

Taxpayer = Tax receiver, unless you have worked hard to earn a lot of money, and then the old definition applies.

Welfare = An outdated, politically incorrect word that used to mean government assistance. For the new definition of government assistance, see "Tax Cut" above.

Redistribution of Wealth = A socialist philosophy generally unacceptable to capitalist societies unless repackaged under another definition found to be more palatable to the general public. See "Tax Cut" and "Refund" above.

If Obama wants to put money in the hands of people in an effort to stimulate the economy, then he should proceed as Bush did last year and dole out checks to the populace. I don't particularly agree with the practice, but at least people would know what is happening.

To dress a government handout (more welfare) in the garb of a tax cut can have some very drastic and negative effects, in my opinion. First, as Dick Morris points out, it means all income tax receipts will come from the top 50% of wage earners. I still happen to be in the camp of those who believe that you hold government more responsible when part of the money is yours. Plus, it makes changing the current complexity-laden tax code virtually impossible since the alternatives such as a "Flat Tax" or "Fair Tax" would mean that the 50% who pay no taxes would have to start paying taxes again.

Another big negative is that the majority of voters can elect representatives that will pass laws with no tax consequences to the bottom 50%. Why not vote for expanded social services, it won't cost them anything, and they may even get a bigger government check. Can you say welfare? Or socialism?

Lack of participation in the funding of government is not a good thing. Alexis de Tocqueville, a 19th Century thinker, said, "A democracy cannot exist as a permanent form of government. It can exist only until the voters discover they can vote themselves largess out of the public treasury. From that moment on, the majority always votes for the candidate promising the most benefits from the public treasury, with the result that democracy always collapses over a loose fiscal policy, always to be followed by a dictatorship."

Don't look now, but it looks like the time when the majority of American households that receive from the government, rather than pay any income taxes, is about to be upon us.

Very best regards,

Gary D. Halbert

Economic & Investment Outlook For 2009

Gary D. Halbert — Tue, 06 Jan 2009 22:10:01 GMT

IN THIS ISSUE:

Editor's Notes On BCA & The Other Gary Halbert
Obama & The New Age Of Big Government
The Economy -- Have We Seen The Worst Of It?
Are The Bailouts Necessary & Will They Work?
The Latest Disappointing Economic Reports
Stock Markets -- Might We Have Seen The Bottom?

Introduction

2008 proved to be a catastrophic year in the financial and credit markets as well as for most investors as judged by the global equity markets. The credit markets and bank lending activity ground to a virtual halt, something not seen in most of our adult lifetimes. Consumer confidence and spending, which now accounts for over 70% of US GDP, fell off a cliff in the span of just 3-4 months late last year. We are now in an unprecedented "credit crisis," the outcome of which remains to be seen.

The US government and the Federal Reserve have responded to the credit crisis in ways that most of us could never have imagined, and they are not nearly done yet. Much more is to come. We can agree or disagree with these giant bailout measures, but like them or not, even more enormous government rescue programs are sure to come in the Barack Obama administration, on top of his already aggressive plans such as nationalized health care, etc.

One thing to keep in mind is that our new President is a man who embraces government ownership and control of the private sector, so we can expect more massive bailouts in the next year or longer as needed. Already, Mr. Obama is suggesting another fiscal stimulus package approaching $1 trillion this year, and that is just the beginning -- I promise. But the point of what follows is not a political piece. The question is whether or not the plans will work.

What we do know is that we are officially in a recession that reporting agencies now believe began in December 2007. Most forecasters now expect that GDP plunged 4-5% (annual rate) in the 4Q of last year, and will continue to fall for at least a couple more quarters. Meanwhile, deflation is becoming a greater threat. In the pages that follow, we will take an in-depth look at the latest economic and inflation numbers. I'll give you the latest thinking from my best sources on what may lie ahead.

But first, I have a couple of important Editor's Notes that have resulted from many reader inquiries, before we get into the meat of this week's letter. Let's get going.

Editor's Notes

The Bank Credit Analyst: I frequently get questions from long-time readers asking why I do not mention the Bank Credit Analyst (BCA) or quote from their monthly reports as I have for many years. Considering the amount of interest, an explanation is in order.

You may recall that BCA maintained throughout 2007 that the subprime mortgage dilemma would be contained to the housing market, and that a recession was not the most likely scenario for the US or the rest of the world. Then in early 2008, BCA did an abrupt about-face on the subprime crisis, complete with a forecast of a credit crisis and a potentially deep global recession.

I have to admit I was surprised that BCA was late in identifying perhaps the most significant trend change in our lifetimes and an oncoming credit crisis. However, no economic forecasting service is perfect, and I have a number of other sources of economic and financial forecasts that were also late to recognize the full effect of the subprime debacle. So that is not the reason I no longer quote BCA.

Quite the contrary. In early 2008, BCA contacted me in regard to my summarizing and quoting their materials. According to BCA, some of their subscribers had complained about having to pay a large amount of money for what I periodically offered to my clients and E-Letter readers for free. When I first began sharing BCA's outlook over 20 years ago, my comments were limited to a monthly newsletter that went only to my clients and prospective clients. Now, however, my Forecasts & Trends E-Letter goes out to over a million e-mail addresses each week.

While BCA has long been a valuable source of information for me, I fully understand their concerns. After all, they make their money through subscriptions, so anything that might diminish their subscription base would obviously need to be addressed. As a result, I agreed to no longer quote or summarize BCA's views of the economy or markets in light of their concerns.

Finally, it is important to note that BCA has never been my sole source of economic information and forecasts. My staff and I review numerous other sources for forecasts and analysis that help me in forming my own view of the economy, the markets, etc.

The "Other" Gary Halbert: As a reminder, to this day I am often confused with Gary C. Halbert, which is most interesting since Gary C. Halbert passed away in early 2007. For the record, I am Gary D. Halbert and am no relation to Gary C. Halbert; in fact, I never met the man. Apparently, Gary C. Halbert was a successful copywriter and marketer at some point in his life, and he had a newsletter called "The Gary Halbert Letter" and a website by the same name.

The confusion typically occurs when someone does an Internet search for "Gary Halbert." If you type Gary Halbert into Google, for example, the entire first page of results are for Gary C. Halbert -- even though the man has been dead for nearly two years. The first Google result for me -- Gary D. Halbert - is not until the lower part of page two.

We have often wondered how much business we have lost over the years from investors who searched the Internet looking for me but found the other Gary Halbert instead and were not favorably impressed! I have no idea why Gary C. Halbert's website is still on the Internet.

If, however, you type in "Gary D. Halbert," you'll find me at the top of the non-sponsor results. Bottom line: if you should refer someone to me, please advise them to include my middle initial "D." if they wish to find me on the Web. Better yet, advise them to go to my website at www.halbertwealth.com.

On that note, let me extend a huge THANK YOU to all of our clients who have referred friends, relatives, etc. to us over the years. Client referrals are one of our best sources of new business!

With the above noted housekeeping items out of the way, let's turn our attention to the economy, the ongoing credit crisis and the investment markets. But first, let's consider the bigger picture of what to expect from President Obama. The following is not meant to be a political slam on our soon-to-be new president; rather it is simply a perspective on the times to come.

Obama & The New Age Of Big Government

There is no arguing that Barack Obama is one of the most liberal politicians of our time, as is Joe Biden. President-elect Obama believes that more government is the solution, not the problem. He has stacked his new Cabinet with Clinton retreads who believe as he does, including Hillary Clinton as his Secretary of State designee.

President-elect Obama vows that as soon as he is in office, he will pass a gargantuan financial rescue bill (bailout) that is estimated to be as large as $800 billion to $1 trillion in an attempt to unfreeze the credit markets and create at least one million new jobs. No doubt the Democrat controlled Congress will go along. It appears that a number of Republicans will go along as well.

Mr. Obama says his huge rescue plan will be targeted at tax cuts and infrastructure projects that will create new jobs. I, however, predict that much of the bailout money will continue to go to recapitalize banks, financial institutions, automakers and other large companies that get into serious trouble. Obama may have no choice if he and the Fed are to stave off a debt deflation and a depression.

In fairness to President-elect Obama, he comes into office at one of the worst possible times in the last century. He is inheriting the worst economy in decades, the worst financial crisis since the Great Depression and a record large federal budget deficit -- just to name a few. He has an enormous job ahead of him with major problems that have no immediate solutions, and which may get worse before they get better.

But keep one thing in mind dear readers. President-elect Obama comes from a political persuasion that believes it is perfectly acceptable for the government to own equity stakes in the private sector. And he comes into power at exactly the time in which much of the public is more than willing to see this happen, and when even some conservative analysts admit that such steps are probably a "necessary evil."

Based on the many comments I receive from readers, it is obvious that many of you are totally against the government bailouts. Be warned, however, that the bailouts are far from over in my opinion. So it is in this context that I move on to more specific issues.

The Economy -- Have We Seen The Worst Of It?

As noted above, we see and read lots of economic, financial and investment forecasts at my company. Here is the general consensus on the economy of late (obviously, there are forecasts that are better and worse than the consensus I see out there). The general consensus is that the US economy (GDP) fell by an annual rate of 4-5% in the 4Q. We won't get the first official GDP estimate until the end of this month.

The general consensus is that the first half of 2009 will also see negative GDP, but perhaps not as bad as the 4Q we just endured. The unemployment rate is expected to rise to at least 8%, and some believe 10%, well before the end of this year. However, most forecasters currently believe that the US economy will bottom out and begin a slow recovery some time in the second half of this year -- assuming, of course, that there are no more big negative shocks, and that the banks slowly resume lending.

Some of my respected sources believe that, if necessary, the Obama administration and/or the Fed will institute some government mechanism that will guarantee bank loans if that's what it takes to unfreeze the credit markets. (I'm not making this up, folks.)

Assuming the economy bottoms out sometime in the second half of this year, the general consensus is that GDP will grow at a below-trend rate of only 1½-2½% for the next several years following 2009 as the world continues to deleverage (i.e. -- reduce debt).

Of course, there are some respected forecasters that believe the above noted scenario is too optimistic. Some believe that the bailouts will not be successful, the credit markets will not unfreeze this year, and that we are headed for a modern day depression. Others believe that even if the bailouts work, we will be facing runaway inflation in 2010 and beyond. Clearly, there are few, if any, rosy scenarios floating around today.

Are The Bailouts Necessary & Will They Work?

Most conservatives (and even some liberals) I talk to are opposed to the various government bailout measures to-date and the trillion dollar rescue package that President-elect Obama has planned. Many say, "Let ‘em all fail." Several media polls have shown that a majority of Americans are opposed to the bailouts. Personally, I would much prefer an economic stimulus plan that eliminated the capital gains tax and reduced other taxes, but that is not going to happen with the Democrats in control of Congress and the White House.

Given that reality, most of the sources that I respect agree that the bailouts and the various actions by the Fed were necessary in an effort to avoid a debt deflation and a possible depression. Their argument is that with consumer spending accounting for over 70% of GDP, and with consumer spending having fallen off a cliff, the government had to step in to keep us from going from a serious global recession to something worse.

In fact, some forecasters are calling on other countries to follow the lead of US policymakers and slash their interest rates and recapitalize their money center banks. Some actually criticize Europe for resisting such rescue efforts, while praising the UK for its financial rescue efforts.

Further, I would also say that there is a consensus in the forecasting world that it was a huge mistake for the government to let Lehman Brothers go bankrupt. Many analysts believe that it was the failure of Lehman that caused the major banks to put a lockdown on lending, even to each other.

I certainly don't expect to make any bailout converts with this discussion. However, I think it is pertinent to point out that there are respected analysts and forecasters that believe the government and the Fed had no choice but to do what has been done, and that the government may have to do even more if we are to avoid a depression.

Now to the question of whether the bailouts will work. At this point, the answer is we don't know. The first "economic stimulus package" of $168 billion last spring was considered pretty much a non-starter. Various sources have estimated that most Americans who received the tax rebate checks in late April and May saved most of the money or used it to pay off credit card debt or other bills, rather than spend the money as was hoped by the Bush administration.

One thing is clear, however: the Bush administration did not have a well-designed plan for how it intended to use the first $350 billion of the $700 billion Troubled Asset Relief Program (TARP). That was obvious when President Bush and Treasury Secretary Paulson changed the objective of the TARP from buying up troubled mortgage-related securities to recapitalizing the major banks and most recently the automakers.

Some (but certainly not all) of the criticism of Bush and Paulson may have been unfair. I don't believe anyone knew how difficult it would be to reinstate trust in the credit markets and to get the major banks lending once again. As discussed above, President-elect Obama will face the same challenge when he takes office, and talk of some kind of government loan guarantee program for the banks continues to gain momentum, for better or worse.

While it remains unclear if the bailouts will work, there is now little doubt that Mr. Obama's request for a massive new rescue program of up to $1 trillion will be passed by the Congress within the next month or two. Over the weekend, several leading Republicans stated that they would support such a huge stimulus program, provided it was not loaded with earmarks. So I believe it is safe to assume we will see Obama get his wish.

The Latest Disappointing Economic Reports

I have been poring over economic data for over 25 years, and I do not remember another time when the various reports have been as overwhelmingly negative as over the last month or so. Let's take a look at the latest numbers. As noted earlier, most forecasters expect that 4Q GDP fell by 4-5%; however, that report won't be out until January 30.

The final report on 3Q GDP was an annual rate of --0.5%, about as expected, following +2.8% in the 2Q. The decline in 3Q GDP was largely the result of a 3.8% drop in personal consumption expenditures.

The Index of Leading Economic Indicators (LEI) fell 0.4% in November (latest data available). The LEI has been falling for over a year. More troubling, the six-month change in the LEI was negative 2.8%, and the 12-month change was --5.6%. The Conference Board reported that the Consumer Confidence Index fell to a new all-time low of 38.0 in December.

Consumers' appraisal of current conditions grew substantially worse in December. Those claiming business conditions are "bad" increased to 46.0% from 40.6% in November, while those claiming business conditions are "good" declined to 7.7% percent from 10.1%. Consumers' assessment of the labor market was also considerably more negative than in November. Those saying jobs are "hard to get" rose to 42.0% from 37.1% in November, while those claiming jobs are "plentiful" decreased to 6.2% from 8.7% a month earlier.

The plunge in consumer confidence resulted in even worse than expected retail sales during the holiday season. Spending Pulse, an organization that collects consumer spending data from MasterCard, says consumers spent about 20% less on electronics, women's clothes and jewelry in November and December in comparison with the same period last year. Spending Pulse says total retail sales declined up to 8% during this holiday season.

The numbers are not all in yet, but it also appears that online sales declined for the first time ever. Reuters reported that online sales for the holiday period up to December 23 fell 3% from the same period last year, marking the first decline in Internet spending since comScore, Inc. started tracking online sales in 2001.

On the manufacturing front, the news is equally dismal, if not worse. The Institute for Supply Management (ISM), a purchasing management group based in Tempe, Ariz., said its manufacturing index was 32.4 for December, the lowest reading since June 1980, when it stood at 30.3.

Manufacturing activity failed to grow for the fifth consecutive month, according to the ISM, and ISM noted that the December decline was representative of all sectors of manufacturing. An ISM index reading above 50 indicates growth, while a reading below 50 indicates a slowdown. A reading below 41 is typically associated with recession in the broader economy.

Industrial production fell 0.4% in November and was 5.5% below yearago levels. Capacity utilization (the factory operating rate) fell to 75.4 in November, down from 81.1 a year ago. Durable goods orders declined 1.0% in November, following the huge drop of 8.4% in October. It was the fourth consecutive monthly decline in durable goods orders.

The unemployment rate jumped to 6.7% in November, the highest level in more than 14 years. Forecasters expect the December unemployment rate to jump to 7% when the latest report comes out on Friday. Nonfarm payroll employment fell sharply by 533,000 in November. As noted earlier, most analysts expect the unemployment rate to rise to 8% or higher in the first half of 2009. At 500,000 jobs lost per month, it could hit 10% by the end of this year if the economy doesn't begin to rebound.

News on the housing front was equally disappointing. Sales of existing homes plunged 8.6% nationally in November. New homes sales also declined again in November. The national median sales price for existing homes fell by the largest monthly amount on record in November. The median price was $181,000 as compared to $208,000 a year ago, a decline of 13.2% nationally. Of course, in many areas prices are down far more than 13% over the last year.

The National Association of Realtors reported that there were 4.2 million unsold homes on the market at the end of November. At the current sales pace, it would take 11.2 months to sell all the homes on the market. NAR also notes that many homeowners have taken their properties off of the market. Understandably, housing starts continue to plunge, with November starts at 625,000 versus 771,000 a month earlier.

Deflation -- Consumer Price Index Goes Negative

As I have discussed above and in previous E-letters, the government and the Fed desperately want to hold off deflation in the economy. This fear is the overriding reason behind the bailouts, including the potentially $1 trillion stimulus package Mr. Obama and Congress are planning. Lawmakers are particularly frightened now that the Consumer Price Index has gone negative for the last several months, and especially as it plunged lower in October and November.

In October, the CPI fell by a full 1.0% - the largest monthly dive since records began to be kept in 1947. Yet the record October decline was significantly eclipsed in November when the CPI plunged 1.7%. The Chained Consumer Price Index for All Urban Consumers (C-CPI-U) decreased a full 2.0% in November. Of course, the significant fall in energy prices is helping this trend along, but there is much more at work here than just falling gasoline prices.

For the 12 months ended November, the CPI actually rose 1.1%. That compares starkly to July of last year when the CPI was up 5.6% on a year-over-year basis. The trend in price inflation is clearly falling rapidly. Even the "Core" CPI -- less food and energy -- is falling. The Core CPI was down 0.1% in October and was unchanged in November.

Wholesale prices are falling even faster. The Producer Price Index fell 2.8% in October and another 2.2% in November. The 2.8% dive in October was the largest monthly decline on record. The Labor Department also reported that the price of imported goods dropped 4.7% in November and more than 10% in the past quarter. Prices are coming down in a hurry! This is Bernanke's worst nightmare!

Price data such as the above, and similar numbers from around the world, are leading to increased discussion about deflation. A recent cover story in The Economist made it pretty much official: Deflation, not inflation, is now the greatest concern for the world economy.

Over the past year, producer prices have fallen throughout the developed world. Consumer prices have been falling for the last six months in France and Germany. In Japan, wages have actually fallen 4% over the past year. Prices are also falling in China and Hong Kong.

So far, none of these price declines looks anything like the massive deflation that accompanied the Great Depression. But the appearance of deflation as a widespread problem is disturbing, not only because of its immediate economic implications, but because until recently most economists regarded sustained deflation as a fundamentally implausible prospect, something that should not be a concern.

Such assumptions are now under fire as the Fed has slashed short rates to zero. I assume we'll be discussing deflation a lot more this year.

Stock Markets -- Might We Have Seen The Bottom?

The US and global equity markets will be buffeted in 2009, on the negative side, by slowing economic growth, continued deleveraging, a shortage of credit and possible deflation. On the positive side, the markets should be aided by extremely low interest rates, the government's massive efforts to reflate the economy and unfreeze the credit markets and the possibility that a lot of money now on the sidelines could come back into the market at some point.

Unlike the general consensus about where the economy is headed this year (worse in the first half, but a recovery by year-end), there is no such consensus regarding where the stock markets are going over the next year or longer. Opinions and forecasts are all over the board.

Some analysts I respect believe that the US stock market is in a secular bear market, and that we probably have not seen the worst of it. If the economy is going to get worse in the near-term, and then grow at below-trend rates of 1½-2½% over the next 2-3 years after 2009, this is a rather dire forecast for corporate earnings, which supports the case for lower stock prices over time.

Other analysts I also respect believe that the waterfall collapse in equity prices in 2008 significantly overshot on the downside, and that the November lows could represent the bottom, although they would not be surprised to see a retest of the late November lows at some point.

Forecasters in the latter camp point to the fact that there is an ocean of money around the world that is sitting in Treasuries and other no-risk/low-risk vehicles earning next to nothing. They suggest that with an even modest uptick in consumer confidence, a flood of domestic and international money could come rushing back into US equities -- especially with the rebound in the US dollar last year.

Most analysts in both camps seem to agree that the equity markets are overdue for a potentially strong corrective rally which could play out over the next several months. Specifically, most forecasters I read believe that there will be some kind of "Obama rally" after the inauguration. The problem is that the broad equity indexes have already rallied 20-25% from the five-year lows in November.

Conclusions

One thing appears clear: 2009 is likely to be another wild year in the markets. So, what is an investor to do? Remain in cash and earn little or no return, or jump back into equities and risk losing even more money if the market retests the November lows as some analysts expect? I can't tell you what the market is going to do in 2009, but I can restate what I have said since beginning this E-Letter in 2002 -- it's wise to have at least part of your portfolio in an investment program that can switch to a defensive posture (cash or hedged) in uncertain markets, in my opinion.

While I don't have space in this week's E-Letter, in upcoming issues I'm going to discuss how active management -- investment programs that have the ability to go to cash or hedge long positions - benefited investors in 2008. I'm also going to highlight the huge inflows into some of these programs during 2008, even though most mutual funds were hemorrhaging assets badly. And you may be interested to learn where these inflows were coming from. What do they know that you don't know? The answer may surprise you.

I'll also bring you up to date on the performance of the latest additions to our AdvisorLink team, the Scotia Partners Growth S&P Plus and S&P Moderate Growth programs. While past performance cannot guarantee future results, suffice it to say that Scotia's programs continue to meet our expectations.

If you'd rather not wait on these future issues and want to learn more about Scotia and the other actively managed investment programs that have the potential to become defensive when market conditions warrant, feel free to give one of our Investment Consultants a call at 800-348-3601 or send us an e-mail at info@halbertwealth.com. You can also find out more about these programs on our website at www.halbertwealth.com, or request a complete Scotia Investors Kit by completing our online Scotia request form.

Wishing you a profitable New Year,

Gary D. Halbert

SPECIAL ARTICLES

Tyranny of the Tax-Exempt (Must Read!!!)
http://www.newsmax.com/insidecover/obama_stimulus_package/2009/01/06/168219.html

Obama's Trillion Dollar Political Stimulus Package
http://www.realclearpolitics.com/articles/2009/01/fiscal_follies.html

Obama Eyes $300 Billion Tax Cut - What A Surprise!
http://online.wsj.com/article/SB123111279694652423.html

Obama Lies About Government Bailout Plan
http://www.aim.org/aim-column/obamas-lies-about-government-bailout-plan

It's Official - 2008 Was A Very Bad Year

Gary D. Halbert — Wed, 31 Dec 2008 15:16:33 GMT

IN THIS ISSUE:

"The 2008 market will go down in history"
"2008: We Learned What We Don't Know"
Happy New Year!!

Introduction

Happy Holidays! I hope that everyone who celebrated Christmas had a very merry one. We certainly did at the Halbert house. I am taking this week off to spend time with my son who is home from college. I will be back to my usual writing schedule next week.

As we close out 2008 tomorrow, I thought it might be good to look back at some of the unusual and unprecedented events that occurred this year. Accordingly, I have reprinted a very good article from MarketWatch that chronicles what happened in the investment markets and the economy this year.

Whenever unprecedented events occur, and we have seen many this year, there is always the question of whether we have learned from those experiences. On that note, I have also reprinted a very good article from economics and business writer Robert J. Samuelson on that very subject. I think you will find it very interesting.

QUOTE:
The 2008 market will go down in history
By Nick Godt

NEW YORK (MarketWatch) -- Investors lost trillions of dollars and U.S. stocks prices plunged to 11-year lows. Overseas markets suffered even worse declines.

Yet, to say that the 2008 market will go down in the history books might almost sound like whistling past the graveyard. As the U.S. and the global economies continue to worsen, investors are still licking their wounds and worrying about 2009.

Looking back to expectations at the start of the year, "the surprise was not that we had a bear market and a recession," said Hugh Johnson, chairman of Johnson Illington Advisors.

"The surprise was that events were as severe as they turned out," said the veteran adviser, who has over 40 years experience in the investment world. "I have been at this for a while and I've never experienced anything like this. It defies words to describe it."

What can be said is that many things that sounded impossible at the start of the year now have to be accepted as facts.

After its astonishing surge to nearly $150 a barrel this summer, oil now trades near $40. The market capitalization of General Motors is now lower than it was in 1927. Bear Stearns and Lehman Brothers are no more. In October, a 900-point swing in the Dow industrials became almost commonplace.

"I'd like to use the old roller-coaster ride comparison," said Paul Nolte, director of investments at Hinsdale Associates. "But it's been more like a one-way trip down the haunted house."

Trillions lost

In a way, it didn't matter that many market strategists and commentators often struggled for the right metaphor to describe the market. The numbers flashing on TV and computer screens across the globe often spoke, and continue to speak, for themselves.

As of Dec. 12, the Standard & Poor's 500 index had lost $6.17 trillion since hitting record highs in Oct. 2007.

That reduction in global stock wealth has outstripped the losses in the last bear market - the S&P 500 lost $5.76 trillion during the entire bear market of 2000-2002. Making matters worse, this one still has room to run.

By Thanksgiving, many individual investors discovered they would have been better off sticking their savings under their mattress rather than the stock market for the past decade.

On Nov. 20, the S&P crashed through the previous bear-market low of 776, made in October of 2002, to end its lowest close since April 1997.

The U.S. showed it hadn't lost its superpower qualities, as a home-grown housing bust and mortgage crisis spiraled into a global market collapse.

The S&P Broad-Market index, which blends more than 11,000 stocks from developed and emerging markets, has lost $17.7 trillion year to date. Most of the losses, or $16.1 trillion, were logged between May and December.

"Until May, global markets were still expected to grow faster than the U.S., as China was seen growing more than 10%," said Howard Silverblatt, index analyst at S&P.

That optimism evaporated as the credit crisis spread around the globe and the U.S. recession clipped the outlook for global growth.

In November, the World Bank said China's economy is likely to expand at a 7.5% rate in 2009, its slowest pace since 1990.

Once leaders in emerging markets, stocks in Russia have now plunged 72%, those in Turkey are off 68%, and those in India have fallen 67%.

In October, Japan's Nikkei 225 hit a 26-year closing low; Iceland's exchange tumbled 81%, while Brazil's Bovespa index slumped 25%, its biggest one-month percentage loss in 10 years.

Dow swings

At times earlier in the year, it looked like investors were going to get a break. After the near-collapse and subsequent bailout of 58-year old investment firm Bear Stearns in March, markets found some degree of stability and even gained back some ground until May.

But as more Wall Street institutions crumbled, all beset by investments linked to bad home loans, fresh selling bruised stocks. After Lehman Brothers went bankrupt late in September, one of a string of large financial failures and government bail-outs that month, stock markets set multidecade records for lows reached and big swings registered.

In October, the S&P 500 had its most volatile month since 1929, right after the stock market crash that preceded the onset of the Great Depression.

The Dow plunged to its worst point drop on record, down 777 points, on Sept.29. By Oct. 15, the index had registered 508- to 733-point drops in three separate session.

The index also proceeded to surge to its biggest point gain on record, up 936 points, on Oct. 13. According to S&P, over the past 60 trading sessions alone, there were 17 days where stocks moved up or down by at least 5%. To put this in perspective, there had only been 17 days of 5% or more swings over an entire 53-year period, between 1955 and 2008.

Between Oct. 27 and Nov. 4, the day of U.S. Presidential election, stocks on the S&P surged more than 18%. But between Nov.4 and Nov. 20, they proceeded to slide 25%, before gaining more than 16% through Dec. 11.

"Playing those swings correctly, an investor could have made a 72% return," said S&P's Silverblatt.

Safe havens or 'money for nothing'

But most investors are unlikely to have tried playing the swings. Safety and preservation of capital became the name of the game for many.

The need to protect one's savings became so pressing that on Dec. 9, the government sold 4-week Treasury bills at a yield of 0%, meaning that bond investors were happy to just have the principal they'd lent back to them without a loss.

The yields on other government bonds, considered the safest among all investment classes, also reached lows unseen since the government began keeping records in the 1950s.

While investors opened their wallets to the U.S. government, they lent very little to anyone else. Commercial paper markets froze after the Lehman collapse, threatening to put out of business anything from big banks to small firms dependent on short-term loans. Borrowing costs for companies surged.

Even banks became increasingly unwilling to lend to each other, as more took huge write-downs from bad assets. The London interbank offered rate, or Libor, soared to record highs near 7% after Congress first rejected a $700 billion bailout for financial firms.

Oil's wild ride

Until July, the one sure bet for the nervous investor had been commodities. Hopes for global growth, along with a combination of natural disasters, geopolitical tensions, a sliding dollar and market speculation, had led energy and food prices to rocket, causing severe food shortages in poorer countries.

It was a shock when oil surpassed $100 a barrel in January. But those prices looked cheap as the futures contracts skyrocketed to $147 a barrel by July.

That level turned out to be commodity's swan song. It has plunged to trade around $40 a barrel in December, a swift descent echoed by other commodities.

"The rise in oil to $147 per barrel and its subsequent decline to $40 was vicious volatility," said Hugh Johnson. "It defies words to describe it. It certainly made life tough for the year."

Goldman Sachs analysts, who were laughed at back in 2005 when they first suggested oil might reach $100 in a "super spike," now predict oil could fall back to $30 a barrel in the coming months.

Gold also hit a record high above $1,000 an ounce in March, before slumping back below $700. The precious metal, however, has managed to crawl back to trade above $800 an ounce as investors seek safe-haven assets.

Besides oil, food stuffs such as corn also first reached record highs above $6.5 a bushel in June, before sliding back under $4 a bushel amid fears of a global recession.

A surge in the dollar helped precipitate the collapse of commodities. The dollar halted its four-year slide around May and proceeded to rally against most of its counterparts as financial and economic concerns spread globally, turning the U.S. currency into a safe-haven play, along with the Japanese yen.

The U.S. currency jumped 13% against a basket of six major counterparts over the course of the year so far.

Dramatic and record-setting swings in nearly every sector of security have sent professional investors thumbing through the record books.

"Nothing compares with the crisis that we have faced," said Johnson of Johnson Illington Advisors. The U.S. stock rout already registers as the fourth-worst bear market since 1898, he said. "It's clearly historic."

Here's another anecdote of how market perceptions and reactions may have changed: With the Dow swinging within an 800 point range on Oct.24, there was little immediate market reaction when Alan Greenspan, the once-venerated former chairman of the Federal Reserve, admitted to making a mistake when he testified to Congress.

While every one of his utterances used to be parsed by analysts, few now reacted when Greenspan said his view of the world might not be right after all.

"Absolutely, precisely," Greenspan said. "You know, that's precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well."
END QUOTE

The following article was published yesterday in the Washington Post, RealClearPolitics.com and elsewhere. Robert Samuelson eloquently points out how many longstanding assumptions were dashed in 2008, as his title suggests below.

QUOTE:
2008: We Learned What We Don't Know
By Robert J. Samuelson

It's the end of an era. We know that 2008, much like 1932 or 1980, marks a dividing line for the American economy and society. But what lies on the other side is hazy at best. The great lesson of the past year is how little we understand and can control the economy. This ignorance has bred today's insecurity, which in turn is now a governing reality of the crisis.

Go back to the onset of the crisis in mid-2007. Who then thought that the federal government would rescue Citigroup or the insurance giant AIG; or that the Federal Reserve, striving to prevent a financial collapse, would pump out more than $1 trillion in new credit; or that Congress would allocate $700 billion to the Treasury for the same purpose; or that General Motors would flirt with bankruptcy?

In 2008, much conventional wisdom crashed.

It was once believed that the crisis of "subprime" mortgages -- loans to weaker borrowers -- would be limited, because these loans represent only 12 percent of all home mortgages. Even better, they were widely held, diluting losses to individual banks and investors.

Wrong. Subprime mortgage losses (20 percent are delinquent) triggered a full-blown financial crisis. Confidence evaporated, because subprime loans were embedded in complex securities whose values and ownership were hard to determine. Similar doubts afflicted other bonds. Demand for all these securities shriveled. Lenders hoarded cash and favored safe U.S. Treasuries. Because investment banks and others relied on short-term debt (a.k.a. "leverage"), a loss of confidence and credit threatened failure. Lehman Brothers failed. The financial system had overborrowed and underestimated risk.

It was once believed that American consumers could borrow and spend more, because higher home values and stock prices substituted for annual savings. Consider: From 1985 to 2005, the personal savings rate dropped from 9 percent of disposable income to almost zero. But over the same years, households' net worth (assets minus liabilities) quadrupled, from $14 trillion to $57 trillion.

Wrong. In recent years, consumers increasingly overborrowed, especially against inflated home values. With the housing "bubble" now collapsed, net worth is falling. Homeowners' equity in their homes -- the share not borrowed -- is at a record low of 45 percent, down from 59 percent in 2005. Consumers have responded by retrenching big-time. Retail sales have dropped for five straight months; vehicle sales are a third below 2006 levels.

It was once believed that the rest of the world would "decouple" from the United States. As Europe, Asia and Latin America expanded, their buying would cushion our recession. A better-balanced world would emerge, with smaller U.S. trade deficits and lower surpluses elsewhere.

Wrong.The crisis has gone global; economic growth in 2009 will be the lowest since at least 1980. Even China has slowed; steel output was down 12 percent in November from a year earlier. The crisis has spread through two channels: reduced money flows and reduced trade. Global financial markets are interconnected. Customer redemptions forced U.S. mutual funds and hedge funds to sell in emerging markets (such as Brazil or Korea), whose stocks have dropped about 60 percent from their peak. Credit has tightened, as money flowing into developing countries is expected to shrink 50 percent in 2009 from 2007 levels, estimates the World Bank. The bank expects trade, up 7.5 percent in 2007, to fall in 2009 for the first time since 1982.

So much that has happened was unexpected that the boom and bust's origins are obscured. These lie in the side effects of declining inflation that started in the 1980s and, in the process of reducing interest rates, boosted stock prices and housing values. Recall that in 1981, when inflation was 9 percent, 30-year mortgages averaged 15 percent. As rates fell (mortgages were 10 percent by 1990, 7 percent by 2001), home prices rose. People could afford more. With lower interest rates, stocks became more valuable.

All the bad habits of recent years -- excessive borrowing by consumers and money managers, careless and reckless lending -- grew in a climate when gains seemed ordained. Even after the "tech bubble" burst in 2000, stock prices at year-end 2002 were seven times their year-end 1981 level. Home prices increased steadily; in the 1990s, they rose 45 percent.

Prosperity, apparently forgiving of mistakes, bred the complacency that undid prosperity. On bad mortgages, losses could be recovered by selling the homes at higher values. Thus rationalized, bad loans were made. Some stocks might decline, but over time, most would rise. Risk seemed to recede, so investors and money managers undertook riskier strategies.

What will emerge from these shattered illusions? Will the crash stir social unrest, abroad if not here? Will Americans become so thrifty that they hamper recovery? Will economic nationalism surge? How will capitalism be reshaped? Much depends on whether the frantic policies to combat the recession succeed. Probably they will, but there are no guarantees. Our ignorance is humbling.
END QUOTE

Happy New Year!!

2008 brought us some tough times, both in the markets and the economy. The credit crisis is still very serious, and the housing slump gets worse by the month. It is clear we are in a recession and we still don't have a good idea how long it will last or if it will get even worse. So, the outlook for 2009 is very uncertain.

Most of the trusted sources I read forecast that the recession will continue through at least the first half of 2009 and maybe longer. None of my best sources has a resolute opinion on whether we've seen the worst of the credit crisis or not. Ditto for the stock market outlook. So it remains to be seen what lies ahead. I don't remember a time of such economic and financial uncertainty in my lifetime.

Fortunately, America has survived serious recessions and financial crises in the past, and I have no doubt that we'll weather this one as well. How long it will take, unfortunately, is anyone's guess at this point. Of course, it never hurts to pray for our leaders, including our new president.

Wishing you a Happy & Profitable New Year,

Gary D. Halbert

SPECIAL ARTICLES

Chronology of Major World Events in 2008 – Part One
http://www.monstersandcritics.com/news/usa/features/article_1448683.php/CHRONOLOGY_Major_world_events_in_2008_Part_I

Chronology of Major World Events in 2008 – Part Two
http://www.monstersandcritics.com/news/usa/features/article_1448684.php/CHRONOLOGY_Major_world_events_in_2008_Part_II

The Recession & More Government Bailouts

Gary D. Halbert — Tue, 09 Dec 2008 21:21:18 GMT

IN THIS ISSUE:

Latest Grim Numbers On The US Economy
The Latest On The Government Bailouts
Fed Announces The Mother Of All Bailouts
Troubling Aspects Of The Fed's Latest Bailout
Fighting A "Debt-Deflation" At Any Cost

Introduction

The economy, the financial crisis and government bailouts were certainly hot topics for discussion among the large group of family and friends that we entertained over the Thanksgiving holiday and the weekend following. These sorts of issues would not normally come up at this annual gathering, but it is just more evidence that the current sinking state of the economy and the credit crisis is on the minds of virtually all adult Americans, no matter their financial strata.

Most of my Thanksgiving guests have been dizzied by all the different government bailouts that have been announced recently (haven't we all!), and most were very much against them, as is a majority of Americans according to several surveys. What most people don't understand is that the government and the Fed will do anything they possibly can to prevent the economy from falling into a full-fledged debt deflation.

Debt deflation is a cycle in which prices fall broadly, in some cases across the spectrum of assets. Most historians attribute the Great Depression to a debt deflation between 1930 and 1934. Likewise, Japan's decade of deflation and severe recession in the 1990s is the model everyone wants to avoid. For obvious reasons our monetary authorities do not want to see either happen again. I will be writing about deflation more in upcoming issues.

This week we will discuss the recent government and Fed bailouts as we go along, including some recent analysis by Stratfor.com and a nice chronicle of how the financial crisis has unfolded thus far. But first we want to take a look at the latest economic data, most all of which are bleak. While 3Q GDP was down only 0.5% according to the latest report, most analysts expect that the economy will plunge by at least 2-3% in the 4Q.

That's a lot to cover, so let's get started.

Latest Grim Numbers On The US Economy

I trust that everyone reading this is well aware that we are in a serious recession brought on almost entirely by the housing slump and the credit crisis which followed. The government and the Fed have proposed massive bailouts in an effort to get the credit markets moving, banks lending, and consumers spending once again. But is it working? The answer is, not yet.

Here are the latest economic reports. Last Tuesday, the Commerce Department revised its estimate of 3Q Gross Domestic Product from -0.3% to -0.5%, annual rate. In the 2Q, real GDP increased 2.8%. The decrease in real GDP in the 3Q primarily reflected negative contributions from personal consumption expenditures, residential fixed investment (housing), and equipment and software that were partly offset by positive contributions from federal, state and local government spending, private inventory investment and exports.

Most economists and analysts are expecting a much greater decrease in GDP for the 4Q. While we won't get the first estimate of 4Q GDP from the Commerce Department until late January, a recent survey conducted by the Philadelphia Fed suggests that real GDP will decline at a 2.9% annual rate in the 4Q. Likewise, the consensus now is that at least the first two quarters of 2009 will see similar decreases in GDP if not worse. There are plenty of analysts that now expect all of 2009 to hold negative growth for the economy. At this point, I cannot disagree. Things are indeed quite bleak.

The Index of Leading Economic Indicators (LEI) fell sharply in October, down -0.8%, marking the fourth decline in the last five months. The LEI declined sharply in October as stock prices, building permits, consumer expectations and the index of supplier deliveries made large negative contributions to the index. Without the very large positive contributions from inflation-adjusted money supply (the largest in seven years), the leading index would have been substantially weaker. Between April and October 2008, the LEI declined 2.4% (a -4.7% annual rate), falling considerably faster than the 1.2% decrease (a -2.3% annual rate) over the previous six months.

Durable goods orders (large ticket items) plunged 6.2% in October, more than double the 3% decline economists expected. The report showed widespread declines throughout manufacturing led by decreases in autos and airplanes. Factory orders plunged 5.1% in October. The manufacturing sector is being hit by the slowdown that is occurring in the rest of the economy. The prospect that the US, the world's largest economy, has entered what could be a severe recession is dragging down growth in other areas and dampening demand for US exports, which had been the one bright spot for the economy this year.

The unemployment rate surged to 6.7% in November as more than 500,000 jobs were lost in that one month alone. Most forecasters now expect the US unemployment rate to soar to 7% or above by the middle of next year. It will not surprise me if unemployment reaches 7% in the 1Q of next year.

As we all know, consumer spending accounts for apprx. 70% of GDP. In October, retail sales dropped 2.8% following a decline of 1.3% in September. It is unusual to see large drops in consumer spending in October with the holiday season approaching, but this is no usual year. Most retailers expect 4Q sales to fall below yearago levels this year.

It is encouraging to note, however, the latest media reports which indicate that on Black Friday (the day after Thanksgiving) retail sales were up 3% over last year. That increase was largely attributed to the fact that retailers had already discounted merchandise to levels not normally seen until later in the season.

The Conference Board's Consumer Confidence Index, which fell to an all-time low of 39.5 in October, rebounded modestly in November to 44.9 largely due to the sharp drop in oil and gasoline prices. However, the University of Michigan's Consumer Sentiment Index, which asks different questions, was basically unchanged in November at 57.9 versus 57.6 in September. Both measures of consumer confidence remain at very discouraging levels.

On the housing front, the numbers continue to worsen with no end in sight. New home sales in October fell to their lowest level in 17 years, according to data released last Wednesday. The US Census Bureau said the sale of new houses tumbled 5.3% in October to an annualized rate of 433,000. That compared to 457,000 one month earlier and was the weakest showing since 1991.

The number of existing homes in the US that were sold in October fell 3.1% compared to September and was 1.6% below the annualized rate in October 2007. Housing starts also fell sharply once again in October to a 17-year low. Building permits also continued to decline significantly in October.

Even though home sales are now down 69% from the July 2005 bubble peak of 1.39 million units, builders have not been aggressive enough in curbing production because the most critical variable of all, the unsold inventory backlog, rose to an 11.1 month supply in October from 10.9 in September. Thus, we may not have seen the worst of the housing slump yet.

The National Bureau of Economic Research (NBER) recently announced that the US economy is officially in a recession that began in December of 2007. This marks one of only a very few times that NBER has made such a determination without two consecutive quarters of decline in real GDP, which is the traditional definition of a recession.

To round out the latest economic reports, the Consumer Price Index fell 1.0% in October, the largest monthly decline in the index since its creation in 1947. The Producer Price Index (wholesale prices) plunged 2.8% in October. These drops in prices reflect the fact that we are in a severe recession, consumer demand is plunging, and producers are dropping prices in reaction.

The data above paint a troubling picture for the US economy and thus those around the world. The trouble is that the US economy is the world's engine of growth, and US consumers are the fuel of that engine of growth. Now, US consumers are being forced to cut back and save more.

The Latest On The Government Bailouts

As noted above, the government's efforts to head-off the US financial crisis have already gone beyond what many of us could have imagined just a year ago. This financial crisis has resulted in so many different rescue operations, involving trillions of dollars. The initial $700 billion rescue package that was finally approved by Congress in October boggled our collective minds. This financial crisis has evolved so fast that it is hard for most Americans to keep track of what has happened, much less understand it. Here is a good, concise chronology published by the Houston Chronicle (Chron.com) on November 25th:

QUOTE: Gov't Announces Another $800B in Bailout Plans

The government's commitments to contain the financial crisis now approach $7 trillion. That figure includes funds to guarantee certain corporate assets and debts, although those funds may never actually be spent. Still, the overall figure reflects the huge liabilities the government is taking on to battle the meltdown.

Among the government efforts announced Tuesday are plans to buy up to $600 billion in mortgage-related assets and up to $200 billion in loans for holders of securities backed by various types of consumer debt.

The new plans are the latest in a long list of government moves:

-- March 11: The Federal Reserve announces a rescue package to provide up to $200 billion in loans to banks and investment houses and let them put up risky mortgage-backed securities as collateral.
-- March 16: The Fed provides a $29 billion loan to JPMorgan Chase & Co. as part of its purchase of investment bank Bear Stearns.
-- May 2: The Fed increases the size of its loans to banks and lets them put up less-secure collateral.
-- July 11: Federal regulators seize Pasadena, Calif.-based IndyMac, costing the Federal Deposit Insurance Corp. billions to compensate deposit-holders.
-- July 30: President Bush signs a housing bill including $300 billion in new loan authority for the government to back cheaper mortgages for troubled homeowners.
-- Sept. 7: The Treasury takes over mortgage giants Fannie Mae and Freddie Mac, putting them into a conservatorship and pledging up to $200 billion to back their assets.
-- Sept. 16: The Fed injects $85 billion into the failing American International Group, one of the world's largest insurance companies.
-- Sept. 16: The Fed pumps $70 billion more into the nation's financial system to help ease credit stresses.
-- Sept. 19: The Treasury temporarily guarantees money market funds against losses up to $50 billion.
-- Sept. 29: The Fed makes an extra $330 billion available to other central banks, boosting to $620 billion the amount available to the Fed through currency "swap" arrangements, where dollars are traded for foreign currencies. It also triples to $225 billion the amount available for short-term loans to U.S. financial institutions.
-- Oct. 3: President Bush signs the $700 billion economic bailout package. Treasury Secretary Henry Paulson says the money will be used to buy distressed mortgage-related securities from banks.
-- Oct. 6: The Fed increases a short-term loan program, saying it is boosting short-term lending to banks to $150 billion. It says that by year's end, $900 billion in potential overall credit will be outstanding. It also says it will begin paying interest on reserves that banks keep with the Fed in hopes of coaxing banks into keeping more money on deposit at the central bank.
-- Oct. 7: The Fed says it will start buying unsecured short-term debt, so-called "commercial paper," from companies, and says that up to $1.3 trillion of the debt may qualify for the program.
-- Oct.. 8: The Fed cuts its benchmark interest rate a half percentage point, to 1.5 percent. It follows a one-quarter point cut on April 30 and a three-quarter-point reduction on March 18.
-- Oct. 8: The Fed agrees to lend AIG $37.8 billion more, bringing total to about $123 billion.
-- Oct. 14: The Treasury says it will use $250 billion of the $700 billion bailout to inject capital into the banks, with $125 billion provided to nine of the largest: Bank of America Corp., which received $15 billion; Bank of New York Mellon Corp., $3 billion; Citigroup Inc., $25 billion; Goldman Sachs Group Inc., $10 billion; JPMorgan Chase & Co., $25 billion; Merrill Lynch & Co. Inc., $10 billion; Morgan Stanley, $10 billion; State Street Corp., $2 billion; and Wells Fargo & Co., $25 billion. The $10 billion for Merrill has been deferred until its purchase by Bank of America closes.
-- Oct. 14: The FDIC says it will temporarily guarantee up to a total of $1.4 trillion in loans between banks.
-- Oct. 21: The Fed says it will provide up to $540 billion in financing to provide liquidity for money market mutual funds.
-- Oct. 29: The Fed cuts its benchmark interest rate to 1 percent, matching the low point reached in 2003. The rate hasn't been lower since 1958.
-- Nov. 10: The Treasury and Fed replace the two previous loans provided to AIG with a new $150 billion aid package that includes an infusion of $40 billion from the government's bailout fund.
-- Nov. 12: Paulson says the government will no longer buy distressed mortgage-related assets, formerly the centerpiece of the bailout, and instead will concentrate on injecting capital into banks.
-- Nov. 17: Treasury says it has provided $33.6 billion in capital to another 21 banks, with the largest stake being $6.6 billion to Minneapolis, Minn.-based U.S. Bancorp. So far, the government has invested $158.6 billion in 30 banks.
-- Nov. 23: The Treasury says it will invest another $20 billion in Citigroup Inc., on top of $25 billion provided Oct. 14. The Treasury, Fed and FDIC also pledge to backstop large losses Citigroup might absorb on $306 billion in real estate-related assets.

Citigroup will assume the first $29 billion in losses, and after that the government will absorb 90 percent of losses and the company 10 percent. In return, the government will receive $7 billion in preferred shares and warrants for more than 250 million additional shares.

-- Nov. 25: The Fed says it will purchase up to $600 billion more in mortgage-related assets and will lend up to $200 billion to the holders of securities backed by various types of consumer loans.

The Fed will buy up to $100 billion in direct obligations from mortgage giants Fannie Mae and Freddie Mac as well as the Federal Home Loan Banks. The central bank also will buy $500 billion in mortgage-backed securities, pools of mortgages that are bundled together and sold to investors.

The program on consumer debt will be supported by $20 billion of credit protection from the $700 billion bailout package enacted last month. END QUOTE

Fed Announces The Mother Of All Bailouts

As noted above, on November 25th, the Federal Reserve announced yet another huge bailout - up to $800 billion - aimed at freeing up seized credit markets. You would expect that this new, unprecedented bailout would be still making news and have been completely and utterly analyzed. I don't find that to be the case.

Actually, it's somewhat troubling that the Fed, acting under its own initiative and without any congressional approval, can uncork a bailout $100 billion bigger than the $700 billion TARP rescue package Treasury Secretary Paulson had to peddle on Capitol Hill. Even more surprising is that this newest bill aims to do the very things that Secretary Paulson initially planned for the $700 billion - buy up troubled mortgage securities - before he changed his mind on how best to use the TARP money.

I'll provide some analysis below, but first let's see exactly what the new Fed bailout has been designed to do. Much of the buzz on the street about this new Fed program has been that this is "Main Street's Bailout," meaning that the relief from this $800 billion of pocket change is designed to get to the ultimate consumer rather than going into bank stocks. Is Bernanke playing a little political football here? Maybe.

Stratfor.com had one of the better descriptions of the Fed's new plan to restore liquidity to the housing and consumer credit markets. I have reprinted an excerpt of Stratfor's November 25 article below, and will follow up with my own analysis:

QUOTE: In the past 24 hours, there have been two more major developments, enacted not by the Treasury but by the U.S. Federal Reserve, which, unlike the Treasury, enjoys both policy independence and control of the money supply.

First, the Federal Reserve is using its resources to take over the original idea contained in the TARP I program, launching a $600 billion package to purchase mortgages and mortgage-backed securities that started the problems in the first place. All of this funding will be applied to Freddie Mac, Fannie Mae and their immediate satellites. Because the Fed will be negotiating the terms of the debt purchase with the Treasury (the twins are currently under government conservatorship), price points will be determined very quickly.

And because the Fed enjoys policy independence and control of the money supply, it will not have to go back to Congress for approval or funding. If it deems necessary, it can simply print currency to "pay" for the effort. In essence, the sticky parts of the bailout program have now been handed to the institution with the most capability for unfettered action: the Federal Reserve.

Second, the Fed is using a new $200 billion credit facility to purchase AAA-rated debt -- credit card debt, car loans, student loans and the like -- that is currently foundering because of the dual impacts of the recession and bank skittishness. This program is less of a bailout and more of a reward for good behavior. The Fed will purchase only debt that is new; banks can swap their new loans for cash and then immediately turn around and lend again. Simply put, the Fed is offering the buy-up program as a sort of bait to draw skittish banks out of their holes. (The Treasury tossed in $20 billion for this as a sort of insurance policy.) [Emphasis added, GDH.]

What the government essentially has done in this admittedly confusing shell game is split the rescue program into two categories: a "good debt" management scheme and a "bad debt" management scheme.

With the exception of the $200 billion AAA facility, the Fed is in charge of the bad debt -- primarily the questionable mortgage-backed securities that touched off the problems to begin with. Because the Fed operates largely free of congressional and even presidential oversight, and because it controls the printing presses, it has the authority and ability to turn on a dime and make the serious decisions about how to reform or even (probably) liquidate Fannie Mae and Freddie Mac. If there is a financial loss, and there certainly will be, the Fed can handle it "off the books," so to speak. After all, it can print currency if need be. There would obviously be negative (inflationary) side effects to this, but the impact on the government's bottom line and the taxpayer's pocketbook would be less direct.

In turn, the good debt will go to the Treasury. Assuming Western civilization as we know it does not collapse, the government will be able to sell back the shares the Treasury purchased in the banks. In fact, profit levels for the government are actually written into the agreements with the banks. Not only will the government get the $350 billion allocated in TARP II back, it will make a healthy profit to boot -- if all goes according to plan. END QUOTE

The key is the last sentence and the last phrase - "if all goes according to plan." So far, I would say, not much has gone according to plan, assuming there ever was one. A year ago, most analysts believed that the subprime problems would be contained in the US mortgage/banking sectors and would not affect the overall investment markets. Now we know that these endemic problems have spread to all credit markets, virtually around the world.

Troubling Aspects Of The Fed's Latest Bailout

Reading through Stratfor's excellent analysis of the Fed's recent announcement, you may have picked up on some potentially troubling words. First, Stratfor talks about how the Fed can simply "print currency" necessary to pay for this bailout. Remember the controversy surrounding a 2002 speech by Ben Bernanke that alluded to printing money and distributing it from helicopters? Well, the printing press has evidently been placed on board the chopper at Gate One.

As a general rule, printing money is de-facto inflationary. History is filled with examples of countries that experienced hyper-inflation due to cranking up the printing presses. However, not as evident in Bernanke's "helicopter" speech was a footnote that addressed the fact that some inflation is actually a good thing, since it erodes the real value of outstanding government debt.

As I will discuss below, it can be argued that the Fed had to print money to fund bailouts or risk a severe economic depression. However, we need to be aware that the side effects from this "cure" may include increased inflation in the future. Even Fed Chairman Bernanke acknowledges the risk. In a speech last week here in Austin, he said that the Fed's balance sheet "…will eventually have to be brought back to a more sustainable level. However, that is an issue for the future; for now, the goal of policy must be to support financial markets and the economy."

Next, the Stratfor analysis discusses how the "sticky" parts of the process have now been handled. It is generally believed that Paulson backpedaled on buying up subprime debt from banks because the negotiations would have taken too much time to do the banks any good. Now, however, the Treasury and Fed will be able to negotiate directly on the price of any debt purchased, making these purchase transactions potentially much faster.

However, at what cost do we gain this additional transactional efficiency? We have an admittedly "unfettered" Fed dealing directly with the Treasury Dept. regarding the purchase and sale of hard-to-value debt. Does this bother anyone else out there, or have we come to the point where we have to believe the old line, "I'm from the government and I'm here to help you?"

Finally, Stratfor notes that the Fed's dealing with the bad subprime debt will produce almost certain losses, but that these can be handled "off the books," again by printing money if necessary. The resulting inflation would be a consequence, but would be a less direct way of spreading the cost around to the public. Note that Stratfor doesn't say that it won't impact taxpayers, just that inflation will be a less direct way of paying the piper than other possible methods.

Fighting "Debt-Deflation" At Any Cost

As noted in the Introduction above, discussions about the recent massive government bailouts, and especially the latest from the Fed, are going on everywhere in America. Surveys consistently show that most Americans do not agree with the huge government bailouts. Choruses such as "Just let 'em fail!" and "Where's my bailout?" are common.

What most people don't understand is that the government and the Fed will do anything they possibly can to prevent the economy from falling into a full-fledged debt deflation. Whether we agree or disagree with the bailouts, it is clear that our monetary authorities, namely Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke, believe that if large financial institutions are allowed to fail on a large scale, it would send the economy into a depression.

It appears quite clear to me that Paulson, Bernanke and company now believe that it was a serious bad decision to let Lehman Brothers go bankrupt. Now, they are doing everything in their power to make sure that no other large financial institution goes under, apparently no matter how much taxpayer money they have to commit, even to the point of firing up the Fed's printing presses as a last resort.

Deflation is typically defined as a persistent decline in the general prices of goods and services, or put differently, a negative inflation rate. A debt deflation is generally regarded as a persistent decline in the prices of goods and services, along with widespread loan defaults and bank failures. The last time the US experienced a serious debt deflation was in 1930-1934, the so-called Great Depression.

In the Great Depression, America saw Gross Domestic Product plunge by 10% annually on average, and the unemployment rate skyrocketed to 25%. Clearly, no one wants to see that happen again, especially Paulson and Bernanke, not to mention President Bush and President-elect Obama.

While most Americans seem to oppose the government bailouts, most of the financial/analytical/forecasting groups that I have followed for years believe that the bailouts were/are absolutely necessary. In fact, some of my most trusted sources believe that the government was slow to react to the credit crisis and has not done enough to make bailout money available.

Certainly, there is also agreement among my sources that the government has made some mistakes and did not have a clearly orchestrated plan for how and when the bailouts would happen or where the bailout money would be directed. Such evidence is clear in simply how many times the plans for the original $700 billion TARP bailout have changed.

At the end of the day the question is: What would have happened if the government and the Fed had done nothing in reaction to the credit crisis? Let's start with the easy ones. AIG would have clearly gone bankrupt sending shock waves through the banking and insurance markets worldwide. Merrill Lynch would have almost certainly gone under, perhaps taking Goldman Sachs, Morgan Stanley and several other large investment banks with it, along with Lehman Brothers.

It is impossible to know what would have happened if these giant financial players had been allowed to fail. Yet most Americans don't seem to care. Just let the chips fall. Would the failure of these instititions have triggered a financial collapse? I think the answer is yes.

But would these financial failures have sent the US economy into a serious depression if the government did nothing? There is no definitive answer. Clearly, Paulson and Bernanke feared that without the bailouts, we would have been looking at a global financial crisis and a worldwide depression of epic proportions.

Most Americans who oppose the bailouts have not, in my opinion, thought through the possible implications had the government done nothing to rescue the credit markets. While we can't be certain that a global depression would have unfolded had nothing been done, we also cannot know that it wouldn't. Think about that.

Finally, I would be remiss not to add the obvious: there is no guarantee that the bailouts will work. Only time will tell. But it is clear that the bailouts are not over. I expect the government to give bailouts to the automakers, one way or the other; if not this year, then President Obama will do it as soon as he gets in office. Likewise, Obama is planning another giant stimulus package - reportedly in the $700 billion range - for early next year.

The point is, the bailouts are not over. More are coming in the Obama administration, if needed. How much more we don't know. What we do know is that we will have a new president that comes from a political persuation that has no problem with the government owning parts of the private sector, which is a little scary now that the government already owns equity stakes in our nation's largest banks and AIG.

But that is another discussion for another time. Time to close and hit the "send" button. Hope this has been helpful.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES:

Graphic NYT: Tracking The Bailout
http://www.nytimes.com/imagepages/2008/11/26/business/20081126_FED_graph1.html

Bernanke's Daring Experiment
http://www.realclearpolitics.com/articles/2008/12/bens_daring_experiment.html

Getting Out of the Credit Mess
http://online.wsj.com/article/SB122878188688689783.html

Instead of Spending, Cut Taxes
http://www.forbes.com/opinions/2008/12/08/friedman-cut-taxes-oped-cx_bw_rs_1209wesburystein.html

Credit Crisis: Do Bush & Paulson Have A Clue?

Gary D. Halbert — Tue, 18 Nov 2008 21:19:08 GMT

IN THIS ISSUE:

Stratfor's Take On The Subprime/Credit Crisis
Treasury Secretary Paulson Changes The Plan
Do They Even Have A Clue What To Do?
Bailout's Next Phase: Consumer Loans (Maybe)
More From Stratfor On The Credit Crisis & The Economy
Gauging The Recession & The Economy - Not Good
Stock Markets Detest Uncertainty & Economic Woes
Conclusions - They Are Few

Introduction

We begin this week with some interesting analysis from our good friends at Stratfor.com regarding the subprime/credit crisis - how it unfolded and how it may play out from here. Following that, we'll look at the latest curve ball from Treasury Secretary Paulson who last week announced that the government will not buy up troubled mortgage securities from banks, but instead will proceed with more equity infusions for financial institutions that are in trouble.

In addition, Secretary Paulson announced that a significant part of the $700 billion rescue package - most all of which was originally intended to buy up troubled assets - will now be redirected toward consumer debt, including such things as student loans, auto loans and credit card debt. One wonders if the government really has a clue about how to resolve the financial crisis and unfreeze the credit markets.

And finally, we take a look at the current state of the economy and the recession. News continues to worsen, especially forecasts for 4Q GDP, which many economists and analysts now believe could be negative 4-5%. All of this continues to weigh on the stock markets, which as this is written, are threatening to make new lows. It's a lot of ground to cover in one E-Letter, so let's get started.

Stratfor's Take On The Subprime/Credit Crisis

QUOTE:
The root of the American credit crisis is similar to that of previous recessions. As profits pile up during economic expansions, investors eventually find it difficult to find investments that generate large returns, so they send their money after riskier prospects. In the [economic] expansion that just ended, the most important of those questionable investments was subprime mortgages, culminating in mortgage loans that required minimal to nonexistent credit checks, down payments or even proof of income. In total, some $550 billion of subprime loans (and a separate $725 billion of Alt-A loans -- the next quality step up from subprime) are currently outstanding.

The worst of these mortgages granted very low teaser interest rates that adjusted to normal rates after a period of two to five years; there were some $350 billion of these in subprime, and an additional $385 billion in Alt-A. While virtually none of these questionable-quality mortgages have been granted since the credit crunch began roughly a year ago, those resets are now weighing heavily on the housing market. As the rates reset, borrowers with questionable income and credit are often unable to meet the new, grossly enlarged payments based on the new rates. The result is a cascade of foreclosures that gluts the housing market, pushing prices down. So far $55 billion of subprime mortgages are in foreclosure, and just over another $80 billion are in severe delinquency. The numbers for Alt-A are $40 billion and $45 billion, respectively.

Under normal circumstances, this is more or less where things would have ended: A glut in regional housing stocks where subprime mortgages were most overused -- especially in the Southern California, Las Vegas and Miami regions -- would lead to a recession in those housing markets and perhaps some leakage into the broader national housing market.

But there is another step in the process that made the problem bigger. Mortgages are only rarely kept by their issuers -- instead they are bundled into packages and sold to interested investors. This serves three purposes. First, since the mortgage maker can sell his loan for a profit, he can then turn around and make another mortgage. Second, this secondary tier of investors brings an entirely new source of capital into the market. Third, these packaged mortgages can be sold to yet more investors, creating a new series of mortgage-backed assets (and securities) that can be traded abroad. Taken together, this widens and deepens the capital pool and reduces mortgage rates for everyone.

The problem is that as market players chased after ever-shrinking returns, no one treated the dubious mortgages as anything different from normal mortgages -- and that includes the ratings agencies whose job it is to evaluate products. All banks and investment houses are required to hold back a percentage of their assets in cold hard cash to keep from becoming overleveraged. This reserve percentage is based upon myriad factors, but the most important one is the risk level of the investments. Mortgage investments are -- or were, until recently -- widely considered to be among the safest investments available because homeowners will do everything they can to avoid missing payments and losing their homes.

Subprime mortgages are more likely to fall into default. But add in the impact of teaser rates -- and the fact that many of these mortgages were granted without requiring down payments so no equity was ever earned -- and essentially the effect is that time bombs were hardwired into these packages of tradable mortgages.

Beginning in late 2006, these teaser rates began to adjust to normal rates and the bombs started going off. That decreased the value of the mortgage-backed assets directly by their affiliation with subprime in specific, and indirectly via their affiliation with property in general. Suddenly, anyone holding the weakening mortgage-backed securities found themselves needing to use those cash reserves to rebalance their asset sheets. As the price drops intensified, anyone who might have been willing to purchase or trade these mortgage-backed securities suddenly lost interest. The holder then held an asset of questionable value that he could not unload.

As the cash crunch of individual firms increased, two things happened. First, investment houses started snapping like twigs because they are uniquely vulnerable to credit crunches. Banks, unlike investment houses, are required to hold a certain percentage of their deposits back to cover their losses should disasters strike; right now that percentage is 10 percent. The major investment houses, however -- which are regulated by the Securities and Exchange Commission instead of the Treasury -- are only required to set aside a minuscule amount of cash, which comes out to less than 1 percent of their total asset list and therefore provides them with a smaller cushion than banks.

By the end of September, the major Wall Street investment houses had been broken (Bear Stearns), gone bankrupt (Lehman Brothers) or were forced to recategorize themselves as banks, thus submitting themselves to the regulatory authority of the Fed (Goldman Sachs). In a few short months, everything on Wall Street changed.

Second, banks also needed to rationalize their balance sheets by dipping into their reserves. Luckily, since banks have a 10 percent reserve ratio, they have much more room to maneuver than investment houses (although some, such as Washington Mutual, still cracked under the pressure).

It is at this point that Stratfor gets interested in the economics of the issue, because it is at this point the problem transforms from angst for Wall Street into a danger for the broader system.

When an investment house faces a credit crunch (or goes under) the impact is rather limited -- the only entities that are truly hurt are those that purchased shares in the house itself -- but when a bank faces a crunch, the impact is much greater. The best means that banks have of rebuilding their emergency reserves after a write-down is to reduce lending and hoard their income until their reserves are built up again. Such actions immediately reduce the availability of credit for everyone across the entire economy -- homebuyers cannot get mortgages, companies cannot borrow to fund expansions, credit card rates go through the roof. Voila, a Wall Street crisis becomes a national economic crisis.

U.S. Treasury Secretary Hank Paulson's $700 billion bailout plan is an attempt to address the problem at its source: the nonliquidity of the mortgage-backed securities. The government will offer to exchange these securities for cold, hard cash. In one fell swoop, banks can rid themselves of untradable assets of questionable value while recapitalizing their reserves. Flush with cash and sporting newly healthy asset sheets, this should unfreeze the credit picture and allow banks to get back into the business of banking -- most notably lending. END QUOTE

Treasury Secretary Paulson Changes The Plan

I am forced to depart from Stratfor's analysis of the credit crisis at this point for one important reason (we will revisit Stratfor below). On Wednesday of last week, Treasury Secretary Hank Paulson made it official that the government is abandoning the original plan to spend $700 billion to buy up troubled mortgage assets from financial institutions.

The next phase of the Treasury's $700 billion "Troubled Asset Relief Program" (TARP), according to Paulson, would have the government continue to take equity stakes in banks and financial institutions vis-à-vis more cash infusions in exchange for stock, rather than buying up their bad mortgage-related assets and taking them off their books.

This seems like an odd turn of events given that the credit markets are still more or less frozen and we are in a recession that is looking more and more severe. Yet Paulson defended the latest swerve in the TARP mission by noting that some of the $700 billion needs to be redirected at increasing the availability of student loans, auto loans and credit cards.

Some analysts viewed the Treasury's latest redirection of TARP funds as merely the recognition that the Bush Administration has finally realized that some of the TARP billions needs to be spent directly on consumers. Clearly, the public perception is that the TARP is simply a bailout of banks and Wall Street financial institutions. Some analysts welcomed the latest announcement.

Do They Even Have A Clue What To Do?

Your editor has a different take on the latest announcement by Treasury Secretary Paulson. First, I have to question whether the Bush Administration and the Treasury Secretary know what they are doing. The original $700 billion rescue plan, which was hastily passed by Congress, was intended specifically to: 1) buy up troubled mortgage-related assets from banks and others; 2) hold those assets on the Treasury's books until the housing slump subsided; and 3) eventually sell those assets back into the market when it was expedient to do so.

Supposedly, the Treasury was busy constructing the TARP infrastructure and hiring lots of people to implement the massive buying of troubled mortgage-related debt. However, in October, the Treasury shifted its focus and allocated some $250 billion for direct equity infusion to the major banks in return for stock (warrants).

The banks that agreed to receive equity investments from the Treasury included Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp. (including Merrill Lynch), Citigroup Inc., Wells Fargo & Co., Bank of New York Mellon and State Street Corp. Interestingly, some of these large banks resisted the effort and opposed the cash infusion in return for equity. However, it was widely reported that Secretary Paulson made it clear that the cash infusion was not optional.

The next twist, as noted above, came last Wednesday when Paulson announced that the TARP will not purchase troubled assets from financial institutions, but instead will continue with equity infusions for banks (and non-banks) and somehow provide other TARP money for student loans, auto loans and credit card loans. This all suggests to me that the Bush Administration and the Treasury Secretary don't know what they're doing!

Obviously, the move to make TARP money available for student loans, auto loans and credit card loans is in reaction to growing pressure in Congress to make some of the money available for consumers, rather than just financial institutions. President Bush and Secretary Paulson know that they must go back to Congress for authorization of the second $350 billion installment of the TARP. But does Congress have any better idea how to spend the money than Paulson?

To me, it makes much more sense for the government to buy up the troubled assets and hold them until the housing market recovers than to buy increasing equity stakes in banks. However, in his press conference last week, Secretary Paulson said that he decided to drop the plan to buy troubled assets because it is no longer the best way to restart the credit markets. What I read that to mean is that it will take too long to buy up the troubled assets, and the banks could fail in the meantime. Thus, the decision to inject $250 billion now in return for stock was made.

Bailout's Next Phase: Consumer Loans (Maybe)

Congress is quite unhappy with Secretary Paulson for not forcing banks to make new loans with the funds they have received from the TARP. Many in Congress are also unhappy that some of the TARP money has not been earmarked to help homeowners avoid foreclosure. Paulson responded last Wednesday stating that, as a part of the new direction, the Treasury is looking into ways to use some of the TARP money to prevent home foreclosures. Specifically, he said they are considering a plan that has been floated recently by the FDIC, although he noted that the plan has some problems in his view.

Paulson stated in his news conference on Wednesday that the market in consumer finance "is currently in distress, costs of funding have skyrocketed and new issue activity [loans] has come to a halt." As a result, Paulson also announced that the Treasury is considering setting up a new lending facility to focus on consumer loans. Paulson said he was more interested in helping the currently stalled market for financing of credit card and auto loans, among other things.

The Treasury Department says nothing has been finalized, but reportedly Paulson and his advisers are looking into using TARP funds, along with some money from outside investors, to buy up credit card debt, auto loans and other, non-mortgage consumer debt. The financing mechanism for that type of debt, often called "securitization," has stalled like much of the rest of the banking sector. Paulson is hoping that buying up debts directly will be a better way of stimulating lending than just purchasing banks' shares and trying to force the firms to extend loans.

Interestingly, this new lending mechanism sounds a whole lot like another "Collateralized Debt Obligation" (CDO). Accordingly, one wonders why buying up credit card and auto loan debt is any better or easier to do than buying up mortgage bonds. In fact, when it comes to credit card debt, it could be an even riskier way to use taxpayer money. That's because credit card debt, unlike home mortgages, is unsecured. If a borrower defaults, there's no house to repossess. What's more, credit card debt, unlike a mortgage, can be wiped away in bankruptcy.

Pardon me, but this raises another obvious question. Would a huge new round of CDO-like securities be good for investors? I think not. We are in the midst of a massive deleveraging in the credit and investment markets. You would think that Bush advisors and Secretary Paulson would realize this.

Given these potential problems, it occurs to me that Secretary Paulson may simply be talking about such consumer oriented programs to satisfy Congress, when in reality he may have no plans to actually implement these proposed new plans. These ideas may simply be lip service for the time when the Treasury has to ask Congress for the second $350 billion to fund the TARP. The TARP reportedly has only apprx. $60 billion left from the initial $350 billion allocation.

Finally, it appears to me that President Bush and Secretary Paulson have decided to simply ‘run out the clock' on the bailout and hand it over to the Obama administration (note: Paulson will not be staying on at Treasury). On Wednesday, Paulson stated that he had set no date for going back to Congress for the additional $350 billion, possibly a hint that he won't.

Paulson also said he has no plans to establish major new programs ahead of President-elect Obama's inauguration. He said, "I'm not looking to make anything more difficult by implementing programs that don't need to be implemented before they're here." Paulson also said the Treasury will likely keep the remaining $60 billion on the sidelines in case of emergencies.

So, it increasingly looks like Bush and Paulson are content to run out the clock and hand this enormous credit crisis over to the Obama team.

More From Stratfor On The Credit Crisis & The Economy

I will tell you that Stratfor is less pessimistic about the credit crisis and what lies ahead for the economy than numerous other sources I read. Dr. George Friedman and his staff believe that the Treasury will be successful in largely turning around the credit crisis next year. Likewise, barring any major surprises, they do not believe that the recession will be long and overly severe. I hope they are right.

QUOTE
In our analysis of the current financial crisis in the United States -- and the world as a whole -- we have sought the center of gravity of the problem. We approached that simply by asking one question: is what is going on simply another inflection point in the business cycles that have occurred since World War II, or does it represent a systemic failure such as that which happened during the Great Depression? This struck us as the urgent issue.

We noted that in the Great Depression, the U.S. gross domestic product (GDP) contracted by nearly 50 percent over three years. It was an unprecedented calamity. Bearing this in mind, we compared the current situation to other events since World War II to see if there was a framework for measuring it. We found that framework in the Savings and Loan crisis of 1989, when an entire sector of the U.S. financial system collapsed and the federal government intervened -- essentially guaranteeing or purchasing commercial real estate, whose price decline had triggered the crisis.

We noted that the total amount allocated by the federal government in that crisis was about 6.5 percent of the GDP (and the amount actually spent, before recouping of costs via sales, was less than 3 percent). We noted also that in the current crisis another sector of the financial system -- the investment banks -- were devastated, and that the federal government intervened, this time at about 5 percent of GDP.

Meanwhile, the equity markets had not declined as much as they did in 2000-2001, and as of the second quarter of this year the economy was still growing by more than 2 percent. From this we concluded that the U.S. economy was moving into a recession but that the recession would not break the framework of the postwar economy, although clearly the degree of government intervention will reshape the financial markets.

The United States is a $14 trillion economy with a potential problem amounting to $1-2 trillion (and probably far less than that). If the government intervenes, it will create inequities and imbalances in the system. But between the size of the economy and the government printing press, the problem will be managed -- particularly because there are underlying assets -- houses -- that can be monetized in the long run. The gridlock in the financial system will undoubtedly create a recession, but there hasn't been one for seven years and it's high time. END QUOTE

Stratfor seems to believe that the worst of the credit crisis is now behind us, barring any major surprises. They note that bank lending has increased somewhat since the $250 billion injection in October. Likewise, they believe the recession will likely end in the first half of next year.

As always, I appreciate Stratfor's insights and the ability to share them with you. I encourage you to visit their website at www.Stratfor.com and consider subscribing to their always insightful analysis. Click HERE to get a free 7-day trial subscription to Stratfor .

Gauging The Recession & The Economy - Not Good

When Stratfor suggests above that "...the recession would not break the framework of the postwar economy...," I take that to mean that they do not believe the current recession will be worse than the recessions of 1973-74 or 1981-82, both of which lasted well over a year. Most economists seem to agree that the current recession probably began in July of this year.

In late October, the Commerce Department reported that 3Q GDP had contracted by an annual rate of -0.3%. On November 25, we will get the second estimate of 3Q GDP, and the consensus now is for a revision to -0.6%. That will not come as a surprise.

What is much more worrisome is the outlook for the 4Q. Economists and analysts are downgrading their estimates for 4Q GDP. I am hearing increasing forecasts of a 4-5% drop in GDP for the 4Q! We won't get the first estimate of 4Q GDP until late January, so it will be interesting to see what the consensus is after the first of the year. Suffice it to say, it will be ugly.

Retail sales fell a record 2.8% in October, and retail chains are bracing for the worst holiday shopping season in years. Best Buy now expects its sales to fall 8% for the year. What a shift - in early September, Best Buy was forecasting a sales increase of 3% for the year. Best Buy CEO Brad Anderson said, "Since mid-September, rapid, seismic changes in consumer behavior have created the most difficult climate we've ever seen." Best Buy rival CircuitCity filed for bankruptcy last week.

Economists and analysts are increasingly forecasting that the recession will last at least until late next year. If that is true, the current recession would be on par with the recessions of 1973-74 or 1981-82. And it could be worse.

Most forecasters now expect the US unemployment rate to climb to at least 8% sometime next year, with many expecting that to occur in the first half of next year. Over a half a million jobs have been lost in the US in the last two months alone, driving the unemployment rate to 6.5%, a 14-year high. 8% unemployment would be the highest in 25 years.

Stock Markets Detest Uncertainty & Economic Woes

Everywhere I go, people ask me the same question: What's it gonna take for this crazy stock market to find a bottom? I don't tend to talk about my business or investments to people in my personal life, but people who have never inquired before are asking me for advice now - family, friends and even people who don't know me well but know I work in the investment industry.

The fact is, no one knows when this bear market will end. If someone tells you they know when the bear market will end, keep one hand on your wallet!

One thing is clear, however. The stock markets have consistently reacted negatively to the government's massive $700 billion bailout plan. Let's take a look at recent market action. Treasury Secretary Paulson submitted the huge bailout plan - which was intended to fix the credit crunch and stabilize the market - to Congress on Saturday, September 20. Take a look at what happened thereafter. The stock market tanked.

The Dow Jones Industrial Average plunged from above 11,000 on September 22 to below 8,000 on October 11 at the low. Certainly not the reaction that Bush, Paulson & Company had expected. The equity markets do not like uncertainty and were shocked at the massive size of the requested bailout - we all were.

The stock market tried to bounce back from the low, but on October 14 Secretary Paulson announced that on the prior day he had met with the nation's largest banks and had informed them of the government's plan to take equity stakes totalling $250 billion in their companies. You can see in the chart above that the stock markets declined sharply once again to near the October 11 low.

The markets once again tried to recover, climbing back above 9,500 in the Dow. Then last Wednesday, November 12, Secretary Paulson announced that the Treasury would not buy any of the banks' troubled assets and would only take equity positions in their stock. Now, we find the equity markets back near their October lows and threatening to make new lows as this is written.

It remains to be seen if the stock markets are in the process of forming a bottom. From a technical perspective, if the Dow can hold above the October lows once again in the next few days, that would be very encouraging (triple bottom), and we could see a much overdue strong rally in this bear market. If not, and we make new lows, expect another round of aggressive selling to follow.

Conclusions - They Are Few

I know that many of my readers are opposed to the government bailout of financial institutions. I assume that many of you will also be opposed to the latest plan to spread some of the bailout money to consumer loans. In normal times, I would agree - just let the chips fall.

However, the current credit crisis is unprecedented and the consequences of letting America's largest banks and financial institutions fail would virtually ensure a depression and a Japan-style debt deflation that could last for a decade or longer.

Of course, it remains to be seen if the government bailout plan will work. But most of my trusted sources agree that some kind of large government rescue plan was required, since letting the credit system go down the tubes would have resulted in financial Armageddon.

Personally, I believe the government will have to resort to buying up many of the toxic mortgage-related securities and taking them off the market before this crisis abates. But based on the hints and inuendo from Secretary Paulson, it seems that President Bush has decided to leave that decision to his successor, Barack Obama. I would not want to be in his shoes.

Finally, I know that many of you who read this E-Letter are facing tough decisions about what to do with your investments, your 401(k) and other retirement accounts at this point. Keep in mind that my staff of Investment Consultants and I stand ready to assist you in making those decisions if you would like to talk about it - free of charge and with absolutely no pressure to invest in the programs we recommend.

You can call us at 800-348-3601 or e-mail us at info@halbertwealth.com. We don't claim to have all the answers, but we've been through bear markets before, and we are happy to consult with you on the issue of what to do now.

Wishing you a market bottom,

Gary D. Halbert

SPECIAL ARTICLES:

Paulson - Fighting the Financial Crisis
http://www.nytimes.com/2008/11/18/opinion/18paulson.html?_r=1&ref=opinion&oref=slogin

To Prevent Bubbles, Restrain the Fed
http://online.wsj.com/article/SB122688652214032407.html

Fred Barnes on how Obama could help Republicans
http://www.weeklystandard.com/Content/Public/Articles/000/000/015/819jyryw.asp?pg=1

The Democrats' Plan To Highjack Your 401(k)

Gary D. Halbert — Tue, 04 Nov 2008 22:19:23 GMT

IN THIS ISSUE:

The Economy Falling Fast Into Recession
Democrats Want To Highjack Your 401(k)
The Democrats' 401(k) Replacement Plan
Socialism Du Jour - "Spread The Wealth Around"
Can We Afford This Nonsense? No, But So What
Conclusions - After Today, Anything Is Possible

Introduction

On this Election Day that is expected to end with a win for Senator Barack Obama, I think it's important to let you in on what the liberals in Congress are already discussing about your retirement planning options. Earlier in October, Congressional Democrats began discussing the possibility of eliminating the favorable tax benefits related to 401(k) plans, effectively killing the very popular retirement planning device.

In its place, the Dems propose to enact a government-sponsored plan that would transfer the role of total retirement security into its hands. The problem is, could the investment options be limited to only a special type of government bond? You know, the kind they use for the Social Security System where you can claim there's a trust fund but the money's all gone.

In any other circumstances, I would say that this proposal doesn't have a snowball's chance of becoming law. However, a year ago I would have told you it would be next to impossible for the Fed and Treasury to guarantee hundreds of billions in worthless bonds, force mergers of financial services companies, buy hundreds of billions in equity stakes in our largest banks or take ownership in a public corporation. If the Dems get a supermajority in both Houses of Congress, I won't be surprised by any neo-socialist boondoggles that may well appear, especially if Obama wins the election.

I fear that the recent bailout maneuvers have started us on a slippery slope toward socialism. Where will it stop? Hopefully, today. If not then, we might see it get a lot worse before it gets better. Whatever turns out to be the case, you need to know what may be coming on the retirement account front, specifically for 401(k)s.

Before we get to that, I will quickly review the latest economic numbers which are grim. We are now in a recession, textbook definition or not, and I expect it will only get worse for some time to come. I will have a more detailed analysis on the economy and what we should expect in an upcoming E-Letter.

The Economy Falling Fast Into Recession

Last Thursday the Commerce Department announced that 3Q Gross Domestic Product fell at an annual rate of -0.3%. This was the "advance" report which relies on somewhat scant data for September, so the next GDP report late this month could well be revised downward. The much-watched ISM Manufacturing Index plunged from 43.5 in September to 38.9 in October, a 26-year low. The Chicago Purchasing Managers Index, a proxy for business spending, imploded from 56.7 in September to 37.8 in October.

Consumer confidence fell off a cliff in October, plunging from 61.4 in September all the way down to 38.0, an all-time low for the index. Personal consumption spending fell 0.3% and durable goods orders slumped 2.9% in September (latest data available). General Motors reported yesterday that car sales for October were down over 45% from yearago levels. Retailers are bracing for a very disappointing holiday season.

Our economy is in serious trouble, folks! And the credit crunch is far from over. I could see this recession lasting a year or longer. I will have more detailed economic analysis in the next week or so, depending on what new surprises we see in the days just ahead.

Democrats Want To Highjack Your 401(k)

By now, many of you may have read about a new Democratic proposal to eliminate the tax incentives provided to 401(k) retirement plans, and replace them with 'government-guaranteed' retirement accounts. On its face, this plan is being touted as a way to restore stock market losses incurred by 401(k) participants over the past couple of months. However, the real agenda is far more rooted in liberal ideology. If you read what follows, I think you'll agree, and it should scare you!

Before getting into what has been proposed, let's take a look at exactly what the Democratic proposal would do away with. Many Americans are not aware of all of the tax benefits available to help workers save for retirement in 401(k) plans, including plenty of people who actually have these retirement plans. The Democrats are no-doubt counting on participants not knowing what they are giving up to make the sale easier.

The Democrats' proposal does not seek to do away with 401(k) plans. Instead, it places the tax advantages enjoyed by employers and employees in the crosshairs. Therefore, it would be beneficial to review just what those tax advantages are. Note that the following benefits pertain to traditional 401(k)s, but are not applicable to special "Roth" 401(k) contributions, which I will cover a little later on. Again, these are the current tax advantages for 401(k) accounts:

Employee contributions to the 401(k) are deductible for income tax purposes, but not for Social Security tax purposes;
Employer contributions are not taxed as compensation to participating employees for income tax or Social Security tax purposes;
Earnings (interest, dividends, capital gains, etc.) on employer and employee contributions are not currently taxed to the participant, but are allowed to accumulate on a tax-deferred basis. To illustrate, let's compare the accumulation of a contribution of $300 per month on a taxable and tax-deferred basis. Assuming a 30-year time horizon and 6% earnings (which are for illustration purposes only and not guaranteed), the taxable account would grow to $172,453, while the tax-deferred account would grow to $227,146. You can see the results using other assumptions by going to the following website for a tax-deferral calculator:

http://www.calcxml.com/do/inv07
Finally, assets grow tax-deferred in traditional 401(k) plans, not tax-free. Thus, withdrawals at retirement are taxed as ordinary income in the year in which they are actually withdrawn. Most retirees withdraw annually only what they need to supplement their other sources of retirement income.

I noted above that these tax benefits pertain to traditional 401(k) plans, but they do not apply to special "Roth-type" contributions and earnings. In Roth plans, contributions are not tax-deductible when made. However, earnings on all Roth contributions can be withdrawn tax-free IF they are held for a sufficient period of time. For younger 401(k) participants, this can be a huge advantage. Note, however, that these special rules do not apply to employer matching contributions.

As you can see, the tax benefits associated with traditional 401(k) plan contributions and earnings are not only favorable to the employer, but also to the employee. The ability to grow retirement assets on a tax-deferred basis is a huge benefit, and is part of the reason that these plans have gained so much in popularity over the last 20 years or so.

The Democrats' 401(k) Replacement Plan

I have read a number of articles describing the alternative 401(k) plan being considered by some of the Democratic leadership. This plan was the brainchild of Dr. Teresa Ghilarducci, an economics-policy professor at the New School for Social Research in New York (where else?). However, I got so many different details from the various articles I read, I figured it would be best to review Dr. Ghilarducci's own testimony and briefing paper rather than counting on hearsay.

It's a good thing I did, because Dr. Ghilarducci's original proposal is quite different in some respects than the plan she revealed in her Congressional testimony. However, either proposal would still likely result in the death of 401(k) plans and would put the government in the role of providing retirement security. Here are the details of her original briefing paper from November of 2007:

As already noted, the proposal would not do away with 401(k) plans, but would eliminate all of the tax benefits as discussed above. I must assume that this also means the tax benefits associated with Roth-type 401(k) contributions as well. This would, in effect, kill 401(k) plans as the tax incentives for employers and employees are the main drivers for their adoption and participation.
Instead of employer-sponsored 401(k) plans, the government would set up special Guaranteed Retirement Accounts (GRAs). Participation would be mandatory for all workers except for those who are covered by an equivalent or better defined benefit retirement plan.
Required contributions of 5% of salary (equally shared by employer and employee) would be made to the GRA each year, and would be administered by the Social Security Administration. Contributions will apply only up to the Social Security earnings cap (currently $102,000 for 2008), and workers will have the option to make additional after-tax contributions to the GRA.
To offset the loss of before-tax contributions in 401(k) plans, workers would receive an annual $600 refundable tax credit, indexed to inflation. Note that the "refundable" nature of this tax credit insures that workers receive it even though they may not pay any income taxes. For lower-paid workers, all or part of the $600 tax credit would be directed into the GRA to insure at least a $600 annual contribution for every worker.
As noted above, the GRAs would be administered by the Social Security Administration and would be guaranteed at least a 3% annual return. However, the original proposal suggests that these contributions be managed by a unit of the government's Thrift Savings Plan, and not placed into government IOUs. Independent trustees would direct the investment of contributions and have the authority to hire commercial money managers. While the government would guarantee a minimum return of 3%, it would also be possible to earn excess returns which could be credited to GRA accounts.
Finally, at retirement, GRA account balances are converted to inflation-indexed annuities based upon the life expectancy of the participant. Even so, individuals will be permitted to take a partial lump-sum distribution equal to the greater of 10% of their account balance or $10,000, and will also be able to select among optional survivor benefits in exchange for a smaller monthly check.

The supposed benefits of this new retirement arrangement will be to provide a benefit roughly equal to 25% of the pre-retirement income of a full-time worker who works 40 years and retires at age 65. Noting that Social Security replaces approximately 45% of pre-retirement income of the average worker earning $40,000, the proposal states that the combined programs can replace 70% of pre-retirement income of such workers.

Of course, that only applies to workers earning their "averages" and working for the period of time they consider to be typical. The actual amount of replacement income will depend upon actual earnings. A table in Dr. Ghilarducci's briefing paper notes that a "high earner" averaging $60,000 per year in earnings at retirement will replace only 61% of pre-retirement pay, while a "low earner" with only $20,000 of earnings at retirement will replace 89% of pre-retirement pay. Now that's what I call spreading the wealth, but more about that later on.

There are many other details of this plan that space does not permit me to discuss. For more details of the original proposal, see Dr. Ghilarducci's briefing paper for the Economic Policy Institute at the following web address:

http://www.sharedprosperity.org/bp204.html

Congressional Testimony Paints A Different Picture

It's safe to say that Dr. Ghilarducci's original proposal is not as bad as what we heard being proposed during her October testimony before the Committee on Education and Labor. This testimony provides some insights as to how the proposal has changed as the markets have wreaked havoc upon the account balances of 401(k) participants, and the government has moved to "bail out" various financial sectors.

For example, the original proposal didn't spend much time talking about "trading in" existing 401(k) accounts for the new GRA, but Dr. Ghilarducci's testimony notes that such a trade-in could occur based on "mid-August [stock market] prices." In other words, the government would pony up the difference between participants' current reduced account balances and what they had in mid-August before the latest stock market meltdown.

Other testimony given during the same Committee hearings stated that $2 trillion of value had been lost by participants in 401(k)s, IRAs and similar retirement plans over the course of the past 15 months. How much of this represented "lost" 401(k) balances is unknown, but whatever disappeared between mid-August and October would be restored by the government.

Also recall how Dr. Ghilarducci originally proposed a reasonable trustee-directed investment plan for the entire GRA. However, her recent Congressional testimony modified this stance. She now proposes that 401(k) accounts "traded in" to restore their mid-August values would be invested in a special type of government bond that earns 3%, adjusted for inflation. The testimony makes it clear that the government bond proposal would apply only to restored account balances traded in for GRAs, but who knows what Congress may decide.

Plus, we all know that these special bonds would likely be similar to those in the Social Security "trust funds." It is a sad fact that money contributed to the Social Security trust funds is simply spent by the government in exchange for IOUs. I have written previously about how the Congressional Budget Office described the bonds in the Social Security trust fund back in 2002, but I'll reproduce it below just to drive home the point:

"Trust fund holdings, as internal liabilities between government accounts, are not assets of the government. Nor do they represent money owed to program recipients individually; payments to Social Security recipients and beneficiaries of other social insurance programs are based on a variety of rules set by law unrelated to trust fund holdings. A federal trust fund is basically an accounting device that measures the difference between the income designated for a specific program and the expenditures made to its beneficiaries. The accumulated difference, or balance, often represents a reserve of future 'spending authority' for the program, but it is not a reserve of money for making payments." [Emphasis added]

"In the future, when receipts for such programs as Social Security fall below their expenditures, the legal authority to pay benefits will exist as long as their trust funds have balances, but the government will have to generate cash to pay benefits either by running a surplus in the rest of the budget--which would probably require cutting other spending or raising taxes--or by borrowing from the public."

Understand that the above described makeover plan for 401(k)s is just the starting point, especially under an Obama Administration and Democrat majorities in the House and Senate.

Specifically, Dr. Ghilarducci's testimony also made it clear that she is not just aiming at 401(k) plans, but also various other types of "defined contribution" plans including profit sharing, money purchase pension plans, 403(b) plans and even IRAs. Perhaps we should christen this proposal "Social Insecurity 2.0."

Other details are far less than clear right now, such as the tax treatment of 401(k) account balances transferred into a GRA, what would happen to workers who don't fit the "average worker's" 40 years to contribute to the plan, and many, many others. If this plan gains any traction in the new Congress, I'm sure we'll hear more about these and other details yet to be disclosed.

Whatever the final form of an actual bill to introduce GRAs, if any, Dr. Ghilarducci's proposals are still a major diversion from retirement planning law that has steadily evolved since the passage of the Economic Recovery and Income Security Act of 1974, otherwise known as ERISA. What would cause Congressional Democrats to trash over 30 years' worth of retirement planning law? I'll give you a hint: it starts with an "S."

Socialism Du Jour - "Spread The Wealth Around"

The first hint at the real motivations behind the GRA proposal should come from the fact that Dr. Ghilarducci's paper was published by the Economic Policy Institute, not exactly a bastion of conservative thought. Plus, the table of contents on the briefing paper was punctuated by the tagline "Agenda for Shared Prosperity." Isn't this just another way to say, as Senator Obama suggests, to "spread the wealth around?"

And don't think this is just an over-the-top reaction from a conservative. Dr. Ghilarducci, the architect of the new plan, said the following during a recent interview:

And what's amazing about this is that it's actually, um, doesn't cost the government anybody (sic). I'm just rearranging the tax breaks that are available now for 401(k)s and spreading -- spreading the wealth.
[Emphasis added - GDH]

You would think that the Democrats would have coached her to not describe it in those exact words, but the bottom line is that spreading the wealth is exactly what GRAs are designed to do.

The carrot at the end of the stick is the restoration of accounts to their August 2008 values, before the latest market crash. Imagine how many Americans would jump at the chance to recoup the market losses of the last couple of months!

Free money, or so it would seem. That's how socialism works: give 'em a short-term benefit in exchange for a lifetime of bondage.

While a lot of Dr. Ghilarducci's testimony dealt with enhancing retirement security, reducing investment-related fees and making up for losses incurred during the recent bear market, a quick review of her Congressional testimony reveals the real reason for this desire to change to a new government-sponsored universal retirement plan.

According to Dr. Ghilarducci, the current system of providing tax incentives to companies and workers for sponsoring and participating in 401(k)-type plans is inefficient. While you and I might define the term "inefficient" much differently, for purposes of the "spread the wealth" crowd, Dr. Ghilarducci defines it as having too much of the tax subsidies go to people who actually pay taxes (ie - higher income earners).

Her testimony notes that 6% of taxpayers with incomes over $100,000 per year reap 50% of the total tax benefits from 401(k) and related plans. Never mind that this 6% of taxpayers pay the lion's share of all income taxes. I don't have numbers for the top 6%, but in 2006, the top 5% of taxpayers paid 60% of all income taxes. Plus, approximately 1/3 of filers pay no income tax at all based on 2006 income tax statistics.

I would argue that it makes sense that people who actually pay taxes should be the ones receiving the lion's share of any tax benefits, not those who pay no taxes at all. Demographics would also seem to dictate that high earners would get most of the benefits. My firm counsels workers to start contributing to their 401(k) plan early to allow compound interest to grow. Thus, it makes sense that those with larger balances are those who have been saving a long time, and who are most likely to have worked their way up into high-paying positions. This proves that working hard and saving early pays off in the long run.

However, the Democrats now want to say that those who worked hard to excel and who took advantage of tax incentives to save a sizeable nest egg should be punished and have their tax benefits given to those who have not been as industrious or mindful about saving.

The bottom line is that this whole proposal is nothing more than a way to redistribute wealth based on liberal ideology. It's being sold as a way to restore balances, guarantee minimum future returns and reduce the uncertainty of market-based investments, but you can rest assured that it's just another step on the road to increased government control of every part of our lives, also known as socialism.

A New Democratic Piggy Bank

I also find it very interesting that one of the new wrinkles that has appeared in Dr. Ghilarducci's proposal between its original release and her recent testimony would allow 401(k) participants to have their account balance restored if they move their account into a new government bond. Considering that billions of dollars will be required to bail out Wall Street due to the subprime crisis, the future of social programs under a Democratically controlled Congress were in question. Where would they get the money?

Now we know one way they might try to get some cash in the coffers - highjack our 401(k)s and other tax-deferred retirement accounts.

Plus, it is currently unknown how much, if any, of the ongoing contributions would be allocated to these special government bonds. Since the whole matter is currently in flux, I could see a Democratic Congress mandating all or part of ongoing contributions be placed into government-guaranteed bonds. Sure, the Democrats will try to sell GRAs as a way to insure retirement stability, but it will really be a way to have access to a gigantic stash of cash.

Can We Afford This Nonsense? No, But So What?

This new 401(k) replacement proposal results in affordability issues at several levels. First, can the government afford to restore mid-August values for everyone in a defined contribution type of retirement plan? After all, the amount of money to do so would be gargantuan! Well, I guess it can as long as they keep the printing presses going at the Fed. However, that doesn't mean it's affordable.

The Congressional Budget Office has estimated that all types of retirement plans (IRAs, defined benefit, 401(k), etc.) have lost apprx. $2 trillion over the last 15 months due to stock market declines. I cannot find a statistic showing how much of that loss was in defined contribution plans like 401(k)s, but I would guess it's in the hundreds of billions.

Plus, what about the defined benefit plans that are now going to be under-funded. It probably won't be long until we see companies with at-risk pension plans asking for a bailout of their own. If we bail out 401(k) participants, can we justify not bailing out employers who may have no other choice than to terminate their plan if they can't get a government handout?

Another level of affordability is in relation to the returns needed in a 401(k) to produce a meaningful retirement benefit. The proposed bond investments will guarantee 3% above inflation on balances "traded in" to the GRA. Since inflation historically runs about 3% per year, that means a 6% return. It will be hard for workers to build much wealth with such low returns.

Finally, we have to look at the effects on the stock market. We don't know exactly how the money "traded in" to a GRA will be treated, but that giant sucking sound you'll hear might be money flowing out of the equity markets and into government bonds. That will mean more downward pressure on stock market prices.

And what will the government do with the trillions of dollars it will be given? Three guesses and the first two don't count: Spend it, of course. Maybe this is how Obama gets the money to fund his lavish new spending programs. It could happen.

What is really hard to understand is that Democrats continually grouse about the regressive nature of the Social Security tax, which is currently 7.65% of pay (matched by the employer). Self-employed individuals must pay both shares, so their tax rate is 15.30%. While Obama's tax plan promises to rebate part of this tax, it would seem a contradiction to add yet another 5% mandatory contribution/tax/whatever for employees to pay. Plus, if employers have to pay half of this mandatory contribution, it will represent yet another expense during a period of recession. Not a good idea!

The entire idea of replacing employer-sponsored 401(k) plans with a government sponsored Social Security - II plan would have been considered ludicrous prior to August of this year. However, after banks, brokerage firms, insurance companies and car makers all lined up for a share of government's largesse, it's now not hard to imagine something this insane actually becoming law.

Conclusions - After Today, Anything May Be Possible

Considering that this proposal has been trotted out during a Committee hearing at a time when Congress is not even in session likely indicates that it's no more than a trial balloon to gauge public reaction. Dr. Ghilarducci's original proposal made no waves when it was released a year ago, likely because no one felt there was a snowball's chance of it ever becoming law.

Now, however, times have changed. The recent market meltdown has many investors worried about their ability to retire with sufficient income. On top of that, lawmakers have seen that the major Wall Street bailouts have been passed without riots in the streets. This just might give them the ability to answer all of their constituents who have asked, "Hey, where's my bailout?"

I want to think that this proposal has very little chance of ever becoming law. Over the last 2-3 decades, there has been a continual expansion of tax incentives to get workers to save for retirement, and for employers to help them do so, and there is no doubt this has been a good thing. Thus, I would hope this will not be dismantled in the next Congress.

But we should all understand that, if Barack Obama becomes our new president with supermajorities in Congress, anything is possible. A massive expansion of government and a rollback of our freedoms are not out of the question. Such an expansion of government has to be funded somewhere, and 401(k)s and other supposedly sacred retirement plans, including IRAs, may appear to be the low-hanging fruit to the liberals who will be in control in Washington.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

'Panic of 2008' - Will the Democrats bring us a Depression? (must read)
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_hassett&sid=aY3kqxNeV7lU

We Could Be In for a Lurch to the Left
http://online.wsj.com/article/SB122576065024095511.html

Economic Ills Will Force Winner's Hand
http://online.wsj.com/article/SB122575838410095279.html

Thomas Sowell - Obama all "Ego and Mouth"
http://www.realclearpolitics.com/articles/2008/11/ego_and_mouth.html

Uncle Sam's $700+ Billion Toxic Securities Fund

Gary D. Halbert — Tue, 23 Sep 2008 20:03:55 GMT

IN THIS ISSUE:

Details Of The Massive $700 Billion Bailout
Government Guarantees Money Market Funds
Will Congress Pass The Bailout Plan?
Should The Government Bail Out Homeowners?
Will Uncle Sam Overpay For The Assets?
Credit Crisis May Tip The Election To Obama
Time To Prepare For A Recession Just Ahead

Introduction

By now, everyone reading this is well aware that the Bush Administration, the Treasury Department and the Federal Reserve Bank are pushing Congress to quickly approve a gargantuan $700+ billion bailout plan, with the hope of saving large banks, investment firms and other financial institutions that are overloaded with troubled mortgage-related securities.

This is by far the largest financial rescue plan ever envisioned on the part of the government, and I would argue, by far the most risky – both in terms of the potential losses for American taxpayers, and in terms of the sweeping, unchallengeable powers it would grant to the government. I will have more to say about the latter in the pages that follow.

Three questions emerge: 1) Is this massive bailout necessary?; 2) Is it the best way to solve the credit crisis?; and 3) Will it work? Unfortunately, the answer to all three is, we just don't know.

I believe that Treasury Secretary Paulson and Fed Chairman Bernanke were correct last week to fear that we were headed for a potentially serious run on banks and money market funds, starting possibly as early as this week, had the carnage in the markets continued. Whether you agree or disagree with the bailout, I think Paulson and Bernanke believed they had no other choice.

Of course, it remains to be seen if Congress will pass the colossal $700+ billion bailout this week as Bush, Paulson and Bernanke are urging. The stock markets that plunged lower early last week reversed their losses late in the week as rumors of the huge bailout package surfaced, culminating with the official announcement on Friday.

Yet on Monday of this week, the stock markets plunged again amid fears that Congress may not go along with the government's massive bailout plan. As this is written, it is impossible to know what will happen. But what is clear is that the US financial markets have frozen up, and if something significant isn't done soon, I believe we will be headed for a stock market crash and a serious recession or worse.

Finally, there will be millions of Americans who do not understand the dire implications of this financial meltdown, and will assume that this is just another massive bailout of the Wall Street rich by the Bush Administration and the Republicans (McCain included). Therefore, I expect this latest crisis and enormous bailout will likely hand the election to Barack Obama.

There are so many ramifications of this massive bailout that I don't even know where to start. But start we must, so here we go.

Details Of The Massive $700 Billion Bailout

We are told that the government's proposed $700 billion bailout may be structured along the lines of the Resolution Trust Corporation ("RTC") established in 1989 to liquidate the assets of failed Savings & Loans. But there is one distinct difference this time around. In 1989, the RTC was formed to take over assets of S&Ls that had already gone into bankruptcy.

This time, should the massive Treasury bailout (or something like it) be passed, the government will be taking over toxic assets of financial institutions that still survive, but are at risk of failure due to the mortgage related securities they hold. Here are the details of the massive government bailout plan, at least as we know at this point.

Under the proposal (the "Act") submitted to Congress on Saturday, the Treasury Secretary would be authorized to purchase mortgage-related assets from any financial institution having its headquarters in the United States, totaling up to $700 billion at any given time. On Monday, the government expanded the bailout to include foreign corporations with "significant operations" in the US that bought mortgage related securities.

The term "mortgage-related assets" is defined in the Act as: "residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008."

If the bailout passes in its proposed form, the Treasury Secretary would be authorized to take wide-sweeping actions at his sole discretion.

Such actions include: 1) designating financial institutions as "financial agents" of the government, and requiring them to perform duties related to the Act as the government may require of them; 2) creating agencies to carry out the bailout and appointing such employees as may be required to carry out the authorities in the Act and defining their duties; and 3) issuing such regulations and other guidance that may be necessary to carry out the authorities of the Act.

Such actions also include: The Secretary shall have authority to manage mortgage-related assets purchased under the Act, including revenues and portfolio risks. The Secretary may, at any time at his discretion, sell or enter into securities loans, repurchase transactions or other financial transactions in regard to any mortgage-related asset purchased under the Act.

In short, the Treasury Secretary would have complete control of how the massive bailout effort is undertaken. The Act states: "The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act."

The only requirement under the proposal sent to lawmakers on Saturday is that the Treasury Secretary must report to Congress within three months of the first exercise of the authority granted in the Act and only semi-annually thereafter. Wow! $700 billion, and you only have to report to Congress twice a year!! But that is not likely to stand.

Over the weekend, Democratic leaders discussed enhancing oversight by carving out a special monitoring role for the Government Accountability Office (GAO), the investigative arm of Congress. The Republican leadership echoed similar wishes for tougher scrutiny, suggesting the creation of a congressional oversight panel, headed by top leaders in both parties.

Oversight, or lack thereof not withstanding, there was another bombshell in the rescue package. The bailout proposal sent to Congress on Saturday states the following: "Decisions by the [Treasury] Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency."

This provision, if it stands, would mean that the Treasury bailout would be beyond the rule of law, both as it relates to the current Treasury Secretary and the next one appointed by McCain or Obama. Obviously, this provision was included to protect against potentially unlimited challenges in the courts which could stall or prohibit the rescue efforts. This is very troubling.

While the brief summary above is not comprehensive, it should give you an idea of the enormity of the latest massive plan to rescue financial institutions to the tune of at least $700 billion – actually much more as I will discuss later on.

We will continue our discussion of the bailout plan below, but first here's the latest on the money market fund developments.

Government Guarantees Money Market Funds

I trust that virtually everyone reading this E-Letter has some assets in money market funds. As you probably know, the turmoil in the financial markets spilled over into the supposedly safe money market mutual funds last week. Last Tuesday, one of the oldest and largest institutional money market funds, the Reserve Primary Fund, announced that its share price had fallen below the $1.00 level to 97 cents. In financial terms, it "broke the buck."

The Reserve Primary Fund dipped below $1.00 as a result of the bankruptcy of Lehman Brothers. The Reserve Primary Fund, with over $62 billion in assets, announced last week that it owned $785 million in Lehman bonds, and that it was writing those bonds down to zero, which effectively caused its share price to break the buck. Redemptions were halted.

Also, last week Putnam Investments closed an institutional money market fund and said it will return money to clients, after investors pulled out cash despite the fund's lack of exposure to troubled financial firms such as Lehman.

To shore up investor confidence, the Treasury Department announced plans Friday to insure and guarantee US money market funds.

President Bush authorized the Treasury to tap up to $50 billion from a Depression-era fund to insure the holdings of eligible money market mutual funds. And the Federal Reserve announced it will expand its emergency lending program to help support the apprx. $3.5 trillion in assets in US money market funds.

The government guarantee will be in place for at least one year. Money market funds will pay a fee to be in the insurance program. So for now, at least, your money in money market funds is as safe as if it were in a FDIC insured bank. Note, however, that the Treasury pronouncement on the money market funds guarantee stated that the insurance only applies to money that was on deposit with such funds on or before September 19. Money deposited after September 19 is apparently not covered by the guarantee.

Now back to the $700 billion mortgage bailout.

Will Congress Pass The Bailout Plan?

As noted in the Introduction, the stock markets surged higher late last week as news of the massive bailout plan surfaced, reversing all or most of the huge losses incurred early last week. But then the nation had the weekend to think about the enormous bailout plan, and whether or not the Congress would go along with the gigantic intervention.

The House of Representatives and the Senate are both controlled by the Democrats. While I believe there is a sufficient sense of urgency regarding the passage of some kind of large bailout plan, I will not be surprised if the Democrats, along with some Republicans as well, will not approve the rescue package. I believe that is precisely why the stock markets tanked again on Monday.

As this is written, several prominent Democrats are insisting that such a bailout must be accompanied by increased regulation and oversight. Certainly everyone would agree that the regulation of our financial markets is sorely overdue for an overhaul. But as Treasury Secretary Paulson made clear over the weekend, he believes the funding of the huge bailout package needs to happen NOW, whereas the regulatory changes will take time to implement.

Over the weekend, Democrats and some Republicans also complained that the proposed $700 billion bailout does little to help homeowners that are struggling to make their mortgage payments. It is very possible that lawmakers will tack on additional hundreds of billions of dollars to the already enormous rescue package that would go directly to homeowners who may be facing foreclosure.

Some Democrats, including Barack Obama, are arguing that the rescue package must include restrictions on the compensation of corporate executives of companies that make use of the rescue program to unload toxic mortgage securities on the government. On Monday, even John McCain suggested that the top executives of companies seeking to participate in the bailout should not make more than $400,000 a year (no more than President Bush's salary).

Some Democrats, including Senators Chris Dodd (D-CN) and Chuck Schumer (D-NY), are pushing for more egregious changes in US bankruptcy laws regarding home foreclosures. The proposal that Dodd has sent to Treasury Secretary Paulson would let bankruptcy judges modify the mortgages of homeowners facing foreclosure to allow them to keep their homes. Judges rewriting existing mortgages so people can stay in their homes? This is scary!

Some Democrats, including Barack Obama, are arguing that the rescue package must include a second economic stimulus package of up to $100 billion, following the $160 billion sent out earlier this year.

Then there is always the risk that Congress will load the already huge bailout legislation with billions more in "earmarks." It would not surprise me if the final bill easily surpasses $1 trillion if it is actually passed, which is looking increasingly uncertain. In that case, one can only wonder if President Bush will sign it.

So, it remains to be seen if the massive bailout Act, or something like it, is passed or not. Based on the stock market plunge on Monday, and the rhetoric coming out of the Senate banking hearings this morning, I would say the odds are no better than 50/50 for passage. If that is the case, look for the stock markets to continue to tank. Something serious needs to happen soon.

Should The Government Bail Out Homeowners?

As discussed above, many Democrats and some Republicans are arguing that, as a part of the government bailout, something should be done to help homeowners who are struggling to make their mortgage payments. In particular, many in Congress want to minimize the effect on homeowners who financed their homes with subprime and other non-traditional mortgages.

Never mind that many of these families should never have been given a mortgage due to their credit history or employment (or unemployment) situation in the first place. Most of us have heard the term NINJA loans: No Income, No Job or Assets. We also heard about the so-called LIAR loans where mortgage applicants purposely lied about their financial condition to buy a house.

Of course, in the spirit of political correctness, the government has now identified families who lied on their applications to get a mortgage as "victims." Thus, while many moan and groan about the lack of moral hazard in relation to the Wall Street bigwigs who wanted to make money, no one seems to want to hold individuals responsible for lying on their applications.

Instead, as John McCain ridiculously claimed last week, they were "forced" to take these mortgages. Give me a break! While many mortgage lenders were clearly too aggressive in offering home loans, no one forced borrowers to take out these loans. Let's get real.

It is clear now that the Democrats who run Congress are going to insist that additional billions be added to the bailout plan that will help out homeowners who are having a hard time making their mortgage payments, with little regard to whether they lied about their financial condition when they applied. If so, the bailout plan could be substantially higher than the $700 billion the Treasury asked for – if it is passed at all.

In fact, if we consider what has already been spent on the mortgage crisis, the total may be well above $1 trillion already, assuming that Congress passes the $700 billion rescue package this week, plus whatever amounts they add to it.

Will Uncle Sam Overpay For The Assets?

Treasury Secretary Paulson made the rounds on the Sunday talk shows, pushing the $700 billion bailout plan, and urging lawmakers to pass it this week before they adjourn. One thing Secretary Paulson did not make clear was how the government would value the mortgage-related assets that it would purchase from those wishing to participate in the program.

A Treasury pronouncement released on Saturday made the following statements about pricing: "Treasury will have authority to issue up to $700 billion of Treasury securities to finance the purchase of troubled assets… The timing and scale of any purchases will be at the discretion of Treasury and its agents, subject to this total cap. The price of assets purchases will be established through market mechanisms where possible, such as reverse auctions."

The problem is, there's no liquid market for subprime mortgages and other mortgage-backed securities that have dragged down banks and investment firms. With no trading in the assets, no one knows what they are worth now or might be worth in the future. They are being carried on institutions' books with values based on various indexes that are in some cases little more than guesses. And as those indexes have gone down, the institutions have recorded huge losses.

Furthermore, some of the instruments are complex, opaque derivatives tied to slices of other derivatives and financed by the sale of credit-default swaps to hedge funds and a variety of buyers. How do you price something like that? 80 cents on the dollar, 20 cents on the dollar, or somewhere in between? Who knows?

The government is, in some respects, constrained in driving a hard bargain because the whole point of the rescue program is to help banks get back on solid footing - not to force them into much deeper write-downs, potentially exacerbating their problems staying afloat. At the same time, the market turmoil has complicated efforts to determine the "real" value of the assets.

Obviously, it is too early for the Treasury to have all these details worked out. Suffice it to say that it will be a complicated process that will have serious implications, not only for the government and the holders of toxic debt, but also for the financial markets themselves.

Credit Crisis May Tip The Election To Obama

Americans have grown increasingly nervous as the mortgage/credit crisis has unfolded this year. The failure of Wall Street financial giants like Bear Stearns, Lehman Brothers, Merrill Lynch, AIG and others has only heightened concerns among the public.

Add to that the significant stock market downturn over the last year, which has affected tens of millions of Americans' investment and retirement accounts. Until now, most people thought this credit problem was at least reasonably under control.

Yet, last Friday's announcement of a $700+ billion government bailout of the banks and financial institutions sent a shockwave not only to Americans but investors around the world. Few, if any, had an inkling that the number would be remotely that large, and now we know that the ultimate number could be much higher, well over $1 trillion. It was a startling revelation!

But here's the reason I now believe the massive bailout may gift the election to Obama. Millions of American voters will see the bailout as nothing more than another George Bush giveaway to his rich friends and cronies on Wall Street – at the taxpayers' expense. Many may believe that John McCain would do the same thing if he were president.

Many Americans will not understand the gravity of the current financial crisis which has the potential to trigger a global recession or worse. Many will not understand Secretary Paulson's plea to enact the bailout now and reform the system and pursue and prosecute the bad guys later.

John McCain and Barack Obama have been in a statistical dead-heat for the last several months, although Obama has been marginally ahead most of the time. McCain got a bump up following his selection of Sarah Palin and the GOP convention, but over the last week or so, Obama pulled back into the lead, marginally, in the national polls.

Because of the latest escalation in the credit crisis, and the gigantic $700+ billion bailout request, I expect that potentially millions of undecided voters will now opt to go for Barack Obama. Even some who had never before considered voting for Obama may be rethinking that decision in light of the latest developments.

A lot can change in the next 43 days to the election. Who knows what other financial surprises may await us between now and November 4? But if I were to have to bet today, I would sadly put my money on Obama to win by a comfortable margin.

I have made no secret that John McCain was not my first choice for the GOP presidential nominee. But I have also made it known that I would certainly prefer Senator McCain over Senator Obama by a long-shot. So, it is not easy for me to predict now that Obama will likely be our next president.

One last political point: the current financial crisis and the enormous $700+ billion government bailout virtually assure that, if elected: 1) Obama will not be able to push through his aggressive spending plans; and 2) McCain will not be able to push through any tax cuts. Realistically, the money for either of these proposals is no longer there.

In light of the credit crisis and the massive bailout plan, McCain is now hedging on his promise of tax cuts, realistically so. Obama on the other hand says his social spending programs, including nationalized health care, are "already paid for." How is that? By allowing the Bush tax cuts to expire (a tax increase) and raising taxes on those making over $250,000 a year. Yet Obama claims shamelessly that he will cut taxes for 95% of Americans. Never mind it's a lie.

Time To Prepare For A Recession Just Ahead

On Friday, the Commerce Department will release its final report on 2Q Gross Domestic Product. In its previous estimate, 2Q GDP was 3.3%, well above most expectations. The pre-report estimate is that the government will raise that number to 3.4-3.5% on Friday. But in light of the deepening financial crisis, this week's final 2Q GDP report will be ignored.

While I have tended to be on the more optimistic side for the last several years as it pertains to the US economy, I am now turning bearish. I believe the events we have seen over the last two weeks will crush consumer confidence in the weeks and months ahead.

It seems clear that most consumers are angered and alarmed by the proposed massive $700+ billion bailout of financial institutions. They certainly are not comforted by it. Many are scared by the magnitude of the crisis. Virtually everyone knows who Merrill Lynch is - or was. Now it is gone as an independent American financial icon. People are realizing that we are in dangerous territory.

I predict we will see a significant slowdown in consumer spending for the balance of this year unless the financial markets stabilize quickly. Consumer spending accounts for over 70% of GDP. If I am correct, then we are headed for a recession.

The Index of Leading Economic Indicators fell 0.7% in July and 0.5% in August (latest data available). The Index has been down in three of the last four months. This suggests that economic growth slowed significantly in the 3Q. I will be surprised if economic growth doesn't fall into negative territory in the 4Q.

Much will depend on whether or not the mortgage bailout works.

Conclusions

Given the scope and magnitude of the recent mortgage-backed securities bailout proposed by the government, I think there are a number of conclusions that we can draw:

1. The massive mortgage bailout is unprecedented and extremely risky, but some kind of government intervention is most likely necessary in order to avert a global financial meltdown;

2. While the government is asking for $700 billion, we already know that the Fannie Mae, Freddie Mac and AIG bailouts transactions will push the combined cost to well over $1 trillion, plus whatever the Congress adds on, and you can bet there will be a major addition that will directed, rightly or wrongly, to struggling homeowners;

3. We are now past the issue of "moral hazard," in my opinion. We are now truly in a financial crisis that could easily spiral out of control very quickly. Something major needs to be done quickly, and there is no time for political games. People are on the verge of panic, and the stock markets may continue to plunge. Expect volatility to remain sky-high for a while longer.

4. I now believe this financial crisis will send us into a recession just ahead. While I have correctly been more optimistic than most of my peers in newsletter-land for the last several years, I am now turning bearish on the US economy. It now appears just a question of how deep it will be and how long it will last;

5. It remains to be seen just how deeply this financial crisis will affect the campaign rhetoric coming out of the two presidential contenders. Any thinking person can see that a $700 billion to $1 trillion bailout will severely restrict any politician's ability to cut taxes or increase social spending, but let's see if we hear any scaling back of such campaign promises; and

6. Finally, I now believe that the housing/financial crisis and the massive government bailout may hand the presidential election to Barack Obama in November. The general public does not fully understand the seriousness of the credit crisis, and will deem the massive bailout as just one more example of President Bush bailing out his rich cronies on Wall Street

The race between McCain and Obama has been neck-and-neck for several months, but Obama has pulled back into the lead following McCain's convention bounce. Barring something unusual, I expect the credit crisis and the bailout to send Obama increasingly ahead in the polls, with a win likely in November.

In fact, the latest polling data out this morning show Obama pulling decisively ahead in Colorado, ahead in Virginia and up to even in Ohio and North Carolina. McCain has to carry every one of these battleground states to win, yet they are now trending to Obama.

If this trend continues, it will be Obama, a Senator for less than three years, who will be in charge of solving the worst financial crisis in most of our lifetimes.

Sorry for a depressing E-Letter, but things are what they are.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

How Fannie & Freddie Failed (prepare to be angry)
http://www.ibdeditorials.com/IBDArticles.aspx?id=306978378974502

Treasury agrees to some changes in mortgage bailout proposal.
http://online.wsj.com/article/SB122209290438362805.html

Obama's spending & McCain's tax cuts are out the window now.
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/19/AR2008091903185.html

‘Wall Street' No Longer Exists
http://online.wsj.com/article/SB122212959612065505.html

Category 2 Hits Texas, Cat 4 Hits Wall Street

Gary D. Halbert — Tue, 16 Sep 2008 21:57:22 GMT

IN THIS ISSUE:

Lehman Brothers Files For Bankruptcy
Bank of America Buys Merrill Lynch
Largest Bank/Brokerage In The World
Will AIG Be The Next Giant To Fall?
Emergency Sunday Wall Street Trading Session
Where Our Clients’ Assets Are Held
Conclusions – History In The Making, Perhaps

Introduction

Hurricane Ike, a massive Category 2 storm, ravaged the coastal areas of southeastern Texas and western Louisiana on Saturday as it moved inland. Galveston and Houston were severely damaged, both by the winds and the massive storm surge. Damages are preliminarily estimated to be in the $25 billion area. As this is written, the death toll is estimated at 33 for those in the storm’s path.

While the nation’s attention was focused on Hurricane Ike over the weekend, there was another storm brewing on Wall Street. We awoke on Monday to learn that Lehman Brothers, America’s fourth largest investment bank, was declaring bankruptcy. We also learned that brokerage giant Merrill Lynch had been acquired by Bank of America, reportedly for $45-$50 billion in stock.

If those two landmark events weren’t enough, we also learned on Monday that American International Group (AIG), the 18th largest company in the world, was entering a major restructuring plan, which would include a major sale of assets in order to raise a huge amount of cash – estimated to be $70-$75 billion - to avoid a fate similar to Lehman Brothers.

It was also revealed that AIG is seeking up to $40 billion in loan guarantees from the Fed. It was reported on Monday that the Fed said NO over the weekend. AIG’s share price plunged over 60% early Monday and closed down over 50% at the end of the day, and is sharply lower again today. Not surprisingly, there is widespread speculation that AIG may be the next US financial giant to fail.

These latest dire financial events last weekend came on the heels of the announcement just over a week ago that mortgage giants Fannie Mae and Freddie Mac had been nationalized by the federal government due to the mortgage/credit crisis. Likewise, the Lehman, Merrill and AIG developments are also largely due to the housing slump and the subprime mortgage/credit crisis.

Stocks immediately plunged on the opening yesterday morning as investors around the world worried about the safety of their money. Unlike the Bear Stearns bailout by the government in March, the Fed allowed Lehman Brothers to go bankrupt. Likewise, the takeover of Merrill Lynch, the world’s largest brokerage/investment banking firm, sparked concerns among investors worldwide. The Dow plunged more than 500 points on Monday.

This week, we take a look at the latest developments on Wall Street and what they may mean for the investment markets. I will also summarize where our clients’ money is invested. For the record, we do not hold any client accounts at Lehman Brothers or Merrill Lynch.

Let’s get started, as there is a lot to cover.

Lehman Brothers Files For Bankruptcy

Founded in 1850, Lehman Brothers Holdings Inc. had grown to become the fourth largest investment bank in the US, with operations around the globe. The firm was a major player in investment banking, equity and fixed-income sales, research and trading, investment management, private equity and private banking. It has also been a primary dealer in the US Treasury securities market.

During the housing boom of the last decade, Lehman became increasingly active in the home mortgage market and the packaging and selling of mortgage-backed securities. A Lehman subsidiary, BNC Mortgage, was a large player in the subprime mortgage market. In August of 2007, Lehman shut down BNC, but this was not the end of the firm’s subprime troubles. According to published reports, here’s how Lehman imploded.

In 2008, Lehman faced an unprecedented loss due to the continuing subprime mortgage crisis. Lehman’s loss was apparently a result of having held on to large positions in subprime and other lower-rated mortgage tranches. Whether Lehman was unable to sell the lower-rated bonds, or made a conscious decision to hold them, is unclear. In any event, huge losses accrued in lower-rated mortgage-backed securities throughout this year.

In the second fiscal quarter, Lehman reported losses of $2.8 billion and was forced to sell off $6 billion in assets. In the first half of 2008 alone, Lehman stock lost 73% of its value as the credit markets continued to tighten. In August 2008, Lehman reported that it intended to release 6% of its work force, some 1,500 people, just ahead of its third-quarter-reporting deadline in September.

On September 10, Lehman announced a third quarter loss of $3.9 billion and their intent to sell off a majority stake in their investment-management business, which included Neuberger Berman and other subsidiaries. Lehman’s stock plunged another 40% on September 11. According to reports, the company was desperately seeking a merger partner at that point and well into last weekend.

It is still uncertain whether Lehman formally requested a Fed bailout, but the government reportedly let Lehman know that it would not come to the rescue with loan guarantees as it did with the Bear Stearns bailout. According to the Wall Street Journal and other sources, Lehman entered into negotiations with Bank of America (BofA), Merrill Lynch and Barclays Bank late last week and over the weekend.

According to the WSJ, BofA pulled out of the Lehman talks as it considered Merrill Lynch to be a better fit. Barclays Bank also reportedly declined to make an offer to purchase the firm. On Sunday, The New York Times reported that Lehman would file for bankruptcy protection for its parent company, Lehman Brothers Holdings, on Monday while planning to keep its subsidiaries solvent during the bankruptcy proceedings.

In negotiations over the weekend, a group of Wall Street firms agreed to provide capital and financial assistance for Lehman’s liquidation in an effort to avoid chaos in the markets. The Federal Reserve, in turn, agreed to a swap of lower-quality assets in exchange for loans and other assistance from the government.

Interestingly, the International Swaps and Derivatives Association (ISDA) orchestrated an emergency special trading session on Sunday to allow market participants an opportunity to potentially offset positions in various derivatives on the condition of Lehman’s impending bankruptcy. More details on this emergency Sunday trading session will follow below.

Shortly before 1 a.m. on Monday morning, Lehman Brothers Holdings announced it would file for Chapter 11 bankruptcy protection. Lehman’s bankruptcy will be the largest failure of an investment bank since Drexel Burnham Lambert collapsed amid fraud allegations 18 years ago.

Bank of America Buys Merrill Lynch

As everyone reading this knows, Merrill Lynch (ML) is one of the world’s largest brokerage firms with offices in 40 countries and territories, with apprx. 60,000 employees worldwide and total client assets of approximately $1.6 trillion. ML is also a global provider of wealth management, underwriting and various advisory services. The company was founded in New York in 1914 by Charles E. Merrill.

Obviously, Merrill Lynch is a global powerhouse in the financial industry. Yet along with Lehman Brothers and many others, ML became a large player in the mortgage markets in the 1990s, including a significant presence in the subprime mortgage market. By late 2007, ML announced that it was writing down $8.4 billion in losses related to the “national housing crisis” (read: subprime), and that its CEO, Stanley O’Neal, had resigned.

During the 12 months from July 2007 to June 2008, Merrill reported losses of $19.2 billion. Over the last year, ML’s share price tumbled from above $75 to below $20 as this is written.

In August of this year, New York Attorney General Andrew Cuomo threatened to sue Merrill Lynch over its alleged misrepresentation of the risk on mortgage-backed securities. A week earlier, ML reportedly offered to buy back $12 billion in mortgage-backed debt and later said they were surprised by the lawsuit. Three days later, the company reported a hiring freeze and revealed that they had charged almost $30 billion in losses to their subsidiary in the United Kingdom.

On August 22, Merrill’s CEO John Thain announced an agreement with the Massachusetts Secretary of State to buy back all auction-rate securities from customers with less than $100 million on deposit with the firm, beginning in October 2008 and expanding in January 2009. Bloomberg reported earlier this month that ML had lost $51.8 billion in mortgage-backed securities as a result of the subprime mortgage crisis. In short, Merrill Lynch was in trouble.

Enter Bank of America (BofA). Charlotte, NC-based Bank of America is the second largest bank in the US based on assets, behind Citicorp. But BofA has more branches (5,700 and counting) than either Citicorp or JP Morgan Chase.

Ken Lewis, BofA’s CEO since 2001, side-stepped the subprime mortgage crisis. Lewis reportedly shunned subprime mortgages as he believed these risky loans could backfire – as they did. He focused instead in building more branches, including international operations, acquiring other financial firms and expanding its asset base.

In late 2006, BofA acquired US Trust Company ($100 billion in assets) from Charles Schwab for $3.3 billion. In late 2007, BofA acquired the US assets of ABN AMRO, the large Dutch bank, for a reported $21 billion. These are just two examples of BofA’s numerous acquisitions.

On August 23, 2007 Ken Lewis decided it was time to test the waters in the subprime mortgage business, as BofA announced a $2 billion repurchase agreement for Countrywide Financial. Countrywide provides mortgage servicing for nine million mortgages valued at $1.4 trillion as of the end of last year, and was a big player in subprime mortgages.

Following that initial investment, on January 11, 2008, Bank of America announced that they would buy Countrywide Financial outright for $4.1 billion. This acquisition, which closed on July 1, 2008, gave the BofA a substantial market share of the mortgage business, and access to Countrywide’s expertise, technology, and employees for servicing mortgages. The acquisition was seen as preventing the potential of bankruptcy for Countrywide.

The point is, Bank of America avoided the subprime debacle and has a long history of aggressive acquisitions.

Largest Bank/Brokerage In The World

On Sunday, Bank of America announced it would purchase Merrill Lynch for $38.25 billion in stock. The Wall Street Journal reported later that day that Merrill Lynch was sold to BofA for about $44 billion or about $29 per share. Other reports on Monday indicated the purchase price was near $50 billion.

BofA gets Merrill’s investment-banking expertise and sprawling, powerful brokerage force, which is a natural fit for BofA’s own increasing focus on domestic banking and brokerage. Over 90% of Merrill’s “Thundering Herd” of brokers is focused on the US, which is BofA’s strength as well. ML’s wealth management is a stable business and its recurring revenue makes up 70% of the unit’s overall revenue, up from 59% in 2003 according to a ML executive.

In return, Merrill gets BofA’s financial stability. Still, Merrill comes with plenty of exposure to toxic assets, including $8.8 billion of gross exposure to collateralized debt obligations (CDOs).

The combined company would have leadership positions in retail brokerage and wealth management. By adding Merrill Lynch’s more than 16,000 financial advisers/brokers, BofA would become the largest brokerage in the world, with more than 20,000 advisers and $2.5 trillion in client assets.

The combination brings BofA global scale in investment management, including an apprx. 50% ownership in Black Rock, Inc., the largest publicly traded US investment management firm, which has $1.4 trillion in assets under management. BofA reportedly had $589 billion in assets under management prior to the ML acquisition.

Merrill Lynch’s stock closed at $17.05 per share last Friday, and some are questioning why BofA agreed to pay $29 per share for the giant brokerage. Numerous analysts speculated as to why BofA offered such a price when ML’s stock was probably headed lower, perhaps significantly lower. Nevertheless, BofA CEO Ken Lewis offered the following upon announcing the deal:

“Acquiring one of the premier wealth-management, capital-markets and advisory companies is a great opportunity for our shareholders… Together, our companies are more valuable because of the synergies in our businesses.”

Interestingly, Bank of America has apparently had its eyes on Merrill Lynch for many years. According to several reports, BofA chairman Ken Lewis, and his predecessor Hugh McColl, had more than a passing interest in acquiring the nation’s largest brokerage firm. Thanks to the subprime mortgage/credit crisis, BofA got ML on the cheap.

Will AIG Be The Next Giant To Fall?

Rumors are flying that American International Group (AIG) is also in serious financial trouble. AIG is one of the largest insurance company in the world. The company describes itself as follows on its home page on the Web:

“American International Group, Inc. (AIG), a world leader in insurance and financial services, is the leading international insurance organization with operations in more than 130 countries and jurisdictions. AIG companies serve commercial, institutional and individual customers through the most extensive worldwide property-casualty and life insurance networks of any insurer. In addition, AIG companies are leading providers of retirement services, financial services and asset management around the world. AIG’s common stock is listed on the New York Stock Exchange, as well as the stock exchanges in Ireland and Tokyo.”

Unfortunately, AIG has been one of the largest underwriters of complex debt securities known as “credit default swaps” that are used as insurance for a wide range of products, as well as a large portfolio of mortgages including subprime loans.

On Monday, New York Governor David Patterson approved a transaction in which various AIG subsidiaries would loan the parent company apprx. $20 billion to bolster its capital as it faces potentially disastrous credit downgrades. Actually, there are questions regarding whether the governor of New York has such authority, and if such loans are legal.

Specifically, many of AIG’s subsidiaries are not domiciled in New York. Such is the case in Texas where AIG is domiciled here. It is my understanding that Texas insurance regulators would have to approve a large loan (potentially several billion dollars) from AIG Texas to AIG’s parent which is domiciled in New York state. The same may be true in numerous other states (and foreign countries) where AIG subsidiaries are domiciled. Thus, we may be hearing more about this $20 billion loan in the days and weeks ahead.

AIG has also sought a $40 billion bridge loan from the Federal Reserve as a lifeline, as the three-part rescue plan it had devised appeared to be crumbling. Once again, it does not appear that the Fed will come to the rescue, at least not directly – yet.

While AIG reportedly has over $1 trillion in assets, the insurance giant is seeking $70-$75 billion in emergency lending, according to several sources. The Fed has apparently tapped Goldman Sachs and JP Morgan Chase to attempt to form a Wall Street lending consortium to come up with the money. It remains to be seen what will happen. My question is, what’s in it for Goldman, JP Morgan and other banks that will be asked to join this lending consortium?

It is interesting to note that the current US Treasury Secretary, Hank Paulson, is the former chairman and CEO of Goldman Sachs. I’m just speculating, but it would not surprise me if some kind of deal between the large banks and the government is struck to save AIG from failure.

Shares in AIG tumbled more than 60% on Monday morning as investors grew concerned that the firm lacked capital to withstand cuts to its debt rating. Ratings agencies had threatened to downgrade the insurance giant’s credit rating by Monday morning, allowing counterparties to withdraw capital from their contracts with the company. S&P, Moody’s and Fitch credit rating services actually lowered AIG debt rating this morning (Tuesday), and AIG’s stock plunged another 35-40% in early trading this morning after the credit ratings announcements.

AIG’s problems are not new. The company reportedly lost $13.2 billion in the first six months of 2008, largely owing to declining values in mortgage-related securities held in its investment portfolio and collateralized debt obligations it owns. As of the most recent quarter, for example, AIG reportedly had $20 billion of subprime mortgages marked at 69 cents on the dollar and $24 billion in so-called “Alt-A” mortgage related securities valued at 67 cents on the dollar.

Thus, there are widespread fears that AIG will be the next giant financial institution to fail. If AIG fails in all of its guarantees, there will be huge (hundreds of billions) exposure for banks worldwide. In addition, millions of Americans own products (insurance policies, annuities, etc.) directly from AIG and/or its affiliates. The Lehman bankruptcy would pale in comparison to the failure of AIG. Therefore, I will not be surprised if the Fed ultimately steps in to rescue AIG if that becomes necessary.

There are also concerns that Washington Mutual, another huge financial services firm, and others, may also be in trouble. AIG is not likely to be the last of the bad news.

Emergency Sunday Wall Street Trading Session

Fading hopes for a Lehman rescue deal last Saturday raised the risk the firm would have to file for bankruptcy on Sunday or early Monday morning. In fact, Lehman hired law firm Weil Gotshal & Manges to prepare a potential bankruptcy filing, the Wall Street Journal reported on Saturday in its online edition.

Bill Gross, chief investment officer of PIMCO, said a Lehman bankruptcy risked an “immediate tsunami” because of the unwinding of derivative and credit swap-related positions worldwide in the dealer, hedge fund and buy-side universe (mutual funds, pension funds, etc.). The implications for the financial markets were huge.

As a result, the International Swaps and Derivatives Association (ISDA) announced late Saturday, with the apparent blessing of US securities regulators, that there would be a special trading session on Sunday afternoon for the purpose of allowing derivatives market participants an opportunity to unwind Lehman-related market positions. ISDA indicated that the special session was actually suggested by the Federal Reserve.

Major players in the $455 trillion global derivatives market rushed Sunday to scale back exposure to a potential bankruptcy filing by Lehman Brothers in the rare emergency trading session. The session opened at 2 p.m. New York time and was due to run until 4 p.m. However, the ISDA later extended the emergency session for another two hours, and reportedly some banks continued to offset their Lehman exposure even after the official session ended.

Trading involved credit, equity, rates, foreign exchange and commodity derivatives. Trades were contingent on a bankruptcy filing by Lehman before the markets opened on Monday. If there was no bankruptcy filing by Lehman, the Sunday trades would have been reversed.

Implications For The Investment Markets

On Monday, the Dow Jones plunged 504 points, or 4.42%, to 10,917.51, moving below the 11,000 mark for the first time since mid-July. It was the worst point drop for the Dow since it lost 684.81 on Sept. 17, 2001, the first day of trading after the 9/11 terror attacks.

In percentage terms, the drop was the steepest since July 19, 2002. It was also the sixth-largest point drop in the Dow, just behind the 508.00 it suffered in the October 1987 crash. The Dow is now down apprx. 23% from its record high of 14,198.09 last October.

Broader stock indicators also fell. The S&P 500 index declined 59.00, or 4.71%, to 1,192.70 — also its biggest drop since just after 9/11 and the first time it closed below 1,200 in three years. The decline on Monday violated the previous S&P low in July, which many had hoped was the bottom in this bear market.

Clearly, the trend is down in the equity markets, and investors worldwide are wondering how bad things may get. Obviously, a lot depends on what happens with AIG, as discussed earlier. If AIG goes down, the negative implications are much larger indeed than the failure of Lehman Brothers.

On the other hand, if some kind of a deal is struck to rescue AIG, even temporarily, stocks would likely get a bounce. In today’s trading session, the Dow Jones Industrial Average tested its July 19 low of 10,732, but did not penetrate it, and then reversed to close up 141 points on the day. I expect there will be technicians who will argue that we’ve seen a double bottom. We’ll see.

Bottom line: If AIG goes down, I would expect the stock markets to plunge yet again, even harder. As a result, I will be surprised if the Fed ultimately let’s AIG go down. The financial implications are just too great, in my opinion.

Even if AIG manages to stay afloat, investors are worried that there may be other large financial institutions that are in trouble. Investors hate uncertainties, and we are far from the point where the financial industry is out of trouble. This argues that the bear market in stocks continues for at least a while longer.

Finally & Most Importantly:
Where Our Clients’ Accounts Are Held

As noted in the Introduction, we do not hold any client accounts at Lehman Brothers or Merrill Lynch. As most of you know, my companies specialize in investment programs that are professionally managed by third party Advisors that we carefully select. Our business is concentrated in three particular areas: 1) our AdvisorLink program which is mutual fund-based; 2) our Absolute Return Portfolios which are also mutual fund-based; and 3) our futures funds.

Client accounts in our AdvisorLink program are held at one of the following mutual fund families and/or trading platforms – Fidelity Institutional Brokerage, Rydex Mutual Funds, TD Ameritrade or Trust Company of America. These are not investment banks.

Client accounts in our Absolute Return Portfolios, which are carefully selected groups of mutual funds, are held at TD Ameritrade.

Assets in our four futures funds are custodied in segregated accounts at MF Global, which is considered one of the leading international brokers for exchange-traded futures and options and a leading intermediary in the markets for other major financial instruments around the world. MF Global provides access to the world’s largest and fastest growing financial markets through offices on five continents and affiliations with more than 70 financial exchanges.

Established in 1783 by James Man as a commodities brokerage firm in London, MF Global is probably better known to many in the investment world as E D & F Man. MF Global spun off from the Man group in 2007 with a public offering and is listed on the New York Stock Exchange as NYSE: MF.

Conclusions – History In The Making, Perhaps

While the US economy is holding up at least reasonably well, the subprime and mortgage related financial crisis is taking its toll on Wall Street financial institutions, one by one. The worsening confidence among lenders and borrowers continues to complicate matters in the financial markets. The question is, have we seen the worst with the bankruptcy of Lehman Brothers and the fire sale of Merrill Lynch, or is there much more to come? That remains to be seen.

Stock markets worldwide don’t like this kind of uncertainty, and they have reacted accordingly. How much more the bear market in US stocks has to go remains an uncertainty. A great deal depends on how much more bad news is to come over the next few weeks. Questions remain about AIG and how many other large financial firms may be waiting to announce similar problems.

I sincerely hope that we are not witnessing history in the making, and that the worst of our financial problems have already been revealed. But the fact is, we just don’t know yet. The housing/subprime repercussions continue to unfold.

Normally, I would take this opportunity to promote the active management strategies I recommend – that have the flexibility to go to cash or hedge long positions during downward trends in the stock markets – but given the latest serious developments in the financial markets, on the heels of the devastation on the GulfCoast, I will forego any advertisement.

I will say that we have recently seen a marked increase in calls from E-Letter readers that have grown increasingly uncomfortable with performance results from their traditional investment advice providers. This is what usually happens in bear markets.

As always, feel free to call us for an independent second opinion and review of your investment portfolio.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

The Resilience of American Finance
http://online.wsj.com/article/SB122152085270539225.html

This Too Will Pass
http://www.ibdeditorials.com/IBDArticles.aspx?id=306370630265658

Do Wall Street’s Woes Help McCain or Obama?
http://www.usnews.com/blogs/capital-commerce/2008/9/15/do-wall-streets-woes-help-mccain-or-obama.html

The Economy, The Electoral Map & The United Nations

Gary D. Halbert — Tue, 02 Sep 2008 20:04:45 GMT

IN THIS ISSUE:

The Economy Surges Above Expectations
Stocks - Have We Seen The Bottom?
The Electoral Map Remains Very Tight
The Scary Democratic Party Platform!!
Dems Endorse Expansion Of United Nations Power

Introduction

This week we hit a variety of topics. First, we'll look at the latest much stronger than expected economic numbers over the last couple of weeks. I believe it is now safe to say that the US economy will avoid a recession in 2008. But 2009 may be another story. Details to follow.

The Democratic National Convention came and went with a great deal of glitz, glamour and moving speeches, including the Clintons who surprised some political observers with rousing speeches for Barack Obama. It appears that Obama got a modest "convention bounce" in the polls, and it remains to be seen if McCain and the Republicans can answer with their convention, especially in light of Hurricane Gustav.

Whether Senator McCain gets his convention bounce or not, at the end of the day it still comes down to the Electoral Map which continues to show that this is a very tight race that could go either way based on the outcomes in just a handful of key swing states. I'll break it down and pinpoint the key states you need to watch over the next couple of months.

Finally, the details of the Democratic Party Platform are coming to light. While there are many things about the Dem's platform that I disagree with, there are several new developments that ought to trouble all Americans. First and foremost, the Democrats, and Obama in particular, want to strengthen the United Nations and commit more of our troops to UN-authorized military operations.

You need to know about this and several other very troubling intentions of the Democrats, especially if Obama wins in November. Cliff Kincaid of Accuracy In Media has chronicled the most troubling aspects of the Dem's platform, and I reprint that eye-opening article near the end below. Be sure to read it and pass it on.

The Economy Surges Above Expectations

The US economy surged in the 2Q, well above expectations, thereby dashing the notion that we're now in a recession. GDP rose a surprising 3.3% in the 2Q, up from just 1.9% in the advance estimate last month, and only 0.9% in the 1Q (details to follow).

The GDP surge in the 2Q was driven primarily by rising exports, consumer spending and government spending at all levels. Personal consumption spending (PCE) rose an unexpected 1.7% in the 2Q, and was no doubt helped along by the tax rebate checks doled out by the Treasury. Consumer spending accounts for apprx. 70% of GDP.

Early estimates suggest that the economy is growing at a rate of 1.8%-2.0% in the 3Q, which is also above earlier expectations for zero to negative growth in the current quarter. Several other economic reports of late look encouraging, but not all, as I will discuss below.

Given the much stronger than expected growth in the 2Q, and the strong likelihood that the 3Q will be positive as well, I think it's reasonable to conclude that the US will avoid a recession in 2008. How the economy holds up next year remains to be seen, but for now, the mainstream media, the Democrats and the gloom-and-doom crowd have been very wrong about the US economy. What else is new?

Several other recent economic reports were also encouraging. Consumer confidence finally rebounded strongly in August. Following a very modest improvement in July, the Consumer Confidence Index jumped from 51.3 to 56.9 last month. Obviously, the significant drop in oil and gasoline prices played a key role in boosting confidence.

On the manufacturing side, durable goods orders rose 1.3% in July for the second month in a row. Industrial production rose modestly in both June and July. Factory orders in June (latest data available) rose 1.7% following a gain of 0.9% in May. The ISM manufacturing index bottomed out in the 1Q and has now risen back slightly above 50.

There was even a bit of good news in the housing sector. New and existing home sales rose modestly in June. But there was also plenty of bad news as well. Housing starts and building permits continued to decline modestly in June. The inventory of unsold homes rose to 4.67 million in July, an 11.2 month supply. The median existing home sale price fell to $212,400, down 7.1% nationally from the same period last year.

The Index of Leading Economic Indicators (LEI) fell more than expected in July, down 0.7%. The LEI has been down in two of the last three months, which suggests that economic growth will slow in the current quarter (consistent with the 3Q forecasts noted above) and perhaps even more in the final quarter of this year. But as suggested above, I do not believe we will be in a recession by the end of this year.

Having said that, it will not surprise me if 4Q growth stalls to near zero or even dips slightly into negative territory. But at this point, I think it is 2009 that we have to worry about. The housing crunch will continue for all of 2009, and will the credit crunch most likely. Some of my trusted sources believe that a recession is most likely to unfold in the first half of 2009.

Stocks - Have We Seen The Bottom?

Stocks historically go up in presidential election years, but not so this year, what with oil prices soaring to near $150 per barrel and gas prices spiking above $4.00 across the country. As this is written, the S&P 500 and the Dow Jones indexes are down apprx. 13% for the year.

Clients have asked if I think we saw the bottom in July when the Dow fell below 11,000 and the S&P 500 touched 1,200. The answer is, I don't know. A big key will be whether oil and gas prices continue to fall this month with peak summer demand behind us. If energy prices continue to fall, then the July low may hold, but that remains to be seen.

On the other hand, it does appear that we are going to see the economy slow down even more over at least the next six to nine months. If we are headed for a recession in the first half of 2009, this will be bad news for stocks, and I would expect the July lows to be taken out later this year.

What I do believe strongly is that stock market volatility will remain sky-high for the rest of this year and probably well into 2009. Most investors are not well suited for this kind of volatility. I've heard from people who bailed out of the stock market over the last couple of months, and are now wondering if they should get back in.

My advice is still the same, especially with this kind of volatility. In my opinion, most investors would be well served to have a portion of their portfolio allocated to active money managers that have the flexibility to exit the market or hedge long positions as need be. There are some professional money managers that flourish during periods of high market volatility. See my June 10 E-Letter to see such an example. (Past results are no guarantee of future results.)

The Electoral Map Remains Very Tight

It appears that Barack Obama got a modest bump up in the national polls following his Hollywood style convention last week. It remains to be seen if John McCain will get a similar bounce later this week. Most analysts have felt like he will, but the hurricane has definitely toned down the GOP convention. So, maybe McCain gets a bounce, or maybe not.

Interestingly, McCain finally pulled to even or slightly above Obama in several of the national polls just as the Dem's convention started. Frankly, he's doing better than I expected, and that is a good thing - especially when you read the article below regarding the Democratic Party Platform. But as I have maintained all along, this presidential race is going to boil down to a handful of key states. Here's our latest analysis of the Electoral Map.

What a difference a month makes! The electoral map is coming into focus. The Obama-Biden ticket is very strong in states totaling 259 electoral votes, while the McCain-Palin ticket is strong in states totaling 227 electoral votes. That leaves 52 votes up for grabs.

Those 52 votes are Ohio (20), Virginia (13), Colorado (9), Nevada (5) and New Mexico (4). McCain is currently running slightly ahead in Ohio and Nevada, while Obama is running well ahead in New Mexico and slightly ahead in Colorado, with Virginia evenly split.

McCain MUST win Ohio and Virginia, losing either will cost him the election. Fortunately for McCain, that does not seem implausible, but you can be sure these states will be very hotly contested, with tens of millions spent in each coupled with numerous candidate appearances.

So, let's assume McCain manages to win both Ohio and Virginia, which will not be easy by any means, but both states historically vote Republican. If so, that brings him to 260 electoral votes, still 10 short of the 270 needed to win. McCain must therefore win Colorado and either Nevada or New Mexico.

Since New Mexico's wildly popular governor Bill Richardson is a big Obama backer, McCain will have to look to Nevada to put him over the top. This is his best bet as Nevada has gone Republican the last two elections and is trending slightly toward McCain as this is written.

But then that assumes he wins Colorado which is not a safe assumption at all. While CO went for Bush in 2004, it is currently a dead heat, and it's a must win state for McCain. McCain could be forced to spend so much time and money securing Ohio and Virginia that he simply can't pour the resources needed into the Western states and Colorado in particular.

Keep in mind that McCain will likely have to take federal matching funds, while Obama has chosen to forego federal campaign funds. McCain will be restricted to a maximum of $84 million in matching funds after the GOP convention, while Obama will have at least twice as much money as McCain to spend.

The Democrats are targeting Colorado, which is why the convention was in Denver, and the Obama campaign will spare no expense to secure the state as they see it as essential to victory, which it is. Colorado is perhaps THE most important swing state to both candidates. This looks to be one of the closest elections in history.

We will take another in depth look at the electoral map later this month and again in late October and make our final predictions on the outcome of the election then.

My Thoughts On The Sarah Palin Pick

My phone has been ringing off the hook with calls from friends and clients asking for my take on John McCain's selection of Sarah Palin, Republican Governor of Alaska, as his running mate. Here's what I think happened. When Obama passed over Hillary and took Joe Biden, this created an opening for McCain to select a woman in the hopes of courting Hillary's supporters.

Of the women candidates McCain was rumored to have considered, I think Senator McCain and his senior campaign aides decided that Sarah Palin was the one that could really catch on with voters. No doubt the selection of Governor Palin was a huge gamble, especially given her limited experience.

Mrs. Palin definitely helps McCain solidify the conservative base, and if she can handle herself well in the next few weeks, she might just catch on with some Hillary supporters and some swing voters. In that case, McCain's gamble might just pay off.

As a football coach for many years, I know that sometimes you have to "throw deep" to stretch the defense. Sarah Palin definitely qualifies as the long ball for McCain. I'm warming up to the pick, as McCain had to do something bold to have a chance against Obama.

The Scary Democratic Party Platform!!

I urge EVERY client and subscriber to this E-Letter to read the article that follows. The mainstream media is NOT talking about these issues. They don't want you to know!

According to the latest Democratic Party Platform, they would have us make a huge commitment of additional taxpayer money and US military forces to the United Nations. Obama and the Democrats would have American taxpayers spending additional billions to improve education worldwide via the U.N., while our own education system is in trouble.

Americans will be called upon to spend more on international abortion "services" and population control via the U.N. Under Obama, the military would be expanded - including open and active homosexuals - to carry out these new U.N. missions. There will also be new energy and emissions requirements on the US.

Last but not least, if Obama wins the Democrats vow to bring back the so-called "Fairness Doctrine" (albeit under a different name), which is designed to reduce conservative talk radio and restrict the ownership of broadcast outlets.

So read what follows from Accuracy In Media very carefully and help get the word out!

QUOTE:

Dems Endorse Expansion of U.N. Power

AIM Column | By Cliff Kincaid | August 21, 2008

Our media are running stories about the planks in the new 2008 Democratic Party platform but they've missed a big one―expansion of the power of the United Nations, and especially more U.S. involvement in U.N.-authorized military operations.

In another bow to the world organization, the platform indirectly endorses Senator Barack Obama's controversial pro-U.N. Global Poverty Act. "It is time to make the U.N. Millennium Development Goals, which aim to cut extreme poverty in half by 2015, America's goals as well," the document says. It leaves out the estimated cost―$845 billion over 13 years.

This plank is listed under the "Invest in Our Common Humanity" title of the platform. The word "invest" is as deceptive as the legislation. It means to spend taxpayer dollars.

While it may seem strange that the platform would not endorse the legislation by name, this reflects awareness of how controversial the Global Poverty Act (S. 2433) and its federal commitment to the U.N.'s Millennium Development Goals have become. Increased foreign aid spending is not popular with the hard-pressed American taxpayer. So the one piece of legislation actually introduced by Senator Barack Obama (which passed the House and Senator Joseph Biden's Foreign Relations committee by voice vote without hearings) is mentioned only indirectly.

A section titled, "Revitalize Global Institutions," is more direct. It declares the need for "stronger international institutions" on "issues from weapons proliferation to climate change." While admitting that the U.N. is in need of "reform," the organization is said to be "indispensable" and the U.S. must rededicate itself "to the organization and its mission." This inevitably means more money for the world body.

Even though the U.S. public school system is rotting from within because of unaccountability and incompetence, the platform calls for more spending on educational systems in other parts of the world. It urges a $2 billion Global Education Fund that will "bring the world together in eliminating the global education deficit with the goal of supporting a free, quality, basic education for every child in the world."

On another international matter, the Democrats declare that "We will repeal the global gag rule and reinstate funding to the United Nations Population Fund (UNFPA)." This means that Americans will be called upon to spend more on international abortion "services" and population control. In this context, the platform urges support for "Health Infrastructure 2020," which is described as "a global effort to work with developing countries to invest in the full range of infrastructure needed to improve and protect both American and global health." No cost is put on this effort.

Similarly, we are not told about how much it will cost to launch the "collective action" needed to confront the "global challenge" of climate change. But we are told that it will require a "Global Energy Forum that will lay the foundation for the next generation of climate protocols." It declares the need for a "global response to climate change that includes binding and enforceable commitments to reducing emissions…" This means more U.N. treaties impinging on our freedom and sovereignty.

It may surprise some "progressives" to learn that while Obama wants to withdraw U.S. forces from Iraq, he has no plan to reduce the size of the U.S. Armed Forces. Instead, "We support plans to increase the size of the Army by 65,000 troops and the Marines by 27,000 troops," it says.

If these troops are not going to be in Iraq, where will they be going? "We believe we must also be willing to consider using military force in circumstances beyond self-defense in order to provide for the common security that underpins global stability―to support friends, participate in stability and reconstruction operations, or confront mass atrocities."

Phrases such as "beyond self-defense" and "common security" constitute an endorsement of the U.N. doctrine of the "Responsibility to Protect." Since the platform declares that U.N. "peacekeeping" operations are "overextended," this means U.S. forces will have to be redeployed from Iraq and other areas to address civil wars and problems in other countries that pose no direct security threat to the U.S.

Meanwhile, the platform says the U.S. Armed Forces under President Obama will be expanded to include open and active homosexuals, despite its obvious negative impact on morale and recruitment. If normal heterosexuals leave the Armed Forces as a result of this policy, Obama may be forced to reinstitute the military draft to create the bigger military he seeks.

Thanks to conservative talk radio and other such outlets, the shocking facts about the Democratic Party platform will be provided to the American people. The conservative media have been a thorn in the side of the liberal establishment ever since President Reagan's Federal Communications Commission (FCC) began the deregulation of the media and new voices started emerging.

But the Democrats, whose base of support is in the old media, which are losing viewers and readers, want more, not less, regulation.

"We will encourage diversity in the ownership of broadcast media, promote the development of new media outlets for expression of diverse viewpoints, and clarify the public interest obligations of broadcasters who occupy the nation's spectrum," the Democratic platform says.

While this may sound appealing, terms like "diversity" and "diverse viewpoints" are liberal code words for using the power of the federal government to muzzle conservative talk radio and turning over broadcast properties and airtime to "progressives." This is the goal of George Soros-funded groups like the Free Press, which puts on an annual National Conference for Media Reform. As I reported in June, at this year's event, the conference turned into an Obama for president rally.

Translated into ordinary language, the term "we" in the context of the Democratic platform plank on the media means more federal government interference.

As explained by Tim Wu, a Columbia Law School Professor and chairman of Free Press, the U.S. Constitution is flawed because the founders did not anticipate the problem of "the abuse of private power." The Bill of Rights was merely designed to protect people against government and the founders were concerned about the exercise of "public power," he explained to the National Conference for Media Reform.

In direct contradiction to the intent and precise wording of the First Amendment to the Constitution, in terms of prohibiting Congressional abridgement of freedom of speech, this grant of massive authority to Congress and the federal government means that the FCC will decide what constitutes "diversity" and the "public interest" in broadcasting. Hence, the FCC, rather than market forces and the people, will decide who gets on the air, who can own media properties, and even who gets Internet access.

Meanwhile, the Democratic Congress can be counted on to increase U.S. taxpayer support for public TV and radio.

Conservative FCC Commissioner Robert McDowell recently warned that the Fairness Doctrine, which allows federal bureaucrats to monitor and dictate broadcast editorial content, may be brought back under a different name. "I think it won't be called the Fairness Doctrine by folks who are promoting it. I think it will be called something else and I think it'll be intertwined into the net neutrality debate," he told the Media Research Center. The term "net neutrality," as defined by George Soros-funded "progressive" organizations, means that federal authorities will monitor and regulate Internet networks, rather than letting private competitive forces operate on their own without governmental interference.

But other powerful "progressive" individuals and groups want the Fairness Doctrine back directly and immediately. The public should know that Democratic control of the White House would result in a 3-2 liberal majority in the FCC and the possible return of the Fairness Doctrine through administrative and executive action without any congressional approval required. House Speaker Nancy Pelosi has already declared she is in favor of it. That's why she refuses to bring the Broadcaster Freedom Act to a vote in the House. The Broadcaster Freedom Act (H.R. 2905) would prevent the FCC from unilaterally imposing the Fairness Doctrine on broadcasters.

The Democratic platform, in short, calls for more and bigger government on the domestic and international levels. This is the real story that the mainstream media won't tell.
END QUOTE

Here is the direct link to the story above:

http://www.aim.org/aim-column/dems-endorse-expansion-of-un-power/

I would encourage readers to forward this around to as many people as possible to get the word out.

There are apparently plenty of readers of this E-Letter that are leaning toward or committed to voting for Barack Obama. Obviously, millions of Americans don't mind Obama's liberal policies and/or intentions on such things as taxes, abortion, nationalized health care, protectionism, Supreme Court judges, gun control, etc., etc.

They apparently also don't mind that he not only opposes offshore drilling, but also that he opposes exploration that would finally quantify just how much oil and natural gas that is in the ground offshore. What, you haven't heard that? Then read this:

http://www.ibdeditorial.com/IBDArticles.aspx?id=303344360938478

Unfortunately, I doubt if many of Obama's supporters know what he and the Democrats have in mind for the United Nations, our military and our taxpayer dollars. Obama is spearheading this effort!

Ditto for the return of the Fairness Doctrine. Liberals complain that conservatives like Rush Limbaugh dominate the airwaves. Yet liberal talk radio programs have fallen flat on their faces time after time. Obviously, tens of millions of Americans PREFER conservative programs.

It's called the FREE MARKET. But since liberal programming can't compete, the Democrats would like to not only restrict conservative programming, but also restrict who can own the various broadcast outlets.

Let's get the word out fast.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Why McCain Still Has a Chance To Win
http://online.wsj.com/article/SB122031196249888759.html?mod=opinion_main_commentaries

Palin - What the Heck is McCain Up to?
http://www.realclearpolitics.com/horseraceblog/2008/09/what_the_heck_is_mccain_up_to.html

Dems Shouldn't Underestimate Palin (written by a Democrat)
http://www.realclearpolitics.com/articles/2008/09/dems_shouldnt_underestimate_pa.html

Thoughts On China, The Olympics & Investing

Gary D. Halbert — Tue, 05 Aug 2008 19:02:06 GMT

IN THIS ISSUE:

The Latest Good & Not So Good Economic News
Stratfor: "Economic Crisis Brewing In China?"
Conclusions - Maybe Lighten Up On China
Keep Your Comments Coming - Thanks

Introduction

As you are well aware, this year's Summer Olympics will be held in China beginning this Friday, August 8 and running through the closing ceremonies on August 24, assuming all goes as planned. China has long been a mystery to the rest of the developed world, and the Olympics will no doubt shed much light on China, its communist government and its culture.

I did not agree with the International Olympic Committee's (IOC) decision to award the 2008 summer games to China back in 2001. But who am I to say? China made many promises to the IOC in 2001 regarding human rights improvements and international media access to the Olympic games this summer. But since 2001, China has failed on several of its human rights promises. I, for one, am not the least bit surprised.

Since we will be barraged with media coverage of the Olympic games from China over the next three weeks, I thought it would be appropriate to give you some insight as to what has been going on within the Communist hierarchy in China in recent years. And who better to bring us that insight than our friends at Stratfor.com who are one of the leaders in geopolitical analysis. I think it will give you a good perspective on China as we watch the Olympic coverage just ahead.

One more thought before we get going. I am very worried about the Olympics in China. I worry that there could be a terrorist attack during the games. I also worry that planned, and unplanned, demonstrations in China during the Olympics could end very ugly, given the regime's past of violently suppressing opposition. I certainly hope not. I sincerely hope that the 2008 Summer Olympics go off without a hitch, and that China comes out a big winner, despite all their deceptions about being a "free" society.

What follows is Stratfor's latest insightful analysis of what is going on in China's government today, in light of the Olympics, and a brief history of how the Chinese leadership has gotten to this point. I will have some of my own comments at the end.

But first there is some good (and bad) economic news to report. We will get to that first and then jump into Stratfor's latest analysis on China and the implications for the Olympics.

The Latest Economic Reports

The Commerce Department reported last Thursday that 2Q GDP rose 1.9%, as compared to 0.9% in the 1Q. This is the government's "advance" report, so it is subject to change two more times in the weeks ahead. However, the advance report was quite positive, especially in light of the plunge in consumer confidence this year. The government noted that 2Q growth in GDP was highlighted (in order) by stronger exports, consumer spending, non-residential building and government spending.

The media generally characterized the latest GDP report as "disappointing" since the pre-report consensus was suggesting a rise of 2.0+%, not the 1.9% as reported. However, I will tell you that as recently as a month or two ago, most analysts (including your editor) were expecting 2Q GDP to be on the negative side. The US economy continues to surprise on the upside, although modestly, and we may well side-step a recession this year.

There was one surprise in last Thursday's GDP report. The Commerce Department revised its estimate of 4Q 2007 GDP from +0.6% to -0.2%. So, the economy did fall very slightly into negative territory in the last quarter of last year, before rebounding to +0.9% in the 1Q of this year. Thus, we did have a quarter of marginally negative growth at the end of last year.

On the inflation front, the latest GDP report noted that the price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 4.2% year-over-year in the 2Q, compared with an increase of 3.5% in the 1Q. But excluding food and energy prices, the core price index for gross domestic purchases increased 2.2% in the 2Q, the same as in the 1Q.

The other economic reports of note were the Consumer Confidence Index and the University of Michigan Consumer Sentiment Index for July, which were released over the last week. The Consumer Confidence Index actually rose to 51.9 in July, up from 51.0 in June, the first monthly rise in six months. The Michigan Consumer Sentiment Index rose from 56.6 in June to 61.2 in July. The pre-report consensus was for yet another monthly decline in both measures of consumer confidence.

While the above noted reports are encouraging on balance, they still indicate a sluggish economy that is likely to remain below trend for some time to come, and inflation continues to rise at least marginally. But given that many analysts and most in the media predicted a recession in 2008, the latest data are certainly welcome.

Now we move on to Stratfor and China and the Olympics.

QUOTE:
"Economic Crisis Brewing In China?

Something extraordinary is happening in China, and we are not talking about the Olympics. Rather, Chinese officials have been clamping down on visa applications and implementing bureaucratic impediments to new and renewed visa applications under the guise of pre-Olympic security.

In some ways, Beijing's plan for a safe and secure Olympics appears based on the premise that if no one shows up, there can be no trouble. But placing restrictions on the movement of managers and employees of foreign businesses operating in China, even if for a limited time as Chinese officials have been at pains to reassure, makes little sense from the standpoint of gaining political and economic benefits from hosting the Olympics. Something just isn't right.

The Post-'70s Economic Framework

Since China's economic reform and opening in the late 1970s, China's economic policy — and thus the basis for the overall development of the nation — has been based on a simple two-part framework. First, draw in as much foreign investment as possible and use the money and technology to strengthen China while using the subsequent economic leverage to secure China. And second, encourage growth for growth's sake to ensure an ever-increasing flow of money through the system to provide employment and social services to a massive and urbanizing population.

Key to this policy has been creating a very open environment for foreign businesses, which bring money, technology and expertise and use their influence with their own governments to keep stable international relations with China — hence reducing international and economic frictions and increasing the efficiency of the supply chain. For more than two decades, Chinese national strategy has thus revolved around the principle of encouraging investment, joint ventures and wholly-owned foreign enterprises in China. There have been two foundations for this strategy: the evolution of financial facilities for transferring and controlling foreign money with a level of transparency nearing international standards, and the ease of movement of personnel in and out of China.

It is this latter point that recently has been hit the hardest. Over the past several months as the Beijing Olympics drew nearer, the Chinese government has effectively frozen up most financial reform plans. It also has issued a raft of new security measures not entirely unlike other host cities in the post 9/11 security environment. But China has gone several steps further than its predecessor hosts, placing official and bureaucratic impediments on visa applications. This not only has targeted potential "troublemaking" rights advocates, it has also impacted foreign businesses ranging from invited guests to the Olympic games to managers and employees of foreign companies in China.

Business and the New Visa Hassles

The visa restrictions in particular have been a source of angst for foreign businesses and business associations. Many smaller operations may circumvent Chinese regulations and travel on tourist visas (provided they can still obtain them). And there are ways around the tighter regulations or bureaucratic hurdles if one has the right connections or the willingness to apply several times or from different locations. But multinational corporations are less willing to jeopardize their operations by skirting the laws. Instead, they are making their concerns known to Beijing and hoping that restrictions are eased in September, as Beijing has rumored and hinted will occur.

In general, these visa restrictions have been brushed aside by foreign observers as simply paranoia on China's part regarding protests or terrorist attacks during the Olympics. In many ways, however, this makes little sense. First and most obvious, the Olympics were supposed to highlight the opening of China — not restrict the very people who have made China a key part of the global economy. Second, imposing tight restrictions in Shanghai, the center of the Chinese foreign-domestic economic nexus, makes little sense on grounds of Olympic security since Shanghai is playing only a minor role in the games compared to Beijing and Qingdao. (Think shutting down visas to New York during the Atlanta games in the name of security, though Shanghai admittedly is hosting some soccer matches.)

Shutting down business visas to keep terrorists out makes little sense anyway — it is hard to imagine Uighur militants traveling on business visas as representatives of foreign multinationals. Furthermore, by restricting business visas — even if not across the board in a coherent fashion — China is putting a massive strain not only on the ability of businesses to trust Chinese regulations and business relations with the government, but also on the fluidity of the global supply chain. Shutting down or impeding visas affects much more than delaying the movement of a single individual into China; it impacts the ability of multinational corporations to move, replace or supplement managers and dealmakers in China. A delayed visa applications of just three months still represents an entire quarter that multinational corporations cannot reliably manage their businesses operations in China, and that doesn't take into account the visa backlog when restrictions are loosened or lifted.

Disrupting an integral part of the global economy for a full quarter because of an international exposition makes little sense. The Germans in 1936 didn't do it, the Russians in 1980 didn't — no one has. One doesn't simply shut down international business transactions for three months or more to stop a terrorist — and particularly not China, which depends on foreign direct investment. This is not simply an inconvenience for some people: It is the imposition of friction on a part of the system that is supposed to be frictionless. And it is not merely individuals who are affected, but the relations between mammoth companies.

A Period of Erratic Policies

China's behavior has been erratic for several months now, if not for the past few years, with the implementation of new and often contradictory security and economic policies. These have all been brushed aside as somehow related to preparation for the Olympics. But they are in fact anomalous. China's behavior is not that of a country trying to show its best side for the international community, nor that of a nation simply concerned about potential terrorist or public relations threats to the Olympic games. In another two months, after the Olympics and Paralympics have ended, it will become clearer whether this was a spate of excessive paranoia or a reflection of a much more significant crisis facing the Chinese leadership — and the evidence increasingly points toward the latter.

As mentioned, China's economic policies in the reform and opening era have been based on the idea of growth. This in many ways simply reflects the Asian economic model of maintaining cheap lending policies at home, subsidizing exports, flowing money through the system and focusing on revenue rather than profits. In essence, it is growth for the sake of growth. This was the policy of Japan, South Korea, Indonesia, Malaysia and Thailand. And it led each of those countries to a final crisis point, striking Japan first in the early 1990s and the rest of the Asian tigers a few years later. But China managed to avoid each of the previous Asian economic crises points, as it was on the lagging end of growth and investment curves.

Following the Asian economic crisis, China fully recovered from the international stigma of Tiananmen Square and became the global economic darling. By the time the 21st century rolled around, China was already taking on the mantle of the Japanese and other Asians. It began to be labeled both an economic miracle and a rising power; a future challenge to U.S. economic dominance with all the political ramifications that brought. Were it not for 9/11, Washington would have squared off with Beijing to prevent the so-called China rise. The reprieve of international pressure that came when U.S. attention turned squarely toward Afghanistan and then Iraq freed China's leaders from an external stress that could have brought about a very different set of economic and political decisions.

With the United States preoccupied, and no other major power really challenging China, Beijing shifted its attention to domestic issues, and its review quickly revealed the stresses to the system. These did not primarily come from "splittist" forces like the Tibetans or the Falun Gong, but rather from the economic policies that had brought China from the Third World to the center of the global economic system. Beijing is well-aware that should it continue with its current economic policies, it will face the same risk of crisis as Japan, South Korea and the rest of Asia. It is also aware that growing internal challenges — from the spread and invasiveness of corruption to geographic economic imbalances, from rising social unrest to massive dislocation of populations — are causing immediate problems.

Economics from Mao to Hu

Mao Zedong built a China designed to be self-sufficient and massively redundant. Every province, every city, every factory was supposed to be a self-contained unit, making the country capable of weathering nearly any military attack. Deng Xiaoping didn't get rid of these redundancies when he opened the economy to foreign investment. Instead, he and his successors encouraged local officials to work to attract foreign investment and technology so as to raise China's economic standard more rapidly. By the time Jiang Zemin was in power it had become clear that the regionally and locally driven economic policies threatened to throw China back into its old cycle of decentralization — and, ultimately, competing centers of power. Attempts by Jiang to correct this through the Go West program, for example, came to naught after meeting massive resistance in the wealthy coastal provinces. The central government accordingly backed off, shifting its attention to reclaiming centralized authority over the military.

Hu Jintao has sought once again to try to address the problem of the concentration of economic power in China's coastal provinces and cities through his Harmonious Society initiative. The idea is to redistribute wealth and economic power, regain central authority over the economy, and at the same time reduce redundancies and inefficiencies in the Chinese economy. With minimal external interference, Hu was able to test policies that by their very nature were going to sacrifice short-term social stability in the name of long-term economic stability. Growth was replaced by sustainability as the target; longer-term redistribution of economic growth engines would replace short-term employment and social stability.

This was a risky proposition, and one that met strong resistance in China. But the alternative was to sit back and wait for the inevitable economic crisis and the social repercussions thereto. In some ways, Hu was suggesting that China risk stability in the short term to preserve stability in the long run. But Hu didn't anticipate the massive surge in global commodity prices, particularly of food and oil. This was compounded by increased international scrutiny over China's human rights record ahead of the Olympics, natural disasters hitting at the availability and distribution of goods, a rise in domestic social unrest triggered by local government policies and economic corruption, several attempted and successful attacks against China's transportation infrastructure, and the uprising in Tibet. Thus, the already-risky policies the central government was pursuing suddenly looked more destructive than constructive from the point of view of continued rule by the Communist Party of China (CPC).

The global economic slowdown was the external impetus China feared — something that could undermine the flow of capital and leave Beijing unable to control the outcome of a reduction in the inflow of capital. At the same time, the internal social tensions triggered both by Hu's attempts to reshape the Chinese economy and by the slow pace of those changes created a crisis for the Chinese leadership. It was hard enough internally to control a measured economic slowdown to reshape the economic structure of China, but quite another thing altogether to have such a slowdown imposed on China from outside at the very moment social stability was in a critical state at home.

A Government in Crisis

China's rapid and contradictory economic and security policies, rising social tensions, and seemingly counterproductive visa regulations appear to be signs of a government in crisis. They are the reactionary policies of a central leadership trying to preserve its authority, stabilize social stability and postpone an economic crisis. At the same time, we see signs that the local governments, and even organs of the central government, are putting up steady resistance to the announcements coming from Beijing. Slapping restrictions on foreign businessmen may make little sense from a broader business continuity sense, but if the point is to begin breaking the backs of the local governments — whose strength lies in their relations with foreign businesses — then the moves may make more sense.

If the central government has reached the point that it is willing to risk its international business role to rein in wayward local officials, however, then the Chinese leadership sees a major crisis looming or already under way. It is one thing to toss out a few local leaders and replace them, quite another to undermine the structure of the Chinese economy for the sake of regaining control over local officials. But if Chinese history since 1949 (and really quite a ways before) is any guide, the core of the CPC leadership is willing to sacrifice social and economic stability to preserve power. One need only look at the Great Leap Forward, the Cultural Revolution or the crackdown at Tiananmen Square for evidence of this. Revolution is not, after all, a dinner party, and maintaining CPC control is paramount to the government.

After each major revolution or crisis, China eventually has recovered. The Cultural Revolution was followed by diplomatic relations with the United States, Tiananmen Square was put aside as China joined the World Trade Organization and surged ahead in gross domestic product (GDP). Certainly, there was change among the leadership and in the way the party dealt with policies at home and abroad. But if there is the likelihood of loss of control due to an impending economic crisis, better to have some role in shaping the crisis to preserve the chance of maintaining a role in the future political structure than to sit by and try to clean up as things fall apart. The Party in fact has a long history of taking a self-generated crisis/revolution over an externally or domestically initiated one.

It may be that the contradictory policies Beijing is tossing around these days will simply fade away after September and things will get back to "normal." But already, Chinese officials are downplaying the previously hyped political and economic benefits of the Olympic games. They are now warning that economic conditions may not be so strong in the future, and at least internally discussing the distinct possibility that at least certain regions of China are facing the same economic crises faced by their mentors Japan, South Korea and the Asian tigers.

Internal Crises vs. the Economy

A recent article in the Global Times, a paper that addresses myriad topics of domestic and international significance and is read among China's leaders, discussed how economics is not the best measure of strength. It referred to the overall comparative GDP and the size of China's military in the late 1800s. Then, China was considered at its weakest, but from an economic or military perspective it could have been considered comparable to the global powers of the day. This hints at the deeper internal debate in Beijing, where true national strength and the role of the economy is under discussion. Assumptions that China is only focused on continued good economic ties with the world shouldn't be taken as gospel — China has a track record of shutting down external connections when internal crises brew.

Numerous polices are being thrown around in firefighting fashion, including blocking or at least hindering foreign business movement in and out of the country and tightening the flow of foreign capital in both directions. They are coming in reaction to flare-ups in economic, environmental, public relations and social arenas. Energy policies are making less sense, imbalances in supply and demand are growing and seemingly contradictory policies are being issued. Social unrest, or at least local media coverage of such unrest, seems to be increasing; either is a sign of weakening control. Local officials are still failing to fall in line with central government edicts. Strategic state enterprises like China National Petroleum Corp., China Petroleum & Chemical Corp. and the China Development Bank are all defying state-council orders — and the State Council itself is apparently going head-to-head with major policy bodies long given control over economic policies.

Something extraordinary is happening in China. And while not everyone may want that to be the case, and so have sought to use the Olympics to explain things away, the easy explanation simply doesn't make enough sense." END QUOTE

Conclusions

It really shouldn't surprise anyone that China is reneging on its promises of media openness and unrestricted media coverage of the Olympics. It is a Communist country after all. Those in the media who believed China's promises have been very naïve. China has been a very controlled, dictatorial society for hundreds of years. Why should we expect them to change now, just because they got the Olympics, rightly or wrongly?

China has been a red-hot sector for investment over the last 5-10 years, and with the meteoric surge in its economy over the same period, why not? And with the Olympics starting this weekend, some investors are pondering whether to jump in now?

My advice, especially in light of Stratfor's analysis above, is that now is not a good time to be investing in China. Not only is its economy in a questionable state at present, it certainly appears that the current regime is willing to make some anti-market decisions to maintain its power and control, especially as the Olympics play out.

Certainly, if you are overweight in China, I would suggest taking some profits ahead of the Olympics. As noted in the Introduction, I will not be surprised if there is some sort of terrorist attack, or attempted attack, during the Olympics.

Likewise, I will not be surprised if there are some ugly actions by the Chinese government against the demonstrations that are reportedly planned during the Olympics. It will not surprise me if the Chinese authorities enact some draconian measures on their own people during the Olympics.

I have no hard intelligence to support these fears, it's just a concern I have. Better safe than sorry.

I Appreciate Your Input - Keep It Coming

It is an interesting challenge for me to write 7-8-9 pages of helpful content on various subjects week in and week out, year after year. I readily admit that some weeks are better than others. But I mix it up as best as I can. More often than not, I write about what interests me most, and I hope that agrees with you as well. Most times it does, based on the comments I get back from you, but not always.

Such was the case last week when I offered my thoughts on the presidential race between Senators John McCain and Barack Obama. What I did was present Obama's own positions on the issues; I did not fabricate any of them; and you can easily find them on his website. Yet the readers' reactions to my stating Obama's own positions were overwhelmingly negative.

As always, I appreciate all reader responses (as long as they are coherent and not vulgar). But I was surprised at the number of negative responses to my article last week, which merely pointed out Obama's public positions and some of his baggage that the media chooses to ignore. It makes me wonder, sincerely, if his many supporters really know what he stands for. Or worse, they don't want to know what he stands for.

Obama is liked by many, including some conservatives. Yet what is clear to me in this election cycle is that many conservatives are so fed-up with George W. Bush that they will vote in a backlash against any GOP candidate. This is sad, but it's where we are today after eight years of Bush.

Some newer readers have no knowledge that I have criticized George W. Bush for his policy decisions on numerous issues in these pages over the last seven years. President Bush has been such a disappointment for me as well as many conservative on so many issues and policies. He will not have a favorable legacy, in my opinion, regardless how the Iraq war ends up.

Barring some surprise, I think Barack will be our next president. I hope I am wrong. We believe that most readers of this E-Letter are high net worth individuals. We will be the bulls-eye for Obama's tax increases. Also keep in mind that doubling the capital gains tax will not be bullish for the stock markets.

Lastly, I always appreciate your comments and feedback, agree or disagree. So, keep your comments and suggestions coming in, and I will continue to read them and try to accommodate them as best I can. Thanks in advance!

Finally, on a personal note, my oldest child goes away to college in less than two weeks, and I will no doubt go through some withdrawal symptoms. Hopefully, that will not affect my writing. As I have written over the years, I have coached my son in year-round sports since he was five years old, so this will be a real adjustment for me.

Fortunately, he will only be 2½ hours from home, and my friends with kids already out of the house and in college tell me I will get over it. I hope so!

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

A highly political Olympic games
http://www.ft.com/cms/s/0/dcc1e390-617f-11dd-af94-000077b07658.html?nclick_check=1

The Economist on China & the Olympics (a long but interesting read)
http://www.economist.com/printedition/displayStory.cfm?Story_ID=11841531

Mr. Obama, Welcome to the NFL!
http://www.realclearpolitics.com/articles/2008/08/mr_obama_welcome_to_the_nfl.html

Obama, the postmodernist (good read)
http://blogs.usatoday.com/oped/2008/08/obama-the-postm.html

Liberal Press Circles Wagons Around Obama
http://www.newsmax.com/limbaugh/liberal_press_bias_obama/2008/08/05/119108.html

On The Economy, The Fed & President Obama

Gary D. Halbert — Wed, 30 Jul 2008 14:30:41 GMT

IN THIS ISSUE:

Economy Holding Up Better Than Expected
Consumer Spending Remains Strong
The Fed In A Policy Box
Obama Acts As If He's Already The President
John McCain's Electoral Mountain
The Vice Presidential Sweepstakes

Introduction

If you talk to people on the street just about anywhere in the US, you find there is a broad consensus that the US economy is well into a recession at this point. Yet the US economy is holding up better than expected. 1Q GDP was revised upward once again in the final report at the end of June. This Thursday, we get the Commerce Department's first estimate of 2Q GDP, and the pre-report consensus may surprise you. We will look at this and more economic indicators below.

Meanwhile, the Federal Reserve finds itself in an increasingly uncomfortable position. It has repeatedly lowered short-term interest rates over the last 12-18 months in an effort to combat the negative consequences of the housing slump, the sub-prime mortgage crisis and the resulting credit crunch. In recent months, however, even with the economy slowing down, inflation is on the rise. Now the Fed is in a dilemma – keep rates low to help the economy or raise rates to head off inflation and risk a potentially serious recession later on. We will discuss this in detail below.

Finally, we take a look at the presidential race and my latest thoughts about Barack Obama who is acting like he is already the president-elect, just waiting to occupy the White House in January. This man has to be the most arrogant presidential candidate in my adult lifetime. This would seem surprising given that his political and policy positions are extremely liberal and his background is suspect. Despite that, he may well be our next president.

My Obama misgivings aside, we will look at the political landscape as it seems to stand now – which states are likely to go to Obama and which are likely to go to McCain – and most importantly, the “battleground states” that could still tip either way. This should be a lively discussion all the way around, so let's jump in.

Economy Holding Up Better Than Expected

Whether you are a conservative, a liberal or somewhere in between, I trust you realize that the Democrats and their accomplices in the media want you to believe that the US economy is in a serious recession and, of course, it is all the fault of President Bush. Likewise, they want you to believe that soaring oil, gasoline and energy prices are the direct result of Bush and Cheney and Big Oil lining their pockets at our expense.

There is no debate on whether the US economy is in a slump – we can all agree on that. Yet the US economy is holding up better than even I have expected in light of the housing slump and the credit crisis. But you will not hear this in the mainstream media. They want the American people in a foul mood, at least until after the election. Despite that, let's look at the latest economic reports, and you can decide for yourself. Here we go.

We start with the latest figures on Gross Domestic Product, the bellwether indicator of the trend in the economy. In its advance report, the Commerce Department estimated 1Q GDP at an anemic +0.6% annual rate of growth. In its second report, the government raised its GDP estimate to +0.9% for the 1Q. And in its final report in late June, the Commerce Department raised its final 1Q GDP number to +1.0%.

What, you didn't hear this reported in the media? Not surprising. +1.0% is nowhere near recession levels. So, what is likely in store for the 2Q? The Commerce Department's first estimate of 2Q GDP will be released this Thursday (July 31). Remember that most analysts, your editor included, have previously predicted that GDP would fall into negative growth territory in the 2Q of this year.

But the pre-report estimates suggest yet another surprise – GDP may have outperformed yet again in the 2Q ended June 30. The consensus estimate is that 2Q GDP rose 1.8%. Where is that recession, may I ask? Here are some of the pre-report estimates on 2Q GDP. Morgan Stanley estimates that 2Q GDP rose 2.2%, well above the consensus estimate. Another source I follow, Macroeconomic Advisers (www.macroadvisers.com), now predicts that 2Q GDP will come in at a surprising +2.6%. If so, that will be another big surprise.

Macroeconomic Advisors also predicts that the US economy will grow by 1.4% in the 3Q. I don't know if they will be correct, but if they are remotely in the ballpark, the media's predictions of a recession this year are out the window.

The point is, we are not in a recession now, as defined by two consecutive quarters of negative GDP. Certainly, there are parts of the US that are experiencing a recession in terms of job losses and the drop in home values. Yet there are other parts of the country where the economy remains strong and home prices and sales remain vibrant, such as where I live in Austin, Texas.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc. are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Consumer Spending Remains Strong

The GDP numbers simply do not support arguments that we are in a recession. But what about other reports? Let's quickly go through the list of recent economic reports. Let me warn you in advance that more of the recent reports have been positive than negative. I'm sure this will come as a surprise, based on what you hear in the media.

The Index of Leading Economic Indicators (LEI), one of my favorite reports, was down –0.1% for June, following rises of a similar amount in April and May. FYI, the LEI has not moved more than 0.2% either way since the first of the year, which is an indication of an economy that is essentially directionless, but not headed into a recession.

It is widely agreed that consumer spending makes up apprx. 70% of GDP. Admittedly, continued strong consumer spending has astounded not only me but most other analysts in the marketplace for quite a while now. The latest data bear this out. Retail sales were up 0.1% in June, following a rise of 0.8% in May. These gains over the last two months came despite a continued drop in consumer confidence.

As I have pointed out often over the last year, US consumers continue to spend despite the drop in confidence and rising consumer debt levels. Several readers have asked me to explain this phenomenon. I have several theories I could advance, but space does not permit, so here is my short answer.

The media has blatantly contributed to the plunge in consumer confidence, but that has not translated into a nationwide plunge in jobs. The labor markets continue to be relatively firm. The unemployment rate remains historically low at 5.5%, although I expect it to rise to 5.6-5.7% for July. Meanwhile, personal income has continued to go up month after month. So most Americans are doing OK in their jobs, and they continue to spend on the things we all spend our money on, which keeps the economy from falling into a recession.

Other Economic Indicators Are Mixed

Here we go with the other recent reports. First and foremost, consumer confidence continues to plunge month after month. Yet consumer spending remains firm as discussed above. Take retail sales, for example. Retail sales rose 0.1% in June following a surprising rise of 0.8% in May. According to the Commerce Department, personal consumption expenditures rose 1.1% in the 1Q, to the surprise of many. Personal spending rose another 0.8% in May according to the latest report. Translation: the economy is in a slump, but it is a minor one and most consumers have not substantially changed their lifestyles – at least not yet.

The latest durable goods orders report for June released last Friday was significantly stronger than expected, rising 0.8% when the consensus was for a decline of 0.3%. The Commerce Department also revised its May durable goods report from a negative to +0.1%. Durable goods are generally long-lasting, higher priced items.

In other reports, industrial production rose 0.5% in June, following a decline of 0.2% in May. The ISM manufacturing index rose modestly to 50.2 in June from 49.6 in May. On the other side, the unemployment rate remained at 5.5% in June. Advance reports suggest the unemployment rate may rise to near 6% by the end of this year.

On the housing front, most reports remain negative, although a few indicators suggest the worst may be over. For example, housing starts and new building permits actually rose modestly in June. Yet sales of new and existing homes continued to fall. Pending home sales fell in May (latest data available), which is good, but is hardly a trend. It remains to be seen what happens just ahead with home prices, but it would seem that a bottom on the national level may finally be in sight by the end of this year.

On the inflation front, indicators are turning higher, or so it would seem. The Consumer Price Index for June was up 1.1% year over year, and the “core” rate was up 0.3%. The Producer Price Index (wholesale prices) was up for June 1.8%, and the core rate was up 0.2%, minus food and energy.

It is increasingly hard to separate the headline inflation rates from the ‘core' rates which exclude food and energy. It will be interesting to see how the government adapts its inflation reports in coming months to reflect this changing dynamic, if in fact they do.

The Fed In A Policy Box

Fed Chairman Ben Bernanke and his fellow members of the Fed Open Market Committee (FOMC) that sets interest rates are becoming increasingly concerned about rising inflation rates. Although the Fed has long been believed to focus on the core rate of inflation (minus food and energy), there is no doubt that Bernanke & Company are closely monitoring headline inflation as well. Bernanke made the following remarks in a speech on June 3:

“The possibility that commodity prices will continue to rise is an important risk to the inflation forecast. Another significant upside risk to inflation is that high headline inflation, if sustained, might lead the public to expect higher long-term inflation rates, an expectation that could ultimately become self-confirming. The Federal Reserve's mandate is to foster maximum sustainable employment and price stability. To achieve these goals, we must also support the return of financial markets to more normal functioning… For now, policy seems well positioned to promote moderate growth and price stability over time. We will, of course, be watching the evolving situation closely and are prepared to act as needed to meet our dual mandate.”

Those remarks delivered at an international monetary conference seemed to suggest that Bernanke is content to keep the Fed Funds rate at 2%, at least for the time being. However, there is believed to be a growing dissent among certain other members of the FOMC. The last FOMC meeting was on June 24-25 when the Fed once again elected to leave the Fed Funds rate at 2%. The FOMC policy statement included the following language:

“The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high…

Although downside risks to [economic] growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.”

These policy statements are carefully scrutinized, and there is little doubt that the Fed is increasingly concerned about inflation. The question is, will the Fed raise short-term rates at a time when the economy is struggling and the credit crunch is still far from over? The interest rate futures markets believe the Fed will raise rates at least once before the end of the year. My best sources, however, believe the Fed will not raise rates before the end of the year.

The next FOMC policy meeting will be held on August 5.

Do Most Americans Really Know Barack Obama?

To the surprise of most conservatives, Senator Barack Obama continues to hold a lead over Senator John McCain in most of the national tracking polls, although McCain has made some gains over the last week or two as Obama went on his global “fact-finding” tour. Most conservatives are astonished at how many Americans have jumped on the Obama bandwagon, especially given his liberal positions on so many issues, his lack of experience and his questionable background.

Let's start with the questionable background. We are told that Obama served as a “community organizer” in Chicago for ACORN (the Association of Community Organizations for Reform Now), which is one of the largest radical groups in America. You can easily check this out on the Internet. Next, there are Obama's ties to now-convicted felon, Tony Rezko. Rezko, a Chicago mover and shaker, was one of Obama's earliest supporters. After Obama was elected to the Senate in 2006, he and Rezko were involved in a questionable real estate transaction involving the purchase of Obama's mansion in Chicago. Obama has since admitted it was a mistake.

Then there is the issue of Obama's former minister of 20 years, Jeremiah Wright, who hit the national spotlight recently with his outrageous sermons. Wright also has a close relationship with and has praised Louis Farrakhan, who is the Supreme Minister of the Nation of Islam and an outspoken anti-Semite.

In addition to his questionable background, there are his various liberal policy positions and votes. Obama has been rated “the most liberal Senator in Congress” by National Review, a prominent conservative think tank in Washington. Obama is pro-abortion and pro-gun control. He will raise income taxes, especially on those making $250,000 or more a year, and he says he will increase the capital gains tax (not good for the stock markets).

He vows to nationalize health care, which in my view is one of the scariest things about Obama. He is opposed to increased offshore drilling for oil and natural gas – ANWR would definitely not be allowed. He is a global warming enthusiast. He opposed the war in Iraq. He refuses to admit that the “surge” in Iraq has worked, even after his latest visit there. And the list goes on.

Then there is the critical question of the Supreme Court. With the advanced ages of several current Justices, it is very likely that Obama will get to nominate at least two Supreme Court justices in his first term should he be elected. He could well nominate another one or two should he win a second term.

As discussed at length in my July 1, 2008 E-Letter, the Supreme Court is fairly balanced at present with four generally conservative Justices and four generally liberal ones, with one swing vote in Anthony Kennedy. Depending on which Justices retire in the next 4-8 years, Obama could swing the court significantly to the liberal side. And with the Democrats firmly in control of the Senate, you can bet Obama's Supreme Court nominees will be approved quickly.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc. are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Obama Acts As If He's Already The President

Despite the negatives noted above, the mainstream media fawns over Obama's every word and refuses, for the most part, to write anything negative about the man – past or present. The ultimate proof of this was his latest overseas trip in which the evening news anchors from ABC, CBS and NBC all jumped at the chance to accompany Obama on his global junket.

Actually, I think Obama hurt himself on his foreign trip by talking and negotiating with foreign leaders as if he is already the President-elect. Excuse me, but we haven't voted yet! Not that I care to admit it, but I have marveled at Obama's confidence (at least when he has a teleprompter). However, his ill-advised discussions with foreign leaders now make me believe that he is one of the most arrogant politicians I have ever seen.

Given all of the above, why is Obama leading in the polls to become our next Commander-In-Chief? Much of it, I believe, is “Bush Fatigue.” Liberals and the media always hated Bush. Everything in the world that is wrong is Bush's fault. Many conservatives have turned against President Bush as well – he has disappointed us on many occasions. Unfortunately, many conservatives don't like McCain and may simply sit out this election, which is effectively a vote for Obama.

It is my belief that many Obama supporters are really just anti-Bush voters who simply want someone in the White House that is not the GOP candidate. That, in my view, is why many Obama supporters have dismissed (or failed to investigate) his questionable past and his liberal policy positions.

I have no doubt that I will receive many scathing e-mails in response to the analysis above from our more liberal readers. But take heart, Obama supporters! The following state-by-state electoral analysis will be sure to warm your hearts. I've asked my associate Spencer Wright to review the latest state polls and crunch the electoral numbers. Unfortunately, it does not look very good for John McCain. Take it away Spencer.

John McCain's Electoral Mountain

National tracking polls have recently narrowed, thus putting the contest between McCain and Obama close to the margin of error as of last week. In fact McCain is enjoying a rather healthy rise in public opinion. In the face of the Obama World Tour 2008, this is very encouraging news. To say nothing of a very real dose of Bush Fatigue throughout the country combined with rising energy prices and the poor economy. So, all things considered, the McCain campaign should be thrilled with the week they have had. Indeed, ANY Republican candidate would struggle in this environment, although it does not help matters that McCain is viewed by many as a weak candidate.

It is important to keep in mind that at this stage most polls are reflecting the views of partisans who do not pick the president. It has been the soft middle of American politics – the so-called “swing voters” - that have determined our president since 1988. And those that comprise the middle generally are tuned out until the party conventions, which is why the conventions have become glitzy five-day infomercials that normally give each candidate a nice bounce in the polls just afterward.

That is why, at this pre-convention stage, the national tracking polls are of marginal value, whereas looking at the individual state polling numbers is a much better way to get a read on the potential outcome. I am not going to bother looking at states that are solidly for McCain or Obama as there is no point. Instead, let's look at the handful of “battleground” states that will determine the outcome of the election.

The battleground states currently are: FL, OH, MI, NC, VA, IN, MO, CO, NM, NV and NH. This leaves Obama with a solid 238 electoral votes and McCain with a solid 163 electoral votes, leaving the 11 battlegrounds to account for a total of 137 electoral votes. Already you can see the path to 270 is much easier for Obama than McCain, as he holds a 75 electoral vote lead in solid states.

Here's my list of where the battleground states stand based on the RealClearPolitics averages. This may differ slightly from some that you see on TV, but I think this is where the race is now. (Note that “EV” stands for Electoral Votes.)

FL (27 EV): Florida was looking like a McCain stronghold until recently. Obama has made substantial gains in the state over the last month. Current Standing: Obama 45.8% / McCain 45.8%. FL is a definite ‘must win' for McCain.

OH (20 EV): Ohio is the battleground of battlegrounds, and it has been hard hit by the recent economic downturn. Bush won the state by thin margins in 2000 and 2004. Current Standing: Obama 46% / McCain 45%. Ohio is a ‘must win' for McCain.

MI (17 EV): Like Ohio, Michigan has been hard hit by the recent economic slump. Add to that its history of voting Democrat across the board from 1992 on and you get a tough landscape for McCain, although recent Democrat victories in the state have been narrow. Current Standing: Obama 46% / McCain 42%. This is a ‘must win' state for Obama.

NC (15 EV): North Carolina is yet another state that leans Republican and should not be this close, another indication of how McCain is doing poorly with the base. Current Standing: Obama 43% / McCain 47%. NC is another ‘must win' for McCain.

VA (13 EV): Virginia is another state that really should not be in contention. While VA went for George Bush in 2000 and 2004, it has been trending Democrat over the past 12 years. Current Standing: Obama 47% / McCain 46%. VA is ‘must win' for McCain.

IN (11 EV): Indiana should not be a battleground state since this state hasn't voted for a Democrat in almost 40 years. This is a sign of McCain's weakness with the GOP base. Current Standing: Obama 47% / McCain 46.5%. IN is a ‘must win' for McCain.

MO (11 EV): Missouri has been in the GOP portfolio more often than not over the last 40 years, voting for a Democrat only three times over the last 10 cycles. Yet the polls are currently very tight in this Midwest bellwether state. Current Standing: Obama 45% / McCain 47%. MO is a ‘must win' for McCain.

CO (9 EV): Colorado voted for Bush twice but by fairly small margins. The Democrats are convinced that it can be flipped. Look for lots of action in this state. Current Standing: Obama 47% / McCain 45%. CO is a ‘must win' for Obama. More on Colorado below.

NM (5 EV): New Mexico split over the last two general elections going narrowly for Gore and then narrowly for Bush. This is another western state that the Democrats believe they can take. Democratic Governor Bill Richardson is very popular and has endorsed Obama and may be in the running for the VP nod. Current Standing: Obama 49% / McCain 43%. NM is a ‘must win' for Obama.

NV (5 EV): Nevada voted for Clinton twice and Bush twice, but never by large margins. Mark this as the third western state the Democrats think they can capture. The YuccaMountain nuclear waste disposal area is a big hot button issue. Current Standing: Obama 45% / McCain 43%. NV is a ‘must win' for Obama.

NH (4 EV): New Hampshire is the rare New England state that does actually vote for a Republican now and then. It voted for Bush in 2000. McCain is very popular in the state, which is why the polls remain close. Current Standing: Obama 44% / McCain 43%. NH is a ‘must win' for Obama.

As noted at the beginning of this state-by-state analysis, Obama has a large lead over McCain in the electoral vote based on the current polls. Thus, you may be wondering why, if Obama already has a built in 75 EV lead, does he need to win any of the “must win” states marked for him? Well, those states represent Obama's path of least resistance to the magic 270 EV total needed to win.

Let's say, for example, that McCain manages to poach MI and salvage OH, VA, MO, NC and FL – states that Republicans normally have a good chance in. Based on current polls, that would be a good showing for McCain. However, Obama can still win by carrying NH, NM, CO and NV. That would give him 272 EV vs. 266 EV for McCain.

Fortunately, I have it from a good source on the ground that McCain is surging in Colorado, with its nine electoral votes, and has pulled to even with Obama in the last week. Assuming McCain carries the states he is expected to – which is a huge assumption – this race could ultimately come down to only one or two key states. We will revisit the standings after the Democratic convention, and again after the GOP convention.

The Vice Presidential Sweepstakes

McCain's biggest problem of late is that he can't get in the news. Obama, with his World Tour, has dominated the news cycles. Yet despite Obama sucking all of the oxygen out of the room, McCain has closed the gap in the national tracking polls to close to the margin of error. But for McCain to get back in the news, he has to do something big.

There is rampant speculation that McCain is on the verge of making his VP announcement to get back into the spotlight. Some believe this would be a good idea as it would not only build upon recent gains, but would shift the media attention from Obama to McCain, at least for a few days. Others like Karl Rove advise McCain to announce his VP choice only after Obama announces his. We'll see.

Of course the size of the McCain VP bounce will depend on who he picks. In my opinion he has three basic options for his running-mate: 1) base; 2) buzz; and 3) boring. He could select Mitt Romney to shore up the GOP base; he could pick Louisiana governor Bobby Jindahl, a young rising star in the GOP, which would create a real buzz; or he can pick someone boring like his old friend Tim Pawlenty, the governor of Minnesota.

Gary and I firmly believe that Mitt Romney is the best choice if McCain is to have any chance to win. Romney could solidify the GOP base and would certainly help McCain in states like Virginia, North Carolina, Ohio, Indiana, Florida and certainly Michigan where his father was a very popular governor. The problem is, McCain doesn't like Romney. Hopefully, his advisors are urging him to pick Romney anyway. We feel that if he picks Jindahl or Pawlenty or some other lightweight, it will be a sign that McCain doesn't think he can win.

And what about Obama? Rumor has it he will also announce any day now. The Democratic National Convention begins on August 25, and Obama should make his choice very soon. Unlike McCain, Obama will likely make his VP pick based purely on two factors: experience and gravitas. Obama is believed to be considering three possible VP choices (in no particular order): 1) former Georgia Senator Sam Nunn; 2) Virginia Governor Tim Kaine; and 3) NM Governor Bill Richardson, who we consider a distant third.

What about Hillary? Gary and I believe that Obama would only choose Hillary if he was falling down in the polls. We could be wrong, of course, but we don't see Obama opting to take on the Clintons' baggage, and the chance that he could be upstaged by either Bill or Hillary. As noted above, Obama still has a lead in the polls. Thus, assuming Obama announces his VP choice before the convention, we do not expect it to be Hillary.

Sam Nunn would seem an unlikely pick because he is a conservative Democrat. However, Nunn is a political heavyweight, even though he retired from the Senate in 1996. On the one hand, conservatives might hope that Obama picks Nunn who might temper Obama's liberalism. On the other hand, I think an Obama-Nunn ticket would be virtually unbeatable.

That's it for the state electoral analysis and my take on the VP sweepstakes. Back to you, Gary.

Conclusions – Pass This Along

Thanks, Spencer. As noted previously, this is one of the more interesting presidential elections in some time. This is one of the most important presidential elections, in that more is at stake than in a long time. Obama is arguably the most liberal presidential candidate to get the Democratic nomination in a generation or more, yet many Americans who are going to vote for him do not know this. Unfortunately, for many, it is simply “anyone but Bush and the GOP.”

Feel free to forward this E-Letter to as many people as you wish, in whole or in part. Investors in particular need to know where Obama stands, because I do not think he will be good for the markets. Senator McCain was not my choice for the GOP nominee, but conservatives need to come out and support him.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Obama's audacity of hubris
http://www.theglobeandmail.com/servlet/story/RTGAM.20080726.wxcorex26/BNStory/specialComment/home

Can McCain Back In Again?
http://www.realclearpolitics.com/articles/2008/07/can_mccain_back_in_again.html

Obama's communist connections?
http://www.aim.org/aim-column/special-report-red-faces-over-obamas-red-mentor/

Forecasts & Trends : Economy

Economic Recovery vs. Rising Unemployment

The Economy & the Commercial Real Estate Bust

Second Stimulus - Good Money After Bad

Have We Turned The Corner On The Recession?

Obama's Tax Policy: None Dare Call It Welfare

Introduction

QUOTE: "Obama Stimulus Fosters Tax-Exempt Tyranny by Dick Morris & (wife) Eileen McGann

QUOTE: "The Tax Cut Mirage by Peter Ferrara

Conclusions

Economic & Investment Outlook For 2009

Introduction

Editor's Notes

Obama & The New Age Of Big Government

The Economy -- Have We Seen The Worst Of It?

Are The Bailouts Necessary & Will They Work?

The Latest Disappointing Economic Reports

Deflation -- Consumer Price Index Goes Negative

Stock Markets -- Might We Have Seen The Bottom?

Conclusions

It's Official - 2008 Was A Very Bad Year

Introduction

Happy New Year!!

The Recession & More Government Bailouts

Introduction

Latest Grim Numbers On The US Economy

The Latest On The Government Bailouts

Fed Announces The Mother Of All Bailouts

Troubling Aspects Of The Fed's Latest Bailout

Fighting "Debt-Deflation" At Any Cost

Credit Crisis: Do Bush & Paulson Have A Clue?

Introduction

Stratfor's Take On The Subprime/Credit Crisis

Treasury Secretary Paulson Changes The Plan

Do They Even Have A Clue What To Do?

Bailout's Next Phase: Consumer Loans (Maybe)

More From Stratfor On The Credit Crisis & The Economy

Gauging The Recession & The Economy - Not Good

Stock Markets Detest Uncertainty & Economic Woes

Conclusions - They Are Few

The Democrats' Plan To Highjack Your 401(k)

Introduction

The Economy Falling Fast Into Recession

Democrats Want To Highjack Your 401(k)

The Democrats' 401(k) Replacement Plan

Congressional Testimony Paints A Different Picture

Socialism Du Jour - "Spread The Wealth Around"

A New Democratic Piggy Bank

Can We Afford This Nonsense? No, But So What?

Conclusions - After Today, Anything May Be Possible

Uncle Sam's $700+ Billion Toxic Securities Fund

Introduction

Details Of The Massive $700 Billion Bailout

Government Guarantees Money Market Funds

Will Congress Pass The Bailout Plan?

Should The Government Bail Out Homeowners?

Will Uncle Sam Overpay For The Assets?

Credit Crisis May Tip The Election To Obama

Time To Prepare For A Recession Just Ahead

Conclusions

Category 2 Hits Texas, Cat 4 Hits Wall Street

Introduction

Lehman Brothers Files For Bankruptcy

Bank of America Buys Merrill Lynch

Largest Bank/Brokerage In The World

Will AIG Be The Next Giant To Fall?

Emergency Sunday Wall Street Trading Session

Implications For The Investment Markets

Finally & Most Importantly:Where Our Clients’ Accounts Are Held

Conclusions – History In The Making, Perhaps

The Economy, The Electoral Map & The United Nations

Introduction

The Economy Surges Above Expectations

Stocks - Have We Seen The Bottom?

The Electoral Map Remains Very Tight

My Thoughts On The Sarah Palin Pick

The Scary Democratic Party Platform!!

Dems Endorse Expansion of U.N. Power

Thoughts On China, The Olympics & Investing

Introduction

QUOTE:
"Obama Stimulus Fosters Tax-Exempt Tyranny
by Dick Morris & (wife) Eileen McGann

QUOTE:
"The Tax Cut Mirage
by Peter Ferrara

Finally & Most Importantly:
Where Our Clients’ Accounts Are Held

QUOTE:
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