The S&P500 dropped 4.5% (down 5.9% y-t-d), and the Dow fell 3.7% (down 5.6%). The Transports sank 9.0% (down 11%), and the Morgan Stanley Cyclicals fell 9.3% (down 5%). The Utilities slipped 0.3% (down 1%), and the Morgan Stanley Consumer index declined 1.9% (down 3.7%). The broader market wasn't quite as weak. The small cap Russell 2000 declined 3.1% (down 6.6%), and the S&P400 Mid-Caps fell 2.6% (down 4%). The Nasdaq100 dipped 2.0% (down 1.1%), and the Morgan Stanley High Tech index declined 3.3% (up 0.4%). The Semiconductors slipped 0.4% (up 1%), the Interactive Week Internet index fell 3.8% (down 0.7%), and the Nasdaq Telecommunications index lost 2.6% (up 0.9%). The Biotechs rose 3.2% (up 1.6%). The Broker/Dealers were hammered for 8.5% (down 7.1%) and the Banks sank 20.8% (down 28.8%). With Bullion down $12.55, the HUI Gold index decilned 1.0% (down 9.1%).

One-month Treasury bill rates ended the week at 3 bps and three-month bills at 13 bps. Two-year government yields were little changed at 0.65%. Five-year T-note yields slipped 2 bps this week to 1.37%. Ten-year yields declined 7 bps to 2.32%, and long-bond yields dropped 17 bps to 2.93%. The implied yield on 3-month December '09 Eurodollars added one basis point to 1.20%. Benchmark Fannie MBS yields rose 2 bps to 3.86%. The spread between benchmark MBS and 10-year T-notes widened 9 to 154. Agency 10-yr debt spreads widened 15 to 92.5 bps. The 2-year dollar swap spread increased 6.25 to 60.5 bps; the 10-year dollar swap spread declined 5.2 to 9.3 bps, and the 30-year swap spread increased 7.5 to negative 10.5 bps. Corporate bond spreads were mixed. An index of investment grade bond spreads widened 12 to 214 bps, while an index of junk bond spreads narrowed 38 to 1,274 bps.

January 14 - Bloomberg (Gillian Wee): "Princeton and Harvard are leading a rush by U.S. colleges and universities to sell bonds after investment losses cut the value of endowments by a quarter in the past six months. Princeton University sold $1 billion of debt... its first taxable issue since 1994, while the University of Notre Dame raised $150 million. A sale last month by Harvard University... brought in $1.5 billion."

Investment grade issuance included Morgan Stanley $5.9bn, Goldman Sachs $3.5bn, Staples $1.5bn, Amgen $2.0bn, Fed-Ex $1.0bn, Princeton Univ. $1.0bn, McDonalds $750 million, Bottling Group $750 million, Reed Elsevier $1.5bn, CSX $500 million, Norfolk Southern $500 million, Emerson Electric $500 million, Indiana Michigan Power $475 million, Donnelley & Sons $400 million, Metropolitan Edison $300 million, Campbell Soup $300 million, Berkshire Hathaway $250 million, Zions Bancorp $250 million, and Univ. of Notre Dame $150 million.

Junk issuers included Fresenius $500 million and MetroPCS $550 million.

International issuers included Macquarie Bank $2.5bn, Export-Import Bank of Korea $2.0bn, Korea Development Bank $2.0bn, Oester Kontrollbank $1.25bn, and African Development Bank $1.0bn.

January 16 - Bloomberg (Jeremy R. Cooke and Michael McDonald): "U.S. municipal borrowers sold at least $7.7 billion of fixed-rate bonds this week, the most since Lehman Brothers Holdings Inc.'s record bankruptcy..."

German 10-year bund yields fell 9 bps to 2.93%. The German DAX equities index sank 8.7% (down 9.2% y-t-d). The Japanese 10-year "JGB" yield ended the week down 6 bps to 1.22%. The Nikkei 225 dropped 7.3% (down 7.1% y-t-d). Emerging bonds and equities were mixed. Brazil's benchmark dollar bond yields rose 16 bps to 6.56%. Brazil's Bovespa equities index fell 5.4% (up 4.8% y-t-d). The Mexican Bolsa sank 6.5% (down 9.2% y-t-d). Mexico's 10-year $ yields jumped 19 bps to 6.13%. Russia's RTS equities was hit for 10.3% (down 10.3% y-td). India's Sensex equities index dipped 0.9% (down 3.4% y-t-d). China's Shanghai Exchange gained 2.6% (up 7.3% y-t-d).

Freddie Mac 30-year fixed mortgage rates dropped 5 bps to a record low 4.96% (down 73bps y-o-y), with a notable 11-wk decline of 150 bps. Fifteen-year fixed rates added 3 bps to 4.65% (down 56bps y-o-y). One-year ARMs fell 6 bps to 4.89% (down 37bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 3 bps this week to 6.79% (up 30bps y-o-y).

Bank Credit dropped $37.7bn to $9.844 TN (week of 1/7). Bank Credit rose $575bn year-over-year, or 6.2%. Bank Credit jumped $452bn over the past 18 weeks. For the week, Securities Credit sank $45.8bn. Loans & Leases increased $8.1bn to $7.133 TN (52-wk gain of $295bn, or 4.3%). C&I loans added $0.3bn, with 52-wk growth of 8.7%. Real Estate loans declined $6.4bn (up 5% y-o-y). Consumer loans rose $5.9bn, and Securities loans increased $5.8bn. Other loans added $2.6bn.

M2 (narrow) "money" supply jumped $64bn to a record $8.188 TN (week of 1/5). Narrow "money" expanded $749bn over the past year, or 10.1%. For the week, Currency added $2.0bn, and Demand & Checkable Deposits surged $47.1bn. Savings Deposits increased $6.5bn, while Small Denominated Deposits rose $6.5bn. Retail Money Funds gained $5.0bn.

Total Money Market Fund assets (from Invest Co Inst) surged $91.8bn to a record $3.922 TN, with a 52-wk expansion of $733bn, or 23% annualized.

Reversing part of last week's large gain, total Commercial Paper outstanding dropped $45.8bn this week to $1.719 TN, with CP down $130bn over the past year (7.0%). Asset-backed CP declined $8.4bn to $771bn, with a 52-wk decline of $56bn (6.7%).

Federal Reserve Credit dropped $108bn to $2.069 TN, with a historic 18-wk increase of $1.181 Trillion. Fed Credit expanded $1.202 TN over the past 52 weeks (139%). Fed Foreign Holdings of Treasury, Agency Debt last week (ended 1/14) increased $3.5bn to a record $2.528 TN. "Custody holdings" were up $456bn over the past year, or 22%.

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $543bn y-o-y, or 8.7%, to $6.813 TN.

Global Credit Market Dislocation Watch:

January 14 - Bloomberg (Tomoko Yamazaki): "Hedge funds posted their biggest decline on record last year, losing $350 billion globally, as the credit crisis crippled returns and forced investors to pull money out, an industry report showed. About 90% of the money was lost in the three months to the end of November, according to... Eurekahedge Pte. Funds that invested in North America declined the most, posting a drop of $183 billion for the year, the report said."

January 16 - Bloomberg (Robert Schmidt and Craig Torres): "Renewed questions about U.S. banks' viability are pushing regulators toward a new plan that would remove toxic assets from bank balance sheets, in what may become the biggest effort yet to unfreeze lending. President-elect Barack Obama's advisers see an increasingly grave banking crisis and are considering proposals far more sweeping than any steps that have been taken so far..."

January 16 - Bloomberg (David Mildenberg and Linda Shen): "Bank of America Corp., the largest U.S. bank by assets, posted its first loss since 1991 and cut the dividend after receiving emergency funds from the government to support the acquisition of Merrill Lynch & Co. The fourth-quarter loss of $1.79 billion..."

January 16 - Bloomberg (Bradley Keoun and Josh Fineman): "Citigroup Inc. posted an $8.29 billion fourth-quarter loss, completing its worst year, as the credit crisis eroded mortgage-bond prices and customers missed more loan payments."

January 14 - Bloomberg (Bradley Keoun and Lisa Kassenaar): "Vikram Pandit is unraveling his empire to save his bank. Citigroup Inc.'s chief executive officer said yesterday he would cede control of the Smith Barney brokerage to Morgan Stanley. Pandit may also dump the CitiFinancial consumer-lending unit, tag Tokyo-based Nikko Asset Management Co. for eventual sale and rein in trading with the bank's own capital, people familiar with the matter said."

January 14 - Bloomberg (Howard Mustoe): "Small-cap technology companies from Silicon Valley to Israel, struggling to raise enough money to survive amid the credit crisis, are selling prized patents to stay in business. VocalTec Communications Ltd. Chief Executive Officer Ido Gur said he needed to sell 15 of the Israeli company's 22 inventions to raise money... Irvine Sensors Corp., whose infrared camera technology is used by the U.S. military, and TurfTrax Plc, a U.K. owner of patents for monitoring horseraces, are also selling or considering a sale of rights to stem a slump in revenue."

January 16 - Bloomberg (Alex Nicholson): "Russian net capital outflow may reach $160 billion this year if the price of oil remains below $40 per barrel, Renaissance Capital said."

January 14 - Bloomberg (Alaric Nightingale): "As many as half of publicly traded commodity shipping lines may breach their loan covenants by April after a record collapse in hire rates, according to Royal Bank of Scotland Group... The cost of second-hand capesizes, the largest group of commodity carriers, plunged 70% last year, according to the Baltic Exchange..."

Currency Watch:

January 16 - Bloomberg (Li Yanping): "A Chinese central bank official attacked reported comments by U.S. Treasury Secretary Henry Paulson that China's high savings rate helped trigger the global credit crisis. 'This view is extremely ridiculous and irresponsible and it's 'gangster logic,' Zhang Jianhua, the bank's research head, said."

The dollar index gained 1.9% this week to 84.21. For the week on the upside, Norwegian krone increased 1.0%. On the downside, the the New Zealand dollar declined 7.7%, the Canadian dollar 5.0%, the Australian dollar 4.3%, the Brazilian real 3.3%, the Swedish krona 2.9%, the British pound 2.8%, the Mexican peso 1.9%, the Euro 1.3% and the Danish krone 1.1%.

Commodities Watch:

January 15 - Bloomberg (Todd Zeranski and Alaric Nightingale): "Morgan Stanley is seeking a supertanker to store crude oil, joining Citigroup Inc. and Royal Dutch Shell Plc in trying to profit from higher prices later in the year... 'There's a lot of people looking for storage,' Denis Petropoulos... head of tankers at Braemar Shipping Services Plc... said..."

January 14 - Bloomberg (Tony C. Dreibus): "Lumber fell the most allowed by the Chicago Mercantile Exchange, dropping to the lowest price in almost 18 years..."

Gold declined 1.5% this week to $842 (down 4.6% y-t-d), while silver was little changed at $11.29 (unchanged y-t-d). February Crude sank $4.83 to $36 (down 19.3% y-t-d). February Gasoline rose 4.9% (up 9.8% y-t-d), while February Natural Gas sank 13% (down 14.6% y-t-d). March Copper declined 2.5% (up 7.8% y-t-d). March Wheat dropped 8.1% (down 5.3% y-t-d), and Corn was hit for 4.8% (down 3.9% y-t-d). The CRB index fell 3.8% (down 3.7% y-t-d). The Goldman Sachs Commodities Index (GSCI) declined 1.9% (down 1.7% y-t-d).

China Watch:

January 14 - Bloomberg (Nipa Piboontanasawat and Kevin Hamlin): "China's economy overtook Germany's in 2007 to become the world's third largest, underscoring the nation's increasing economic and political clout. Gross domestic product expanded 13% from a year earlier..."

January 13 - Bloomberg (Li Yanping and Nipa Piboontanasawat): "China's exports fell the most in almost a decade in December as the deepening global recession cut demand for the nation's toys, clothes and electronics. Shipments dropped 2.8%, the customs bureau said... That compares with a 21.7% gain a year earlier. Exports grew 17.2% for all of 2008, down from 25.7% in 2007."

January 14 - Bloomberg (Judy Chen): "The increase in China's foreign- exchange reserves "masked" about $100 billion in capital outflows in the fourth quarter, RBC Capital Markets said. China's currency reserves... climbed $40 billion last quarter to $1.95 trillion....The slower pace of accumulation is partly because foreigners dumped local assets and reversed bets on yuan gains, according to strategists led by Nick Chamie, RBC's head of emerging-markets research."

January 13 - Bloomberg (Li Yanping and Kevin Hamlin): "China's money supply and loans jumped more than economists estimated in December... M2... climbed 17.8% from a year earlier, the fastest pace in seven months..."

January 14 - Bloomberg (Chia-Peck Wong): "Home prices in Macau may fall by between 10% and 20% this year amid rising unemployment as casino operators halt construction projects and fire workers to cut costs, Jones Lang LaSalle said..."

January 14 - Bloomberg (Chia-Peck Wong): "Hong Kong's sales of new private homes fell to the lowest level since 1996 last year... The number of new non-government-built residential units changing hands last year fell 47%..."

Japan Watch:

January 13 - Bloomberg (Toru Fujioka): "Japan's corporate bankruptcies rose the most in eight years in 2008... Bankruptcies climbed 11% from a year earlier to 15,646 cases last year, the fastest pace since 2000, Tokyo Shoko Research Ltd. Said..."

Asia Bubble Watch:

January 15 - Bloomberg (Patricia Kuo and Aaron Pan): "Bond markets in the Asia-Pacific region are having their busiest January for at least a decade, with $32.3 billion in sales, as government guarantees and stimulus plans help boost investor appetite. New issues almost tripled compared with the first two weeks of last year, and more than doubled the $12.4 billion of January 2007..."

January 13 - Bloomberg (Leony Aurora): "Indonesia more than doubled its budget deficit target to 132 trillion rupiah ($11.8 billion) for this year to spur growth in Southeast Asia's biggest economy. Finance Minister Sri Mulyani Indrawati expects the economy to expand 5% this year..."

Latin America Watch:

January 13 - Bloomberg (Andres R. Martinez): "Mexico will postpone construction of its planned Punta Colonet port on the Pacific coast, and may scrap the project entirely, as interested bidders struggle to find financing for the $4.88 billion complex."

Unbalanced Global Economy Watch:

January 13 - Bloomberg (Theophilos Argitis): "Canada's trade surplus narrowed to the lowest in more than a decade as energy exports plunged. The surplus shrank to C$1.28 billion ($1.04 billion)..."

January 14 - Bloomberg (Colm Heatley): "Irish house prices fell almost 15% in 2008 from a year earlier as rising unemployment and the global credit crisis deterred buyers, according to... Daft.ie."

January 13 - Bloomberg (Matthew Brown): "The pound fell against the dollar and the euro as reports showed the U.K. economy slumped the most in two decades and home sales dropped to the lowest level since at least 1978."

January 14 - Bloomberg (Robert Hutton and Mark Deen): "Business Secretary Peter Mandelson said the U.K. government will guarantee as much as 20 billion pounds ($29 billion) of bank loans to medium-sized companies in order to keep credit flowing during the recession."

January 14 - Bloomberg (Chris Bourke): "U.K. real-estate companies may need to be rescued by shareholders this year to stay afloat. The largest commercial-property firms need to raise as much as $20 billion this year to restore their balance sheets at a time when financing is scarce, according to... Bernd Stahli, an analyst at Merrill Lynch..."

January 14 - Bloomberg (Sharon Smyth): "House prices in Spain fell 8.8% in December from a year earlier, according to Tasaciones Inmobiliarias SA, the country's biggest home valuer."

January 14 - Bloomberg (Lorenzo Totaro): "Industrial production in Italy fell more than expected in November as the global economic slowdown aggravated the nation's worst recession since 1992 and prompted companies to cut output and jobs. Production dropped a seasonally adjusted 2.3% from October..."

January 16 - Bloomberg (Milda Seputyte and James M. Gomez): "The Baltic countries of Latvia, Lithuania and Estonia are facing unrest and street protests over government austerity measures that may make political leaders casualties of the worst economic collapse in the European Union."

January 15 - Bloomberg (Alex Nicholson): "Russia may have a 4 trillion ruble ($124 billion) budget deficit this year if the price of Urals crude averages $32 a barrel and the average exchange rate is 34 rubles to the dollar, Interfax reported."

January 15 - Bloomberg (Emma O'Brien): "Russia's ruble dropped to a record low against the dollar after the central bank accelerated its devaluation of the currency and Vedomosti reported the government slashed its estimate for oil prices by 20%."

Bursting Bubble Economy Watch:

January 15 - Bloomberg (Dan Levy): "U.S. foreclosure filings jumped 81% last year as falling house prices, tighter mortgage lending and the longest recession in a quarter century battered property owners, RealtyTrac Inc. said. More than 2.3 million properties got a default or auction notice, or were seized by lenders..."

Central Banker Watch:

January 16 - Bloomberg (Jody Shenn): "The Federal Reserve, engaging in what Chairman Ben S. Bernanke this week termed 'credit easing,' bought $23.4 billion of Fannie Mae, Freddie Mac and Ginnie Mae mortgage bonds under a program aimed at lowering home-loan rates."

January 14 - Bloomberg (Craig Torres): "The Federal Reserve's top two officials urged a new effort to address the toxic assets held by financial companies... Chairman Ben S. Bernanke and Vice Chairman Donald Kohn said in separate remarks yesterday that the illiquid investments raise questions about the 'underlying value' of banks and may hinder 'private investment and new lending.' They called for the government to remove or insure the assets."

MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:

January 16 - Bloomberg (Shannon D. Harrington): "Moody's... said it expects to cut the ratings on a 'large majority' of collateralized debt obligations that bet on companies using credit derivatives... The so-called synthetic CDOs may be cut three to seven grades in many cases after Moody's increased the assumptions for company defaults and correlation of defaults."

Real Estate Bust Watch:

January 14 - Wall Street Journal (Prabha Natarajan): "The rapid reversal of fortunes in commercial real estate is taking down yet another sector: apartment complexes. Owners and developers of multifamily buildings are trying to stay afloat as the deteriorating economy and escalating job losses create low vacancies in apartments, difficulties in raising rents, and shortfalls in projected revenues from these buildings... Much of the multifamily sector's problems center on troubles in converting apartments to condominiums, as is the case in Miami, or on the challenges in converting rent-controlled units to market-rate apartments, as in New York's Manhattan."

January 14 - Bloomberg (Daniel Taub): "Construction spending on offices, shopping centers, hotels and industrial buildings in the U.S. will fall this year and next as the recession prompts businesses to delay or cancel plans, the American Institute of Architects said. Non-residential construction likely will drop 11% this in 2009 and 5% in 2010..."

GSE Watch:

January 13 - Bloomberg (Jody Shenn): "The Federal Home Loan Bank of Seattle joined its San Francisco counterpart in suspending dividends and 'excess' stock repurchases, after the declining value of mortgage bonds likely led to a regulatory capital shortfall."

Speculator Watch:

January 14 - Dow Jones: "Hedge fund GoldenTree Asset Management is offering securities to investors who want to withdraw cash, The Financial Times reported... In a letter to investors last month, GoldenTree said: 'Withdrawing partners that do not elect to revoke their withdrawal request will receive their proceeds primarily in kind. It is unlikely that any cash will be distributed.' This has triggered protests from investors, many of whom would have problems disposing of the securities as GoldenTree specializes in investing in complex, often illiquid, debt instruments."

January 14 - Bloomberg (Tom Cahill): "Man Group Plc, the largest publicly traded hedge-fund manager, said assets under management fell 21% in the last three months of 2008..."

January 16 - Bloomberg (Gillian Wee): "Private-equity firms had their second-best year of fund raising in 2008, leaving them with $1.02 trillion to invest in leveraged buyouts, venture capital and real estate, according... Preqin Ltd."

Fiscal Watch:

January 13 - Bloomberg (Rebecca Christie): "The U.S. budget deficit soared to a record in the first quarter of the 2009 fiscal year, surpassing the shortfall for all of last year... The deficit swelled to $485.2 billion... For all of 2008, the shortfall was $454.8 billion. The monthly budget picture also worsened, as the excess of spending over revenue widened to $83.6 billion in December, compared with a $48.3 billion surplus a year earlier... 'We are inheriting a daunting fiscal position," Peter Orszag, nominated by Obama to be the White House budget director, told the Senate Budget Committee. The budget shortfall in the 12-month period to Sept. 30 will likely exceed $1 trillion 'even without steps to mitigate the economic downturn,' he said. Government revenue fell 14% to $237.8 billion last month, while spending soared 41% to $321.4 billion compared with a year earlier."

Muni Watch:

January 13 - Bloomberg (Adam L. Cataldo): "State governments from Rhode Island to California have run up estimated pension-fund losses of $865.1 billion... Assets for 109 state funds declined 37% to $1.46 trillion over the 14 months ended Dec. 16, according to the Center for Retirement Research..."

January 13 - Bloomberg (Michael Weiss): "Detroit's bond ratings on $2.4 billion in debt was cut, most below investment grade, because of the city's failure to maintain balanced budgets, Moody's... said."

California Watch:

January 14 - Wall Street Journal (Stu Woo): "The past two days have felt like summer in California, as unseasonable warmth sweeps the state -- possibly presaging a third straight year of drought, a worrisome possibility for a state already hit hard by the economic downturn. Another dry year could mean water rationing for businesses and individuals. It could also slow business expansion and affect the agricultural industry, ski resorts and efforts to keep firefighting costs down, after a year in which state and federal officials spent $1 billion combating wildfires... Even before this week, the state was facing a water shortage..."

New York Watch:

January 16 - Bloomberg (Michael Quint): "New York state raised its forecast for next year's deficit by $128 million to $13.8 billion as a weakening economy led to a projected 4.1% decline in wages instead of a 3% drop as previously assumed."

Crude Liquidity Watch:

January 14 - Bloomberg (Haris Anwar): "United Arab Emirates-based banks may face worsening loan quality as the region's slowing real-estate market increases the prospects of developers defaulting, according to Moody's... 'Moody's is mainly concerned about the loans to 'opportunistic' developers that have been extended over the past four to five years," John Tofarides, a... Moody's analyst said..."

January 14 - Bloomberg (Camilla Hall): "Tumbling oil prices are forcing many of the richest Persian Gulf states to record budget deficits and limit a critical source of foreign investment for poorer Arab countries."

January 15 - Bloomberg (Haris Anwar): "Abu Dhabi Investment Authority may have lost $125 billion last year, pushing the sovereign wealth fund to second place behind Saudi Arabia, as the global credit crisis eroded the value of its assets, the Council on Foreign Relations said."

January 14 - Bloomberg (Anthony DiPaola and Glen Carey): "The Dubai developer that's building the world's tallest tower delayed the project after the global financial crisis halted a property boom in the Gulf."

A Divergence:

The 2009 stock market has quickly come face-to-face with the reality that the worst of our banking system's problems have yet to pass. Today, Citigroup reported an $8.3bn fourth quarter loss, about double what was expected. Bank of America posted a quarterly loss of $1.8bn (its first loss since 1991). In both cases, huge additional governmental support has been required.

The breakup of the great global "financial supermarket" is now moving briskly. Citi management this morning announced a plan to create a new entity ("bad bank"?) to aggregate "non-core" assets. This entity - including Citi Financial, Citi Mortgage, the company's asset management business and a pool of securities - will account for approximately $850bn of Citi's $1.95 TN of total assets. The government has directly invested $45 billion in the bank and is now backing $301bn of Citi's real estate loans and securities.

From Bank of America came the news of additional "emergency" governmental support necessary to consummate the acquisition of troubled Merrill Lynch. The government will inject an additional $20 billion of "capital" into the deal (on top of an earlier $25bn), along with guarantees on an $118bn pool of risk assets (said to include mostly Merrill residential and commercial mortgage-backed securities, and Credit default swaps).

Bill Gross's current investment thesis "buy what they [the government] buy" seems only to apply to fixed income. In the stock market, investors are scurrying away from the banking sector where it has become apparent that the government will be taking an ever-increasing role in ownership and Credit Policy.

It remains my view that our maladjusted economy is in the earliest stage of what will prove a grueling and protracted adjustment period. And with Wall Street finance incapacitated, there will be no alternative than for the banking system to aggressively expand Credit. In rough terms, Bank Credit will need to expand in the Trillion dollar range (10% growth) this year if there is any hope of stemming depressionary forces and stabilizing the system. The way I see it, system-wide Credit expansion of $2.0 TN or so will likely be required, of which about half will be forthcoming from federal borrowings.

Keep in mind, however, that while Washington stimulus would be expected to support general spending throughout the economy, it will be the almost sole responsibility of the banking system (with governmental support) to extend the necessary Credit to reverse the downward spiral in our nation's troubled asset markets. This will be no small feat. Yet it may be a case that the banks are today in such awful shape that they have no option but to accept massive federal government aid and, along with it, a likely new mandate to get out and lend. Expect the new Administration to hit the ground running.

Candidly, the current environment presents the most difficult macro analysis of my career. The collapse of Lehman was a seminal event in U.S. and global finance. Overnight, Trillions of Wall Street's financial claims lost their "moneyness." Trust in history's most powerful mechanism of Credit expansion was shattered - and for years to come will remain shuttered. Near- and long-term ramifications are momentous, especially when it comes to the performance of asset markets. But, at the same time, the collapse of the historic Credit Bubble has also granted global policymakers an unprecedented mandate to inflate governmental debt and obligations. The promise of basically unlimited deficits and Credit guarantees is required to shore up the "moneyness" of the core of monetary systems both at home and abroad.

Will these deficits and guarantees be sufficient to stabilize financial and economic systems? What are the inflationary ramifications of such policymaking? How long will the markets so contently accommodate the unmatched expansion of government obligations - and along with it governmental intrusion into all things financial and economic? There is no easy analysis or clear answer. Is the renewed collapse in bank stocks a harbinger of a dramatic worsening of economic prospects? Or could it perhaps be more a case of stock declines discounting future shareholder dilution and other issue related to larger governmental ownership and control?

As gloomy as economic reports and news headlines have been, there have actually been scattered hopeful signs of system stabilization. Corporate debt markets are showing unequivocal signs of life. January is on pace for the strongest month of corporate debt issuance since May. And even the junk bond market is showing a dim pulse. At the same time, municipal debt issuance this past week was the most robust since the Lehman collapse.

It is worth noting that many key debt spreads remain significantly below the levels from the dark days of November. At about 220 bps, investment grade spreads are 60 bps below November highs. Junk spreads narrowed 30 bps this week. And Credit Default Swap pricing for many topping The List of Credit Problem Children - including MBIA, Ambac, MGIC, Sears, GMAC, Ford Motor Credit, and ResCap - are today significantly below the crisis levels from a couple months back.

At 93 bps, agency debt spreads are about half the level of the November spike. Agency long-term borrowing costs have sunk from above 5% during the fourth quarter to today's 3.25%. It is also worth noting that benchmark agency MBS yields are now below 4.0% after surpassing 6.0% in November. While mortgage rates are no longer the invaluable indicator they were during the mortgage finance Bubble, I don't want to completely discount them either. There has already been a meaningful jump in mortgage refinancings. I would also expect these rates to somewhat support housing transactions, although the weak stock market and a barrage of job cut announcements weigh further on confidence.

In short, it is not so easy to discern an area of acute systemic crisis commensurate with the pounding taken this past week or so by the banks and financials. I'll this evening label this dynamic "A Divergence." It is possible that there is acute stress out there not visible to the naked eye. Perhaps the major banks are in worse shape than they appear. And housing and the economy could be taking additional legs down, although this would be a surprising development considering the current financing environment. The international backdrop remains problematic. And one should assume there are more hedge fund shoes to drop. Reasonable analysis would see speculator de-leveraging and liquidation overhanging the markets for some time to come. So, it's an especially tough call - and A Divergence that beckons for analytical focus.