Here at The Daily Reckoning, we’ve got substantial doubt about a number of things.

As to GM, we share the auditors’ concern. The world is full of car factories. Most of them can make cars better, faster, and cheaper than GM. Meanwhile, demand for autos is not growing as quickly as the global growth in auto-making capacity – especially in America. Not that we’re trying to pass judgment. Let the Mr. Market do that!

But GM has friends in high places…ready to lean on the scales of Mr. Market’s justice. The automaker has already borrowed $13.4 billion. It is asking for another $30 billion. But what kind of a dope would lend $30 billion to a company whose own auditors say they’re worried that it might go out of business?

Then again, who would lend money to AIG four times in a row…after discovering each time that the company was in worse shape than before?

If you guessed anything but ‘the US government,’ you are not paying attention.

The rest of the world’s lenders are idiots too – but of a different sort.

Allow us to simplify the world’s credit markets circa 2009: the world’s lenders are eager to make loans to the world’s biggest debtor; they don’t trust anyone else. The world’s biggest debtor, meanwhile, lends to the people private lenders don’t trust – the borrowers who can’t pay the money back.

Meanwhile, sales are falling; profits are collapsing; dividends are disappearing; stock prices are plunging.

Yesterday, the Dow closed down 281 points. Oil held at $43. Gold rose $21. The correction in gold could be over.

One out of every five mortgaged houses in America is now underwater. And a record 5.4 million Americans are either behind on their mortgage payments or in foreclosure.

House prices are still going down. You have to be a Lloyd Bridges to explore the U.S. housing market now.

This unprecedented drop in house prices has put millions of households underwater too. Martin Feldstein estimates that U.S. households have lost $12 trillion. It will take a decade of savings at a high rate to replace this money, he says.

The savings rate has soared…from below zero in 2006 to over 3% now. Rising savings will take $500 billion a year out of the consumer economy, Feldstein believes.

No wonder retailers are reporting weaker and weaker sales. In February, only Wal-Mart reported higher sales. Wal-Mart benefits from the ‘trading down’ effect. Now, when people spend money, they want cheaper alternatives…

Meanwhile, the cop who had the Wall Street beat when the biggest heist in history was going on…and who engineered the loans to AIG and GM…is now the chief of police. Tim Geithner said he was working night and day on Obama’s rescue plan, “because we know how directly the future of our economy depends on it.”

But as our old friend Marc Faber points out, neither Mr. Geithner, Mr. Bernanke, nor any of the men who rule us, seems to have any idea what they are talking about. As Chairman of the New York Fed, writes Faber, Mr. Geithner “did not seem to ‘know,’ in the period preceding the crisis, how the future of the economy depends on a sound financial system!”

Faber goes on to explain that not only did the key players fail to understand what was going on – when it was obvious to him, us and millions of others – they then misdiagnosed the problem and prescribed the wrong treatment. They thought it was a liquidity crisis; so they threw billions in cash at dying institutions.

At every step of the way, the feds have been clueless, hopeless, and defenseless. It was the feds who lent money at negative real interest rates for more than five years. It was the feds who pretended to “regulate” and “control” the marketplace…claiming to protect investors from fraud and malfeasance. It was the feds who licensed the banks…set banking standards…blessed derivatives because they “distributed risk more widely” (Greenspan)…urged people to buy adjustable rate mortgages (Greenspan again)…praised sub-prime lending because it encouraged home ownership…and even told consumers to “go out and buy an SUV” in order to give the economy a boost (Fed governor Robert McTeer).

The feds piled up the tinder…poured on the gasoline…and lit the match. And now, what do you know…they’ve all joined the fire department!

*** One small step for the Bank of England; one giant step towards bankruptcy.

“QE”. It does not refer to the Queen of England…but the latest codeword in central banking – quantitative easing. The Bank of England said yesterday that it would buy government bonds itself. This is known to economists as “monetizing the debt.” Because the bank takes in debt…and turns it into cash. Just like that.

The European Central Bank took a little step too. It cut rates – as did the Bank of England – by half a point. That brings the BoE down to 0.5% and the BCE to 1.5%.

Mervyn King, head of England’s central bank, said he was going to quantitative easing because, in effect, nothing else had worked. They were already lending money to English banks below the consumer price inflation level…which is to say, at negative real interest rates. But the banks weren’t cooperating. They took the money…but there it sat. They didn’t lend it out.

That is why it is obviously NOT a liquidity crisis. The problem isn’t that the banks don’t have enough cash…or access to cash…it’s that they don’t know what anything is worth. They can’t make a loan, because they can’t be sure of getting the money back.

We’ve already laid this out for you, dear reader. We’re going to do it again, in case you weren’t paying attention: this is not a liquidity crisis…and not a recession either. It’s a depression. In a depression, the economy needs to adjust to a NEW REALITY…whatever it may be.

Martin Feldstein, mentioned above, provides more figures. In the new reality of 2009, there’s about half a trillion less in consumer spending…because consumers are saving money, rather than spending it. And you can take out another $250 billion just from the crack-up in the housing industry. No building…no construction jobs…no financing jobs…no selling jobs…no furnishings…etc. etc.

That’s $750 billion less each year to support American’s retail…and indirectly, wholesale…providers.

The Obama administration is trying to make up for this private spending with public spending. But his plan, as bold as it is, will only put back about $300 billion each year. That leaves a $450 billion shortfall…which could easily remain for the next 10 years.

This is the new reality that every business, investor and household in the country must live with. Revenues will go down. Sales will go down. Profits…earnings…dividends…you know where this leads.

Well….

Actually, none of knows where it leads…exactly. From today’s perspective, it appears to lead to a Japan-like slump…a long period of adjustment to the new reality…delayed, worsened and stretched out by the efforts of our leaders.

But then…there’s that QE.

We can’t read tomorrow’s headlines…but we can read the names on tomorrow’s tombstones – they’re our own. What has to happen will happen. The United States is now engaged in the most massive spree of Madoff financing the world has ever seen. It needs to borrow more and more just to pay for previous borrowing.

At some point in the not-too-distant future…this system must crack-up. Normally, Madoff would go broke and go to jail. But what would happen if he had a printing press in his basement…and the legal write to print up as many $100 bills as he wanted?

Would the story have ended differently? Would he have the integrity to avoid full-scale quantitative easing? As to that…as to so many things…we have ‘substantial doubt.’

Source: A Crash Course in the World Credit Markets

With the nation’s economic landscape laid to waste, it should be no surprise that home foreclosures were soaring, too: Residential real-estate foreclosures doubled between 1926 and 1929 – before the Great Depression actually began. According to a new study by the Federal Reserve Bank of St. Louis, the foreclosure rate jumped from 3.6 per 1,000 mortgages in 1926 to 13.3 in 1933. In that year, in fact, 1,000 home mortgages were being foreclosed each day.

By Jan 1, 1934, as many as half of all residential mortgages were delinquent, putting them at risk of foreclosure.

Clearly something had to be done, elected officials believed. In an attempt to slow that surge, 27 states changed key laws in a way that created a temporary moratorium on foreclosures. Still other state and municipal governments passed permanent measures that made it tough for aggrieved lenders to foreclose on properties whose mortgages were delinquent.

With the benefit of hindsight, it’s not at all clear that the benefits of these moves outweighed the costs – many of which were unintended, says Daniel C. Wheelock, a St. Louis Fed economist and the author of the new research study, “Changing the Rules: State Mortgage Foreclosure Moratoria During the Great Depression.” The study appears in the November/December issue of the St. Louis Fed’s Review magazine, which covers national and international economic developments – especially when there’s a monetary impact.

“Governments cause both immediate and long-term effects when they rewrite the terms of contracts between private parties,” Wheelock wrote. “One immediate effect of mortgage-relief legislation during the Depression was reduced [disclosure rates on farms, which were being hit even harder than the residential real estate sector]. However, over the longer run, foreclosure moratoria and other changes in mortgage laws may have made loans costlier or more difficult to obtain” for future borrowers.

Indeed, the study shows that future borrowers had to face a marketplace where loan capital was in short supply and interest rates were sky high. Lenders made loans tough to get – and then charged a lot for them via high interest rates – because they needed to compensate for the very real possibility that these new laws would restrict their ability to foreclose on delinquent loans.

Fast-forward 74 years, to 2008. Nearly 1% of U.S. home mortgages entered foreclosure during the first quarter; by the time that three-month stretch came to an end, nearly 2.5% of all U.S. mortgages were in foreclosure.

And the news keeps getting worse. In the July-September quarter, 18% of all properties with a mortgage were “underwater” – that is, worth less on the market than what the owner owed on the loan, data supplier First American CoreLogic Inc. told BusinessWeek. It gets worse. That statistic represents more than 7.5 million properties, and another 2.1 million mortgages were within 5% of shifting “upside down.”

All told, nearly a quarter (23%) of U.S. mortgages were underwater or were in a near-negative-equity position. Nevada (48%) and Michigan (39%) led the nation with the highest percentages of negative equity, followed by Florida (29%), Arizona (29%), California (27%), Georgia (23%), and Ohio (22%).

In late July, U.S. President George W. Bush signed the Housing and Economic Recovery Act of 2008, whose provisions included a $300 billion increase in Federal Housing Administration loan guarantees – which were designed to induce lenders to refinance delinquent home mortgages.

A foreclosure-prevention mentality took hold, with loan modification plans and programs such as Hope for Homeowners becoming increasingly common, HousingWire.com reports. Such states as Massachusetts, as well as some local cities, have sought to put foreclosure moratoriums in place; federal legislators, too, have tried to get in the act.

A tentative Bush Administration plan aimed at keeping as many as 3 million homeowners who are behind on their mortgages from losing their houses will be difficult to administer, and could end up costing the country hundreds of billions of dollars more than the plan’s architects expect, a Money Morning contributing editor and credit-crunch expert says.

R. Shah Gilani, a retired hedge-fund manager and Money Morning contributing editor who is emerging as an expert on the worldwide financial meltdown, noted that the plan was apparently still that – a plan. Even so, he said that “any bailout plan that directly addresses foreclosures is political posturing that will ultimately be overwhelmed by inevitable economic realities.”

The plan – which would be part of the $700 billion banking-system rescue package the government approved early this month – would cost $40 billion to $50 billion, with the money being used to cover future losses on loans that are deemed eligible for federal support.

The New York Times carried the first reports of the Bush Administration’s new housing rescue proposal last Thursday. According to the newspaper report, this program would be the most sweeping and direct government initiative aimed at home-loan borrowers since the financial crisis started last year.

Unfortunately – at least with respect to the contentions made by the St. Louis Fed study – this program is a classic foreclosure-moratorium initiative.

As proposed, the federal government would incur half the loss on a home loan if the mortgage company that controls the loan agrees to lower the borrower’s monthly payment for at least five years. On any given loan, the mortgage company would reduce the payment borne by the homeowner by writing off part of the loan balance, reducing the loan’s interest rate or changing other loan terms, sources told The Times.

In this case, the devil truly will be in the details: Trying to take a massive rescue plan – and matching the benefits up with individual homeowners – may be just too much to ask, Money Morning’s Gilani says.

“Who will be eligible, how will that be determined, what will happen when prices continue to fall and mortgage holders eventually walk away” are just some of the tough questions a workable plan would have to answer, Gilani said. Plus, “is the government going to shackle them to their mortgages the same way they’re shackling taxpayers to all these other ill-begotten bailout schemes?

When it comes to the idea that money from the federal government’s Troubled Assets Relief Program (TARP) may be used to manage a bailout of troubled mortgages, all options are still on the table, and the plans under consideration have been stuck in the negotiating room for some time, HousingWire reported.

In a story earlier this week, The Wall Street Journal suggested that “disagreements over how to structure a federal foreclosure-prevention program are complicating and potentially delaying what is likely to be the Bush Administration’s last attempt to forestall sliding home prices.”

According to another HousingWire report, one plan that may be gaining some support is the idea of a federal subsidy for troubled borrowers. On Sunday night, a source near the Pennsylvania office of U.S. Sen. Robert P. Casey, D-Pa., provided the housing news service a copy of a memo that’s said to have sparked some of the ongoing negotiations now taking place.

The memo outlines the mechanics of a mortgage bailout that would cost as much as $441 billion, relying primarily on a three-year subsidy for troubled borrowers that would be repaid in five years, with interest. At that point, the participants would likely be able to sell their homes or refinance the mortgages at amounts that would enable them to repay the loan.

The subsidy plan reportedly represents the thoughts of Assured Guaranty Ltd. (AGO) Chief Executive Officer Dominic J. Frederico, who had been asked by legislators to provide his thoughts a few weeks earlier.

Other proposals are being studied, as well.

No matter what shape or form they take, however, Wheelock, the economist, warns that there will be a price to pay. There’s something to be said for allowing the marketplace to work – and an operational free market includes defaults and foreclosures, with the end result being that only the strongest borrowers remain in the end.

It’s a lesson we should have learned during the Great Depression, Wheelock says.

Wrote the St. Louis Fed economist: “The [foreclosure] moratoria reduced … foreclosure rates in the short run, but they also appear to have reduced the supply of loans and made credit more expensive for subsequent borrowers. The evidence from the Great Depression demonstrates how government actions to reduce foreclosures can impose costs that should be weighed against potential benefits.”

Source: Study of Great Depression  Shows Intervention Postpones Foreclosures, But Causes Mortgage Rates to Spike