A piece tonight in the WSJ is painful reading about what is happening in California, the state first and most severely struck by the subprime credit crisis. There is the odd glimmer of light -- like that San Diego real estate shows signs of bottoming -- but it is  mostly bleak stuff.

With its export businesses, manufacturing sector, professional services and big retail employers, California looks like many other U.S. states, only more so. California's $1.8 trillion economy -- twice the size of India's and accounting for about 15% of the U.S. gross domestic product -- is powerful enough to have ripple effects nationally. It is home to Hollywood, five of 30 Major League Baseball franchises and the largest farming sector in the nation.

California was also at the leading edge of the nation's recent housing bubble, which is where its current problems started. Home prices in California rose higher and faster than in most of the U.S., and started weakening earlier, in 2005. Some mortgage-holders defaulted. Others struggle along under a mountain of debt. The problems spread to the state's financial sector, which was heavily exposed to local real estate. As Californians cut their spending, job losses spread from the housing sector to retail stores and auto dealers. Now the state's unemployment rate is 7.7%, among the highest in the nation.

More here.

I'll let this go more or less without commentary as it's just too good, but it is a headline from the NY Times on December 4, 1914.

More here.

After all this time Treasury is now getting around to saying it might start actively taking equity stakes in banks as part of a recapitalization program. Gosh. Now where have I heard that idea before? I can't quite recall. Oh yes, pretty much everywhere but Treasury.

Anyway, as Treasury and the Fed have discovered, nervous banks with access to the Fed spigot are like worried consumers who get stimulus checks: They don't spend, they hoard. And given that the fundamental issue isn't liquidity -- there is absurd amounts of cash out there -- but insolvency, and given the experience of other countries during similar credit crises, and given how slow and expensive TARP is likely to be, I'm glad Paulson, Bernanke, et al. are seeing some sense.

Now, if it's not too much to ask, it would be nice if Ben and Hank -- with some assistance -- picked favorites didn't try and prop up every bank. Please?

More here.

Canada is not China.

   -- An anonymous ex-Fed official explaining U.S. eagerness to find Canadian buyers for U.S. banks. "Fed Trolls Canada to Rescue U.S. Banks"

Let no-one say, pace Al Capone, that the U.S. still doesn't know which side of the street Canada is on. It is on the side of the street with better-capitalized non-Chinese banks.

With short-selling set to come back into the markets today, there are lots of worried people out there. I'll confess to being somewhat more sanguine, if only because I struggle to see how things could have been materially worse in the last week, what with having had the worst year-to-date in history (including the Depression years).

Anyway, for those of you still pushing for a continued ban on short-selling -- and yes, I see your emails and messages and I know there oodles of you -- you may be interested in trying a different approach. Perhaps you might think about, say,  converting to Islam.

'In Islamic Finance, we deny the conventional way of thinking, which aims of creating a new dollar out of every dollar', says renowned Pakistani Shariah scholar Sheikh Dr. Taqi Usmani. By selling a stock short, the 'investor' may gain while the underlying company loses value - a clear violation of the ban of unjust deeds, stated in the Holy Quran, Sure Al Baqara, 2, 278 - 279: 'Deal not unjustly, and ye shall not be dealt unjustly'.

Islamic Finance is about serving society. By selling a stock short, an avalanche of more short-sellers might be triggered, leading the firm to expensive stock buy-back initiatives or in the worst case to bankruptcy.

There you go. Convert to Islam and declare short-selling haram and get it over with. Then again, short-selling isn't the only thing that's haram:

As well as short selling, day trading is labelled as speculation and therefore is counted as haram as well. Market participants are certainly allowed to profit, but this should add value to the entire economic system.

Oh, you go too far! Day-trading is haram!? Next thing you know selling useless insurance against credit defaults will be haram, and then .... hmmm, wait a minute.

More here.

Some harrowing if unsurprising data from S&P and PE Week Wire:

• Year-to-date, 60 of the 2,238 companies tracked by S&P with speculative grade debt are in default
• 22 of those 60 are are private equity  backed, implying a 37% default rate so far
• Assuming defaults rise to 5% from the current 2.68%, that implies another 111 defaults, a figure to which you can attach the 37% figure from above
• Buyouts are now drawing down heavily on revolving lines of credit, which suggests we could see some major busts come Q1 09

More here.

Some quick links to items of interest:

• New special report from The Economist on current crisis (Economist)
• U.S. home equity extraction has hit lowest levels in more than a decade (Bloomberg)
• Nick Leeson: The government got you into this mess, so don't trust them to get you out (Daily Mail)
• Glimmers of light showing in credit markets (Bloomberg)
• China exports to U.S. "small beer" for economy (Bloomberg)
• Iceland takes over biggest bank Kaupthing as entire banking system has now failed (Bloomberg)
• The living yield curve (Smart Money)
• What will the crisis mean for venture capital? (BusinessWeek)
• How to recapitalize the banking system (Mankiw)
• Former FDIC chairman Bill Isaac on getting fixes right (The Deal)
• Jet fuel surcharges finally coming off prices (BusinessWire)
• If easy money causes a bubble, does easy money cure a bubble? (Bloomberg/Baum)

With the London Interbank Offered Rate (Libor) at record levels, thus hurting short-term borrowing, as well as blowing up many mortgages linked to the floating rate, it's useful to remind yourself how exactly Libor works.

[via Bloomberg]

Fairly astounding data nugget on the collapse in daily rates charged by bulk shipping carriers:

UNCONFIRMED reports a panamax was fixed for a voyage that covered bunkers and port costs only stunned London brokers today, as bulk carrier charter rates continued their month-long freefall.

The fixture, yet to be verified by the Baltic Exchange, was rumoured to be for a 1981-built panamax coming out of the Middle East Gulf for a journey via the west coast of India, to take a cargo of iron ore to China.

If true, the deal represents an amazing turnaround for panamax charter rates, which have plunged from over $50,000 per day in late August.

The charter arrangement for the elderly vessel represents an effective rate of “zero dollars per day” and plunges the industry back to its darkest times in the early to mid 1980s.

... Panamax average time charter rates hit a high of nearly $95,000 per day on October 30 last year. But the rate was still as high as $91,000 per day in late May, when China’s reccord-breaking appetite for iron ore from Brazil and Australia saw demand for bulk carriers outstrip supply.

More here.

Harrowing/amusing/disturbing chart from the folks at Bespoke today. It shows the percentage of the S&P 500 financial sector that a Paulson Buck ($700b) bought you over the last month since the TARP plan was announced:

Nice video from the people at Marketplace explaining collateralized debt obligations in terms of wine and wine glasses.

Provocative comment from Jim Chanos this morning on CNBC:

Given that it was the bank CEOs and broker CEOs who went to Washington calling for the ban, the question I would have loved to seen asked of (Lehman Brothers CEO Richard) Fuld or anyone going forward at the hearings…would have been ‘Mr Fuld...at any point was your proprietary trading desk short the shares, long puts or long CDS contracts on other banks and brokers between February and September of this year?’

More here.

Russia is trying out the time-tested "What me? No crisis" approach to managing its current market problems:

The main channels have either downgraded or ignored altogether Russia's financial turmoil since it began in mid-September, according to media monitoring companies and research by The Moscow Times. On Monday, for instance, none mentioned the meltdown in Russia or any possible repercussions from the crisis. Only the smaller Ren-TV and Zvezda channels mentioned the stock plunge, according to Medialogia, a private company that tracks the media. [...]

The Kremlin recently instructed both state and privately owned television channels to avoid using words like "financial crisis" or "collapse" in describing the turmoil in Russia, said Vladimir Varfolomeyev, first deputy editor at Ekho Moskvy radio.

"Specifically, the blacklist includes the words 'collapse' and 'crisis.' It recommends that 'fall' be replaced with the less extreme 'decrease,'" Varfolomeyev said in comments posted on his LiveJournal blog late last week.

More here.

[via FP]

Here is (according to Reuters) the timeline for what will be an epic CDS auction tomorrow related to the Lehman bankruptcy. There are huge losses to go around, confusion about counter-parties, and I expect a host of releases tomorrow afternoon as people disclose their newfound liabilities.

9:45 a.m.-10 a.m. Auction participants will submit bids and offers for the debt backing the credit default swaps, which will be used to determine the initial recovery rate of the swaps.

10:30 a.m. Auction administrators Creditex and Markit will publish the initial recovery price and the open interest for the contracts will be published. The open interest reflects the amount of bids and offers that have been made, and will show if there are more buyers than sellers, or vice versa.

12:45 p.m. -1 p.m. Participating dealers will submit limit orders for the debt on behalf of themselves and their clients to fill the open interest

2 p.m. The final price of the auction will be published.

Most people expect prices in the 12-to-13 cents on the dollar, leading to payouts in the $400-billion range.

Nothing to do with the looming financial apocalypse, but it's sunny and there is a fresh coat of snow up at Whistler BC. Life will (eventually) be okay.

This is completely anecdotal, but in flying around North America in recent weeks I have had fewer departure delays and more early arrivals than at any time in recent memory. I'm regularly getting in 10-30 minutes ahead of schedule, which can't be because the prevailing wind is always pushing me in the right direction. I'm guessing it's because there are simply fewer planes jockeying for slots.

Fascinating piece over at RGE Monitor by Nouriel Roubini on the back-room machinations that led to today, where the emphasis with respect to the $700b bank bailout is now on equity injections, not the flawed idea of purchasing banks' toxic assets.

So where did Paulson get the authority to do such capital injection when there was no such authority in the wording of the legislation? Several of us had been explicitly and feverishly talking to Congress and the Fed and other senior officials (last week before the passage of the legislation) to include such explicit wording in the legislation; such campaign included the October 1st column by George Soros in the FT where he strongly argued – as many of us had recommended – to design legislation that explicitly allowed for public capital injection in banks.

... See the following important exchange between Jim Moran and Barney Frank that is now on the legislative record of the House:

Mr. MORAN of Virginia. Thank you, Madam Speaker. I won't take that much time. I do want to thank the chairman for his masterful leadership on this bill, and I do want to clarify that the intent of this legislation is to authorize the Treasury Department to strengthen credit markets by infusing capital into weak institutions in two ways: By buying their stock, debt, or other capital instruments; and, two, by purchasing bad assets from the institutions, in coordination with existing regulatory agencies and their responsibilities under this legislation, as well as under already existing authorization for prompt, corrective action and least cost resolution.

Mr. FRANK of Massachusetts. Will the gentleman yield?

Mr. MORAN of Virginia. I'd be happy to yield.

Mr. FRANK of Massachusetts. I can affirm that. As the gentleman knows, the Treasury Department is in agreement with this, and we should be clear, this is one of the things that this House and the Senate added to the bill, the authority to buy equity. It is not simply buying up the assets, it is to buy equity, and to buy equity in a way that the Federal Government will able to benefit if there is an appreciation.

... So, all is well that ends well. A totally flawed and ineffective legislation that did not explicitly allow to do the right thing – recapitalize banks with public capital injections – and was rather aimed to do the wrong thing (wasting $700 bn of taxpayers’ money to buy only toxic assets at an inflated price) was rescued at the last moment right before the House vote via an interpretation of the wording of the legislation in the record of the House that allowed such recapitalization.

Here is the Paulson Problem in a nutshell:

• If he doesn't speak, people panic because nothing is improving in the financial system
• If he does speak, people assume things are getting worse in the system, or that Paulson is doing a 180 on a prior plan (like TARP-to-equity-injection).

Paulson is rapidly losing whatever credibility he once had.

People keep talking about the perils of nationalizing the banking system. Newsflash: There currently is no banking system, if by that you mean a network of organizations lending to one another and to quality companies in a predictable way. (Look at the spread on today's IBM issue for an example.) Instead, there are a bunch of paralyzed deposit-hoarding institutions stuck in a game theory experiment that no-one understands or can exit.

The solution to a systemic breakdown in tightly-coupled systems is to uncouple the systems, build in slack, and break the feedback mechanisms -- and not necessarily in that order. In this context you can do that most directly by either recapitalizing a select set of banks immediately, or by letting banks fail and consolidate. Either way, you end up with uncoupling and the eventually reappearance of trust, whether through a government backstop or through defaults and collapse. I tend toward the former approach, but I fully understand its risks and the attractiveness of the latter to some people.

Either way, trying to fix things on the fly, without breaking the feedback mechanisms, and without introducing slack to protect a fragile and badly damaged system from the next inevitable lurch, is stupid, destructive and childish.