"Why don't you move back into your own house," his father wanted to know.

"Dad, I've got a good tenant in there. Besides, it's not in very good shape. I'd rather sell it than invest more money in it. And there are so many places on the market, I can rent something better. Even after a big drop in prices it is still cheaper to rent than it is to buy something."

There are probably millions of homeowners who would like to sell - if they could. This hidden inventory of unsold houses will depress housing prices for a long time.

But there's a crisis coming in commercial real estate too.

"An extreme amount of commercial debt is to mature over the coming years," writes real estate investor George Karahalios in Marc Faber's Gloom, Doom and Boom Report. "And unlike the residential market, there is no safety net (Fannie Mae) for commercial loans. Instead investors must rely on financing through commercial banks, a few insurance companies, and other private lenders who now demand much higher interest rates and more equity for the risk associated with these investments. Thus, not even the Fed's printing presses can save commercial property prices, and I am expecting certain locations to crash, perhaps falling as much as 50-80% from the peak."

So you see, dear reader, there is bad news ahead - a lot of it. Stocks will go down. Gold will go down too - most likely - when people realize that the economy faces a long, deflationary depression...not a period of inflationary growth.

But while stocks are fair weather friends, gold sticks by you in foul weather too. Right now, gold is rising on good news. Eventually, it will soar when the news turns bad. (Though...not necessarily right away...)

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• The Housing Slump Has Fattened the Inventory of Unsold Homes
• Commercial Real Estate May Be the Next to Fall
• Trends Make Investors Less Afraid of Risk
• Ireland Going Through Same De-leveraging Process as the US
• Housing Prices Follow GDP Growth and Inflation

Starring Ben Bernanke, Tim Geithner and a cast of millions...

The new movie - Zombieland - about a group of survivors in a world of zombies, was the biggest grossing film in America and Canada over the weekend. It must reflect the zeitgeist of the North American public...a deep feeling that we are living in a decaying world.

Maybe it comes from the growing awareness that the old bubble economy of the 2002-2007 period is dead. Now, survivors must defend themselves from the zombies.

Survivors are being attacked in the streets, in their homes, and at their workplaces. Zombie banks - kept alive by artificial stimulants provided by the feds - take their money and their houses. Living-dead companies block new competitors. And the zombies at the Fed and the Treasury department try to gnaw on their savings, encouraging inflation to eat away the purchasing power of the dollar.

As to this last point, the feds have gotten nowhere. They wear down their teeth for nothing. Prices are going down, not up. Houses are 30% cheaper than they were in 2006. Hotel rooms are 20% cheaper than last year. You want a luxury room? Just ask for an upgrade. Chances are good that no one is renting the luxury suites. Just make them an offer. Discounts are available almost everywhere. The Sony Playstation, for example, is now available - 25% off.

Stocks are cheaper too. They've been going up for the last seven months, but they're still about a third less than they were in 2007.

Stocks fell again on Friday. Investors began to fret that maybe...just maybe...the authorities don't have this zombie problem under control.

"Jobs news gets worse," The New York Times tells us.

Since the stock market began going back up in March, the United States has lost 2.5 million jobs. It has lost jobs every month since December 2007. Now, unemployment - officially at one in ten workers - is the worst it has been in 26 years.

What kind of recovery is this? We don't know, but if it continues much longer we'll all be unemployed.

But not to worry, dear reader. Secretary of the Treasury Tim Geithner says the signs of recovery are "stronger" than expected.

We wonder what signs he's looking at. Of course, this is the same doctor who was on the scene at the New York Fed when strange things began happening. The financial industry started acting funny in the bubble years...spending money like there was no tomorrow. And then, wouldn't you know it, there wasn't any tomorrow. They dropped dead in the crash of '07-'08. But with huge injections from the Fed, they've turned into Zombies.

Of course, Tim Geithner missed the whole thing. So maybe he's not the best source of recovery sightings.

A survey by Business Roundtable tells us that the ranks of the unemployed are likely to swell. Only 13% of employers have plans to hire more workers. The rest are either sitting tight...or turning workers loose.

Naturally, of all those people cut off from paychecks, more than a few are looking a little peaked. Their eyes sink back in their heads. Their skin turns grey. Soon, they're starving for raw meat.

"Personal bankruptcies soar," says The Wall Street Journal.

And not surprisingly, when they become desperate, they tend to default on their mortgages. We know already that auto sales drove off a cliff when the summertime 'Cash for Clunkers' program came to an end. Now, summer's over. Housing sales should decline too - forcing more homeowners into default and foreclosure.

The zombies are having a depressing effect everywhere. The stock market went down again on Friday...the Dow fell 21 points. The oil market didn't do much better, with the price of the black good still below $70.

As for gold, the yellow metal continues to hold above $1,000. It fell below $1,0 00 for just a couple days. On Friday, it was back to $1,004.

The $1,000 level used to be a ceiling for the gold price. Now it seems like a floor. Are the Chinese buying below $1,000? Maybe. Do we have a Beijing put option available to us? That is, has the risk been taken out of the gold market by China's desire to stock its vault with something other than dollars? It is an intriguing thought. We don't know the answer.

We are holding onto our gold. It's insurance - protection against the feds. If they do something really stupid, the price of gold will soar. If they don't do anything really stupid, well, we'll be surprised. After all, they've already turned America into Zombieland.

Bill Bonner
for The Daily Reckoning Australia

• A Dispatch from the Zombie Wars
• Where, Exactly, is this Economy Headed?
• Funny Business at the Banks
• Economy Has to Grow at 1% to Stay Even With Population Growth
• Unemployment Rate at a Five Year High

"US consumers are cutting back, and where they are not cutting back, they are scaling down. This new cycle is all about 'getting small' and it is deflationary. For yet another in the litany of signs pointing in the direction of social change towards thrift, have a look at what is transpiring at the upper echelons of the income strata - Now Even Millionaires See the Benefits of Budgeting on page B5 of the Saturday NYT is a must read.

"Not only are the rich trading down, but the article quotes a high net worth financial advisor who said 'many of our clients are very happy to be sitting on bond portfolios and cash reserves.' And see the article on page 2 of the Sunday NYT - Beauty Products Lose Some Appeal During Recession. According to the NPD Research Group, total sales of department store beauty products are down 7% from year-ago levels. Women are apparently opting for the 'natural look' - "some people are selectively replacing higher-priced items with cheaper products from drug stores and discount stores."

Right on, David!

And here's the CEO of Pepsico:

"The age of thrift is here."

Even in Japan, after 20 years of coughing and sneezing, people have caught "the thrift bug," says The New York Times.

What's a consumer economy need in order to keep growing?

Uh...it's needs consumer spending.

What do consumers need in order to boost spending?

Uh...they need more money!

Oh, there's where it all starts to come apart, doesn't it? Where do they get more money? They either earn it...or they borrow it. And right now, they can't earn it - not with 12% unemployment in California! Workers have no bargaining power. And they can't borrow it either. The banks won't lend - not with the value of their collateral still falling.

Word comes this morning that mortgage delinquencies have hit a new record. And here's a headline warning of worse to come:

"$30 billion home loan time bomb set for 2010."

Even solvent homeowners who aren't forced into foreclosure still find it beneficial to walk away from their houses. "Strategic defaults,' says The Los Angeles Times, are becoming a problem for mortgage lenders.

We didn't read the article. Instead, we began to think. What if we owned a house worth $200,000 with a $300,000 mortgage? What would be the smart thing to do? Easy...walk away from it. Then, buy it back at auction!

Desperate consumers do what they have to do. Canny consumers do what's smart. And now it's smart to walk away from any debt that you don't actually have to pay.

As for adding more debt, you can gage yourself from the comments above, consumers are not eager to borrow. They've seen what happens when they go too far into debt. They're older and wiser than they were in the bubble years. It's been 10 years since the tech bubble exploded. Since then, stock market investors have made nothing - zero. And now houses are falling too.

So, if a fellow needs money for his retirement, where is he going to get it? Not from his house. Not from a pay raise. And not from his stocks either. He needs savings. He needs real money.

Americans aren't so stupid after all. When they need to stop spending, they stop spending. When they need to save, they save. Too bad about the economy.

Yes, what is good for individuals seems to be bad for the economy. When people save instead of spend, the consumer economy stalls. And then economists think there is something wrong. They think an economy needs to expand constantly. And so, they try to find 'solutions' to the 'problem.'

Actually, there is no problem at all. It's just the way capitalism works. There are booms. And there are busts. Periods of growth...and periods when the mistakes made during the boom are corrected. There's a time for every purpose under heaven. That's the way it works. The economy breathes in and it breathes out.

And there's always some dumb economist trying to smother it with a pillow!

Bill Bonner
for The Daily Reckoning Australia

• Consumer Economy Not Going to Return to Robust Growth Anytime Soon
• Two Ways to Deleverage an Economy
• The Percentage of the U.S. Economy Devoted to Consumer Spending Went Up and Up
• America’s Consumer Economy Needs to Consume Less
• The Interest Only Mortgage Option

"Once envied, Wall Street bankers are now mocked," says a headline at the International Herald Tribune.

So many people are getting on the bankers' case; we're beginning to feel sorry for them. After all, what did they do wrong?

Well...they floated the whole world economy on a sea of debt... even making loans to people they knew were going to sink.

And they took bonuses on profits they hadn't actually earned.

And they paid themselves the cash that their banks now desperately need.

And, they created trillion-dollar debt torpedoes - which are now exploding all over the planet, leading to $32 trillion in losses...so far.

And they set the stage for a cycle of mass unemployment, strikes, depression, protectionism, riots, revolutions, poverty and probably even starvation.

And, oh yes, they blew up their own banks too.

But aside from that, they are pretty decent fellows, no? More about bankers and CEOs...below...

Meanwhile, in Spain, unemployment grew 47 % in the last 12 months. 14% of the workforce is out of a job.

In Ireland, "public sector workers face pay cut," says the Financial Times. The Irish government is running out of time and money.

In China, 20 million people have had to give up their city jobs and go back to the countryside in search of work.

IBM says it cut salaries by 15%. UPS said it froze its payroll.

U.S. property owners lost $3.3 trillion last year, says Bloomberg. Houses in Las Vegas fell 41%. In Phoenix, they went down 43%. Miami homeowners saw a 40% decline.

But yesterday, investors thought they saw a little light on the horizon...perhaps a rescue ship? The number of pending sales, of existing houses, actually went up in December. This was enough, according to the press reports, to bring them back into the stock market and raise the Dow 141 points.

Oil held steady at $40. And gold rose $14 to $892.

Our guess is that the little light investors thought they saw will turn out to be another torpedo blowing up. Millions of homeowners and stock market investors have gone down already...but there are many still afloat. And many torpedoes that still haven't found their marks.

In Japan, for example, property prices began falling in 1991. They fell for the next 13 years...reaching a low in 2004 equal to where they had been in 1973!

If that pattern plays out in the United States, the housing market won't hit bottom until 2020...when you'll be able to sell your house for what you paid for it in 1989.

As for stocks...

"Despite the vicious bear market we experienced in 2008," writes our old friend Marc Faber, "the Dow Jones in real terms is still higher than at its 1929 and 1966 peaks."

Marc admits that the inflation adjustment figures - provided by the people who create the inflation - may not be perfectly accurate. But even if you adjust the numbers to much higher levels of inflation since '29, "stocks in real terms would still be nowhere near their 1932 or 1982 lows."

You can avoid the fuzziness caused by inflation by looking at the price of stocks in terms of gold. Over the very, very long term, gold holds its value. An ounce of gold buys about as much stuff now as it did during the reign of Julius Caesar. How could that be? The explanation is simple: mankind adds to the quantity of gold above ground at about the same rate that it adds other goods and services.

That doesn't mean that gold's price is stable - far from it. The price goes up and down - depending on what else is going on. Generally, the more confidence people have in the financial system, the less need they have for gold. But over the long run gold has been the world's most reliable, most universal store of value.

The stock market low of the early '80s coincided with a low-ebb of confidence in the dollar and in bonds. At one point, the price of gold rose over to $800 an ounce...while the Dow fell to 776. That one-to-one ratio marked a turning point. Thence, stocks soared and gold fell.

The next turning point came 17 years later - in 1999 - when gold was back to $260 and the Dow was over 10,000. At the peak, it took 43 ounces of gold to buy the Dow stocks.

Since then, gold has been in a bull market, while stocks have declined. But even now, it still takes about 10 ounces of gold to buy the Dow stocks. Which tells us that this correction still has a long way to go. Wait until the Dow and gold reach the same number...then, the light you see on the horizon may be daylight.

*** The Singularity is Near is a book by Ray Kurzweil. It refers to a time - in the not-too-distant future - when machines will be smarter than bankers. And now, the Financial Times tells us that the moment is not far off - only a few years. Then, machines "will solve problems including energy scarcity, climate change and hunger."

Which makes us wonder; what's in that pink ink? Something is addling brains at the FT. Machines can already think better than humans. That is, they can already do calculations faster than we can. And they can remember things better too. And, using Google, they can find things and make connections faster.

Machines can help build safer bridges. They can help cure diseases. They can play chess and tell you where you left your car keys. But they can't solve social and political problems...at least not directly. A smart computer could help build a more energy efficient automobile, but it can't solve the problem of energy scarcity. Because there isn't really an energy scarcity problem. Engineers, technicians and businessmen produce and sell energy - just like they produce and sell diamonds or custard pies. Stuff - including energy - is always 'scarce.' Even sand is scarce. The Sahara may be full of it; but when you want some for your backyard, it won't be free. Machines - as smart as they are - can't solve this 'problem.' Resources are allocated either by the invisible hand - the give and take of free people - or by the heavy hand of whoever is in power. Smart machines aren't going to change that.

*** "The Great Repression" Niall Ferguson calls it. He's referring to the fixers' attempts to stop the correction. Ferguson favors treating the oversized debt with a mixture of boondogglization and liquidation. He thinks the state should take over banks...recapitalize them...and re-privatize them "say in 10 years."

"Honor the rule of law...in the breach," he continues, oxymoronically. He would simply force mortgage-holders to accept new terms and conditions - notably a much lower interest rate. This would lower homeowners' payments, thus allowing more of them to hold onto their houses. In effect, he proposes a kind of pre-emptive default...like removing a man's kidneys before he is dead...or having a cigarette before making love. By order of the government, a portion of the mortgage's value would be liquidated...stiffing the lenders, but favoring the borrowers.

*** In the complaints about corporate pay comes a tedious refrain. Corporate jets are a "symbol of greed and excess," says a Financial Times comment.

But this time, the FT comes to defend the CEOs: "The reality is that boards that lavish tens of millions on a top executive would be squandering resources by asking them to spend precious hours in security-obsessed airports..." continues the report.

Again, we wonder what has gone wrong at the FT. Have they ever spent any time with a "top CEO?" In our experience, a CEO's time is taken up with countless meetings...countless conferences...luncheons...phone calls...briefings and reports. A corporate jet is a marvelous addition to his routine. It enables him to fly off to yet more meetings...while having a staff conference en route. Then, when he arrives at the airport, a limousine awaits him...with yet another person with whom he must meet ...along with briefing papers and preparation documents for his next rendezvous.

If he is aggressive and acquisitive, one flight will take him to a meeting with lawyers, where he will discuss the strategy of a takeover. The next flight will take him to a meeting with the financiers, where he will discuss the terms of the options and other emoluments to be distributed. And yet another flight will take him to a meeting with investors...where he will recite the lines given him, with authority and confidence. His firm is not merely in pursuit of excellence, he will tell his audience; it IS excellence embodied. Just look at the last quarter's results!

All of this makes him feel terribly important...and it describes the life of the typical Wall Street big shot during the bubble years.

Too bad corporate boards didn't cancel the jets 10 years ago. Maybe...sitting in an airport without an Internet connection, the CEOs might have had a moment to think. About how little they really understood about their own businesses... About what mediocre clowns and connivers they really were. About how markets routinely turn geniuses into morons and heroes into schmucks. And maybe...maybe a bright light might have shone forth from their reflections...causing them to realize that they were on a flight to Hell.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• All Ordinaries Reach 52 Week Low
• Bailout on Wall Street Has Left the Door Open for Other Industries
• After the Bailout of Wall Street, Everybody Wants Cash
• Illegal Gold Mining
• Ranting Against Free markets and Wall Street

But he hung around with the wrong crowd - lowbred types in high political circles - and look where it has gotten him. Tomorrow, he'll be called upon to stand before a hundred million viewers, put his hand on a Bible, and lie.

To the question - will he swear to uphold the Constitution of the United States America - he will give the answer he has rehearsed. Yes, I can! Then, like almost every American president since John Quincy Adams, he will ignore it.

But before we return to tomorrow, let's turn back to yesterday…or, Friday. So far this year, stocks are down nearly 7%. But at least the Dow bounced a little at the end of last week - up 68 points.

Oil held at $42. And dollar was steady at $1.33 per euro.

The excitement on Friday was in the gold market - the yellow stuff bounced $32. Why would gold go up…when the world economy is clearly going down? We don't know. But if we were Mr. Obama, we'd approach this new job like renting a car from a disreputable agency. We'd want to take a good look and take note of all the dents and defects before driving off the lot. We wouldn't want to get charged for the previous drivers' mishaps!

The founding charter of the U.S.A. made no allowance for going into the banking business…nor the auto business…nor any other kind of business. Neither did it allow invasions of foreign countries, without a declaration of war…or imagine a standing army that costs about as much as all the rest of the world's armies put together.

In the beginning, the U.S. government was specifically limited in what it could do. Now, very little remains that it can't do. But in all matters - big or small…torturing people or taking their money - government leaders must pretend to be acting in the national interest. It's a low-down, dirty business that usually attracts people of the same sort. People like George W. Bush and Joseph Biden…people with no sense or no principles - or neither. People who don't know a lie when they hear it or…don't mind telling one.

That's why we're sorry to seem Obama in the trade; he seems like such a nice fellow.

But politics…alas, someone's got to do it. As the old Latin expression puts it: The voters want to be deceived; then let them be deceived.

So many patsies…so little time. Bernie Madoff could barely keep up with all the people who wanted to give him money. The hopefuls joined his Palm Beach country club just for the opportunity to slip a few extra large bills in his pocket. Old buddies sought him out…eager to part with their entire fortunes.

And look at the Treasury market! The patsies line up to buy I.O.U.s from a deadbeat debtor who already owes money all over town. And now he's passing out more I.O.Us…at a faster and faster pace…trillions of dollars' worth of them. Not only that, the debtor in question has said publicly that he intends to lower the value of his paper - at all costs.

And now the voters…the general public…the lumphouseholders - they're dying for a lie too. They want someone to tell them that he's got the recession under control.

Well, if they're going to be deceived someone's got to tell them lies. Barack…you're up!

The people want to believe that if the president weren't such a screw-up, we wouldn't be in this mess. In other words, if the administration would get its act together, it could "do something" to get the good, ol' times back.

Rarely do we get an opportunity to come to the defense of George W. Bush. But here we will say without equivocation: this financial crisis is not his fault.

Sure, he made it worse by wasting $2 trillion on that silly war of his - the 'war against terror.' And sure, he should have gotten rid of Alan Greenspan at the beginning of his term…and he should never have signed so many spending bills without a fight. And, it's too bad he didn't understand what was going on in the financial sector and warn people - instead of jawing on about how great the U.S. economy was. But, heck, who did? He acted like a moron; no doubt about it. But who didn't?

So give George W. Bush a break. Let the man skulk back to the ranch without trying to pin this financial collapse on him. He didn't cause the problems; and he couldn't cure them either. The financial problems faced by the U.S.A. cannot be solved by politicians. They can only be made worse by politicians.

The problem is that there are a lot of bad loans, bad investments and bad businesses that need to be cleaned out. All the politicians can do is to try to prevent the clean up…

*** The lumpen want to be deceived; so the politicians take it as an opportunity. Last October, for example, they raided the Treasury for $700 billion that they could pass out to their friends on Wall Street. Of course, that program was supposed to be in the 'national interest.' The banks were supposed to lend the money out to the taxpayers whence it came.

As absurd as it sounds, and as unconstitutional as it surely is, it is nevertheless the law of the land. And now that a few months have passed…and a few hundred billion have been passed around, we're beginning to understand what happened to it.

The New York Times reports:

"Speaking at the FBR Capital Markets conference in New York in December, Walter M. Pressey, president of Boston Private Wealth Management, a healthy bank with a mostly affluent clientele, said there were no immediate plans to do much with the $154 million it received from the Treasury.

"'With that capital in hand, not only do we feel comfortable that we can ride out the recession,' he said, 'but we also feel that we'll be in a position to take advantage of opportunities that present themselves once this recession is sorted out.'

"'The Treasury secretary, Henry M. Paulson Jr., said in October that banks should 'deploy, not hoard' the money to build confidence and increase lending. He added: 'We expect all participating banks to continue to strengthen their efforts to help struggling homeowners who can afford their homes avoid foreclosure.'

"But a Congressional oversight panel reported on Jan. 9 that it found no evidence the bailout program had been used to prevent foreclosures, raising questions about whether the Treasury has complied with the law's requirement that it develop a "plan that seeks to maximize assistance for homeowners."

What did they think? Bankers don't make loans in the hopes of getting 'good citizenship' awards. They lend money when they think they can make money at it. Now, with so many balance sheets in such bad condition, they are afraid their loans won't be repaid.

Typically, Thomas L. Friedman has a solution. The president should get 300 banking presidents in a room and give them a "come to Jesus" speech, he says. By that, he means the feds should play a more muscular role in the banking crisis. Good banks should be saved. Bad banks should be dissolved.

And what about all those bad loans? Ah…the New York Times columnist has a solution for that problem too. The government should buy them up…hold them…and then "sell them later when the market rebounds."

See how easy it is, dear reader. Problem solved. That's what Obama should promise the voters.

And if the patsies will believe that…maybe they'll kick in a few hundred billion more for Wall Street.

Bill Bonner
for The Daily Reckoning Australia

• The Country is Going into a Recession with its Finances in the Worst Shape Ever
• Statistically One Vote Doesn’t Make Any Difference
• One in Four US banks Announce Unprofitable Quarter
• Barack Obama and His Nobel Peace Prize
• Life of the Late Mr. Omar Bongo

The RBA wouldn't have been that fussed about the action in the stock market yesterday. It's got its eye on the Australian economy. The new cash rate of 4.25% is the lowest in seven years. And it could go lower. In its statement on monetary policy, the Bank said inflation wouldn't be much of a worry in 2009.

"Financial market sentiment remains fragile," Governor Glenn Stevens wrote, "as evidence accumulates of weak economic conditions in the major countries and a significant slowing in many emerging countries. Commodity prices have fallen further. This, combined with the likelihood of below-trend growth in the global economy, suggests that global inflation will moderate significantly in 2009."

If the RBA over-cooked things to the tight side in raising rates through 2007, you get the feeling they are making the same mistake on the loose side, and that it will lead to an unwelcome and massive rise in inflation in 2009, probably after the middle of the year. Central banks, like markets, tend to overshoot first and ask questions later. But please don't confuse Mr. Stevens with the head of catering on the Death Star.

Australian monetary policy is now in an "expansionary setting" according to the RBA's statement. Picture if you will, rolling hills at sunset, with fields of lush, deep, dark green grass. Row after row of trees line the horizon, heavily laden with green and gold notes. This, we suppose, is what an "expansionary setting" for monetary policy might look like.

But it's not as if the money is just there for the taking, is it? Homeowners with fixed rate loans must choose to refinance. And they have to get a loan from the bank. And we're not so sure the banks are going to sign off on big loans in 2009. You've already seen the hard ball the banks are playing with the miners.

Now there's this in today's Age, "ANZ has raised doubts about passing on further cash-rate cuts in full after warning that wholesale funding costs are likely to remain inflated in the medium term." ANZ and Westpac went ahead and passed on most of the RBA rate cut, but not all of it. And it raises an interesting problem.

For ANZ, there are two prices for money. There is the price it pays to borrow money in the "wholesale" market. This is the global capital market. And despite the laxative efforts of the Fed, global capital is not exactly free-flowing at the moment. That means ANZ continues to pay more to borrow globally than it is used to.

The second price of money is what you pay for it. ANZ has lowered that price. But you can see that if it's wholesale price of funds remains "elevated" that it faces a simple choice. It can pass on the full rate cut to consumers, continue to pay the wholesale price of funds, and take the hit on its profit margins as the spread widens. Or it can stiff the consumer and keep margins high. What do you think it will do?

Here we come back to a point made a few weeks ago, that successful businesses must, in the long-run, be run for the benefit of customers and not, say, the employees. The investment banking model admittedly challenged this thesis.

Investment banks existed primarily for the benefit of investment bankers, who hopefully, on the side, did a decent job of getting capital from the people that had it (the capitalists) to the people that could put it to its most productive use (entrepreneurs).

Somewhere along the way, the capital itself got hijacked by the investment bankers and money shufflers. They had a big party. And in the process, a whole generation of savings has gone down the economic toilet. Capital is now becoming scarcer and more expensive.

Also, we say "savings," but really the money lost is destroyed. You can't make up for that by creating new money. All this new spending is borrowed from future generations, who must now pay back the trillions of U.S. bonds sold to foreigners in order to finance Wall Street's capital destruction. It's a tax on the future and the unborn, and in moral terms, it's deeply disturbing.

But back to business. It turns out, then, that the interests of investment banks (and to some extent, retail banks) were not at all aligned with customers (or shareholders). Now, the banks are paying the price. And in a world where no one bank had a monopoly on printing money, these banks would be put out of business by sounder guardians of the currency. Competition for sound money would expose the counterfeiters.

But wait. Isn't the Fed a private bank? Why yes. Yes it is. And you can be sure the Fed is looking out for the interests of its member banks. In fact, according to Bloomberg, the Fed has just extended three of its lending programs designed to "ease credit conditions."

"The Federal Reserve extended the term of three emergency-loan programs to April 30 from January 30, aligning their expiration dates with other central bank efforts to mitigate the credit crisis. The Primary Dealer Credit Facility and Term Securities Lending Facility, created in March, and the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, begun in September, were lengthened in light of continuing strains in financial markets."

This is what we meant by the development of a modern kind of feudalism. Indicted on the stage of history for gross mismanagement of paper money, the central banks know that ordinary people are losing confidence in their product (paper money). Once the illusion of paper money is shattered, confidence goes too. It never recovers.

That's why the banksters are trying so hard to keep people from asking serious questions about the nature of our monetary system. They want you to go about your business, stay forever in debt, and send them interest payments for the rest of your life like a cubicle farm serf. That's no way to spend a life! More on life tomorrow.

Dan Denning
for The Daily Reckoning Australia

• RBA Rate Cut Does Little to Unlock Credit Market
• Government Stimulus Programs Make Life Harder For Banks
• 1% Aussie Interest Rate Cut?
• Fed Now the Middle Man in Interbank Lending Market
• World Economy Faces Hyperinflation or Deflation?

A headline tells us that homeowners are no longer remodeling as much as they used to. As expected, the people who hustle granite countertops are finally getting a rest.

Poor General Motors...GMAC says it's closing offices in the United States and Canada following a $2.3 billion loss. First, the company takes it on the chin from mortgage losses. Now, it's getting jabbed by losses from auto finance. Repossessions, like housing foreclosures, are rising. The repo lots are said to be bulging at the seams.

Jeremy Grantham says he thinks housing prices in the United States will go down 20% to 30% from their peak. That's a potential loss to Americans' implied wealth of as much as $6 trillion. This is part of what leads Financial Times columnist Martin Wolf to describe the coming slump in the United States as the "mother of all meltdowns ."

Wolf refers to the work of New York University economist Nouriel Roubini, who argues that the housing decline will put 10 million homeowners upside down, with more mortgage than house. It will lead to collapsing credit...defaults...and huge losses to lenders. It will also bring about a big cutback in consumer spending and unavoidably push the United States into a deep recession.

One of the wild cards of the doomsday scenario is the performance of the derivatives market. No one knows exactly what is in some of these instruments...and no one knows how they will hold up in a crisis.

One thing we do know here at The Daily Reckoning is that they will not hold up as expected. We know that because the assumptions behind them were, fundamentally, nonsense. The most sophisticated mathematical model in the world is not worth a campaign promise if the theory behind it is wrong. And the idea that you can model future prices on the basis of past prices with any predictive reliability is simply wrong. Speaking loosely, it is the problem noticed by Heisenberg when was trying to observe and measure atomic particles at the same time...or ethnologists when they are watching savages gootchy goo. The act of observation causes distortions. As soon as you notice "stocks outperform bonds over the long-term," for example...you cause a distortion in the stock market. People buy stocks, expecting better performance. Buying drives up prices. Then, higher initial prices bring lower rates of return over the long run.

Using Black-Scholes pricing model...and other sophisticated tricks...the salesmen proved that they could produce higher yields with lower risk. The models, of course, depended on the future being like the past. But never before had investors been offered such opportunities to distort the price curve!

The derivative market exploded in the 2001-2006 period, with annual rates of growth (from memory) of nearly 100%. But then, subprime debt blew up...and buyers started asking questions. In 2007, the derivatives market fell apart. And so far this year, new derivative sales are off 93% from the year before. CDOs, SIVs, Monolines...they've all had big trouble.

"Many CDOs could be worth less than 5 cents on the dollar," Strategic Short Report 's Dan Amoss tells us. "Final values won't be clear until the loans supporting these securities go through the default and recovery process.

"Many Wall Street firms cannot simply confess their final losses, because delinquencies have just started picking up from generational lows. Also, these firms may soon discover that the insurance covering defaults of their CDO holdings is worthless."

And now comes the Financial Times with more trouble. "CPDOs are at risk," say the FT . What are CPDOs, we had to ask? They are Constant Proportion Debt Obligations...a kind of derivative on a derivative...a bet on the derivative index.

Not knowing anything about them ourselves, we turn to someone who does for an opinion:

"If these [structured products] do get unwound en masse, the effect on the market will be horrible," said credit strategist Barnaby Martin at Merrill Lynch. "Between $1,000bn and $2,000bn of synthetic CDOs have been issued over the last four years. Any unwinding will likely be crammed into a much shorter time period."

Bill Bonner
The Daily Reckoning Australia

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