This is just a brief note to make you all aware that it’s being a very remarkable week in the Land of Fixed-Income and Monetary Policy.

I’ll post much more on this topic as soon as I can, but the Federal Reserve has qualitatively changed the nature of their response to the financial crisis. As of this week, they’ve embarked on what is called “quantitative easing” of monetary policy.

To oversimplify somewhat, they’ve transitioned from trying to effect policy by manipulating the price of credit, to directly creating credit themselves. This is by way of the flurry of new facilities they announced yesterday.

You can see for yourself one of the immediate consequences: yesterday morning, retail mortgage rates dropped almost 90 basis points. In most parts of the country, you can get a 30-year fixed rate mortgage for about 5.30%. It remains to be seen whether this will lure buyers back into the housing market, but it’s a hopeful sign.

Elsewhere, the Treasury has gone into overdrive, creating vast new supplies of the most desired asset class in the world, namely full-faith-and-credit US Treasury paper.

We’re going to see the yield curve flatten considerably in the near term. The Fed funds rate (which is currently targeted at 1%) is actually near zero. This limits the ability of short-dated paper (like T-bills) to increase in value.

Meantime, there is a lot of new supply hitting the 3-year sector of the curve. Treasury is now issuing new 3-year notes every month, and the new banks on Wall St. (which used to be investment banks) are issuing 3-year notes with an FDIC guarantee. That’s going to push up yields at this maturity.

And then there’s the Fed, which is out there buying up long-dated securities like Fannie/Freddie debt and mortgage-backed securities, and securitizations of consumer debt (student loans, credit cards, car loans). This will take sone supply out of the long end of the market and keep yields low.

More later.

-Francis Cianfrocca

Last week was Citigroup’s turn. Citi is one of the world’s best-known banking brands, and was once America’s largest bank by market capitalization.

Last week, investors knocked 60% off the value of Citi’s stock, in a nerve-rattling selloff that was too reminiscent of Bear Stearns and Lehman Brothers for comfort.

Citigroup is too large to fail. It has about 200 million accounts in more than 100 countries. Its balance sheet has $2 trillion in assets. They also have more than $1 trillion in off-balance sheet assets. (The latter are of great concern because they’re not subject to the same reserve and capital requirements as the normal stuff.)

Here’s the term sheet that appeared on the FDIC’s web site in the wee hours this morning. Usually the authorities try to get things like this done by 7pm Eastern time on Sunday nights. But tonight they had a bit more wiggle room because markets in Tokyo are closed for a holiday.

Market reaction as I write (around 6am ET) is mildly positive. The US Treasury yield curve is flatter overall with higher yields in the belly.

The Treasury and the FDIC have essentially agreed to guarantee the value of certain assets of Citigroup, in a manner that shares a few features with prior bailouts, like the “Maiden Lane” structure engineered by the New York Fed for Bear Stearns, and the Treasury’s conservatorship of Fannie Mae/Freddie Mac.

Let’s see if I can explain this really simply.

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So this week we witnessed the jarring spectacle of three wealthy, well-dressed CEOs flying from Detroit to Washington, DC, each in his individual private jet, to ask for anywhere from 25 to 50 billion dollars of your money.

Instead, Congress turned them away. Democrats (if you take them at their word) said they wanted to give Detroit a big slug of money from the Treasury’s bank-bailout fund.

Republicans, understandably wary of the public reaction to allocating new money for yet another bailout, proposed instead to redirect $25 billion that has already been allocated for fuel-economy research, and allow the automakers to use it for operating capital instead.

In the end, Senate Majority Leader Harry Reid decided that it was his way or the highway, and he refused even to bring the Republican proposal (offered by Senators Dodd and Voinovich) up for a vote.

The news reporting naturally spins all of this as a desire on the part of Republicans to stand in the way of a solution.

So Reid let everyone get out of Dodge for the Thanksgiving holiday, and they’ll (presumably) come back in early December to give it another shot.

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To go along with the piece I wrote earlier today (here), the bond market appears to have picked up on the theme of deflation. The 30-year US Treasury bond rocketed upward in price to more than 118 and a half by today’s market close, and much of the move came late in the day.

This price corresponds to an interest-rate of 3.49% for the long bond. Just this morning, it was trading to yield over 3.90%. For the bond to drop over 40 basis points of yield in a single day is simply unheard of.

If this pricing holds up (and bond yields have been exceptionally volatile for many months now), it indicates at the very least that there is now an expectation that inflation will be non-existent for years into the future.

But I don’t think that’s the whole picture here.

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There are words you don’t ever want to use in polite company, and deflation is one of them. Unfortunately, it’s a serious possibility that we now need to consider.

Yesterday, the Bureau of Labor Statistics reported that the overall level of consumer prices declined by about 1% in October. The so-called “core inflation rate” declined by 0.1%, the first such decline in more than twenty-five years.

(The core rate subtracts out food and energy prices, and is seen as a more stable and relevant price index for policy purposes.)

The biggest declines in October came in prices for apparel, transportation, and energy. But even in the sectors which showed price increases (such as health care and food), the gains were considerably lower than in preceding months.

One month of data does not a trend make, so why am I raising the flag about this? And besides, isn’t it a good thing that we’re all paying less for gasoline?

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The most urgent piece of economic news and policy over the next several weeks will be the fate of the General Motors Corporation. It will take precedence over the general policy response to the worsening recession.

The problems in the auto industry go well beyond the Detroit Big Three. All eleven of the major automakers with operations in North America have come under severe stress, as a result of the sudden reluctance of consumers to buy new vehicles. But the situation at GM is even worse than many people perhaps realize.

As I wrote here, GM’s immediate financial situation is why they’re in dire straits now. As of the end of September, they reported about $16 billion in balance sheet cash. At a burn rate of roughly $1 billion a month, they (and we) figured they had enough cash to get through a good part of next year. The plan was to hope that economic conditions recovered enough by then to improve their cash-flow position, and get some new capital into the company.

What happened to change all that, is that US consumers suddenly went on strike in October. GM reported October sales that were 45 percent below the levels of October 2007.

I’ll give you a minute to pick your jaw up off the floor. You’re ready to go on now? Ok.

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Have you ever been in a situation where you’re running a company, and you’re lining up a round of financing, but you run short of time? And you need to complete some kind of near-term funding to avoid doing something really painful, like a layoff?

Welcome to bridge-loan hell. Bridge financing is pretty normal and standard in many cases, but when done out of necessity, it’s not something you ever want to face. You’re asking someone to put capital into a business which is in obvious distress. Speaking figuratively, you’ll have done well if you can get terms that only require you to give up your first child and not all the rest of them.

That’s kind of where General Motors is, right about now.

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I’ve been struggling mightily with this. Not only every talking head and newspaper writer in the whole world, but also large numbers of my acquaintances have entered a state of near-delirium over the result of last Tuesday’s election.

Many of them have been saying “Please, just let us have this moment.” This is startling because at some level, they’re acknowledging that the hope, joy and even (God help us) the tears that they’ve invested in what is merely the result of an exercise in transferring political power, are phony and will not last.

Puh-leeze, people! A Nobel-prize winning economist, Paul Krugman, literally wrote last week that there’s something wrong with any person who didn’t weep for joy at this election result.

Let’s take one of Krugman’s colleagues at the New York Times, racialist columnist Bob Herbert. Now Herbert is no one’s idea of a top-flight journalist. And it’s not original for him to have written last week that he was shedding tears of joy over the election, because now that we’ve finally elected a black man to run our government, we’ve proven ourselves worthy of his love.

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