Financial thoughts

new york — Stocks rose Wednesday, extending a global rally, as President Barack Obama prepared to set up a so-called bad bank to absorb toxic investments, and Yahoo Inc. and Germany’s SAP AG reported better-than-estimated earnings.

Citigroup Inc. and Bank of America Corp. surged more than 13 percent after a White House official said Obama’s team may announce the outlines of its plan next week. Deutsche Bank AG and Barclays Plc added at least 18 percent in Europe. Yahoo and SAP, the largest maker of business-management software, climbed more than 5.2 percent. The Standard & Poor’s 500 index gained for a fourth straight day, its longest streak since November.

"The impact of the bad bank idea is positive for equities in that it moves us in the direction of finding a solution to the cloud of bad assets that continues to weigh on proper valuations," said Alan Gayle, senior investment strategist at Ridgeworth Capital Management, which oversees $70 billion in Richmond, Va. "It’s giving nervous markets a lift."

The S&P 500 added 3.4 percent to 874.09, with financial companies posting 19 of the top 20 gains. The Dow Jones industrial average climbed 200.72 points, or 2.5 percent, to 8,375.45.

Citigroup added 66 cents, or 19 percent, to $4.21, while Bank of America, the largest U.S. lender by assets, jumped 89 cents to $7.39. JPMorgan Chase & Co. climbed 10 percent to $27.66. Fifth Third Bancorp and State Street Corp. jumped more than 31 percent.

Financial companies in the S&P 500 rallied 13 percent collectively, with 79 of 81 companies advancing make payday loan.

The "bad bank" initiative may allow the government to rewrite some of the mortgages that underpin banks’ toxic debt, in the hope of stemming a crisis that has stripped more than 1.3 million Americans of their homes. "You’re getting a big relief rally in the financials, and that’s lifting the whole market," said Michael Binger, Minneapolis-based fund manager at Thrivent Asset Management, which oversees about $70 billion. "If the bad assets can be taken out, banks will feel more comfortable in where their capital ratios will be. And if that’s the case, they’ll be more ready to lend and the credit market freeze will thaw."

Wells Fargo & Co., the second-biggest U.S. home lender, rallied 31 percent to $21.19. The bank maintained its dividend and said it doesn’t need more federal aid as it reported its first quarterly loss since 2001 following its takeover of Wachovia Corp.

Yahoo, owner of the second-most-popular U.S. search engine, added 7.9 percent to $12.24.

Sun Microsystems Inc. added 22 percent to $4.86. The world’s fourth-largest maker of server computers reported sales and earnings that topped analysts’ estimates after cutting jobs to cope with the recession.

Life insurers advanced after state insurance commissioners endorsed industry proposals to loosen capital requirements, paving the way for a potential vote on Jan. 29 to change reserving rules. MetLife Inc., the biggest U.S. life insurer, jumped 20 percent to $33.27.

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Rhode Island is a tiny state with big problems. With just over one million residents, it ranks in the top 10 in terms of foreclosure, unemployment and state budget crunches.

CNNMoney.com traveled there in early January to witness the hard times up close. Over the next five days, we will use Rhode Island to illuminate the real economy on Main Street — and give voice to kitchen table conversations across America — as Washington debates how to get the nation back on track.

We will tell the stories of the jobless returning to school to learn new trades and the senior citizens feeling the pinch of state budget cuts.

We will talk to renters being evicted because their landlords are facing foreclosure and spend time with a community housing group hoping to use federal funds to turn around a neighborhood suffering from the mortgage meltdown.

And we will let Rhode Islanders tell you, in their own words, how they are coping.

Take Cheryl Smith-DuBois of Bristol. Her husband, a carpenter, is out of work and the couple is trying to scrape by on his unemployment and her job as a Mobil cashier. Looking to save every penny, she hardly gets to see her grandchild, who lives less than 15 minutes away, because she’s trying to save on gas.

"It’s hard to live within a box," said Smith-DuBois, 61.

Smith-DuBois’ struggles and Rhode Island’s plight are common. States around the country are reeling from one of the worst economic and financial crises since the Great Depression. As people lose their jobs and stores lose their customers, states are seeing their income and sales tax revenues dwindle. Declines in business profits only exacerbate the problem, driving down corporate tax revenues.

The confluence of these trends means many states are wrestling with multi-million budget deficits and cutting services and personnel.

Some 45 states faced or are predicting shortfalls in their budgets for this year or next, according to the Center on Budget and Policy Priorities, a Washington think tank. At least 41 states and the District of Columbia have mid-year budget gaps totaling $43 billion, or nearly 9% of their collective budgets.

"The picture will get worse, at least in the first half of 2009," said Robert Ward, deputy director of the Nelson A. Rockefeller Institute of Government. "Beyond that, we can hope that the picture starts to get better or at least stabilizes."

Rhode Island is scrambling to close a $350 million gap in its budget for the 2009 fiscal year, which began July 1. This shortfall comes after the state already slashed services and reduced personnel to plug a $425 million deficit in its $6.9 billion budget at the start of the fiscal year.

Last year, the state cut in half community service grants that assist the elderly, the youth and the poor; tightened the requirements for health coverage for low-income parents, and reduced funding for public colleges by $19 pay day loans.5 million, forcing them to hike tuition by as much as 10% for the fall semester and even more for the spring.

To deal with the mid-year gap, Gov. Donald Carcieri has proposed slicing 6% of aid to municipalities and eliminating some retirement benefits for state workers, such as the annual inflation adjustment. It is also depending on federal aid to see it through.

"I am very concerned that the economy is continuing to slide," said Carcieri in a televised address earlier this month. "While this plan closes the gap as of today, we could be facing more shortfalls by the end of this fiscal year."

Even without these state service cuts, Rhode Island residents are feeing the pain. As manufacturing and other jobs disappeared, the state’s unemployment rate zoomed to 10% in December, the highest in more than three decades and more than double what it was a year ago. Its November rate of 9.3% was the second highest in the nation.

And homeowners, who enjoyed a meteoric rise in housing values during the real estate boom, are dealing with a 3.18% foreclosure rate, the 10th highest in the United States, according to the Mortgage Bankers Association.

Other states are also suffering in the economic downturn.

Michigan is coping with an unemployment rate of 10.6%, amid the auto industry’s decline. Florida and Nevada, which have the highest number of homes in foreclosure at 7.3% and 5.6%, respectively, are trying to rebuild their housing markets.

And, during his annual State of the State address earlier this month, Gov. Arnold Schwarzenegger said California is "in a state of emergency" and faces insolvency within weeks in the wake of a projected $42 billion deficit.

Recognizing the dire straits of the states, President Barack Obama and congressional Democrats are planning to pump billions into their economies as part of an $825 billion stimulus package. States will get more money for a wide range of services, including education, senior nutrition and infrastructure projects.

"This recovery and reinvestment plan will provide immediate relief to states, workers, and families who are bearing the brunt of this recession," Obama said in a speech earlier this month. "Government at every level will have to tighten its belt, but we’ll help struggling states avoid harmful budget cuts, as long as they take responsibility and use the money to maintain essential services like police, fire, education, and health care."

Tuesday: "Recession realities: Stories from the frontline" — Unemployed workers go back to school for new careers.

How is your local economy affecting you? E-mail your story to realstories@cnnmoney.com and you could be included in an upcoming article. 

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Chrysler LLC, which suffered a 30% drop in sales last year, announced a massive new incentive program to move vehicles off dealers’ lots.

The carmaker will begin marketing the incentive plans, called "Employee Pricing Plus," in ads on Monday.

Under the program, all 2008 and 2009 Chrysler, Dodge and Jeep vehicles will be available at prices similar to those Chrysler employees pay — typically thousands of dollars below the sticker price.

In addition, customers will receive discounts of up to $3,500 on 2009 vehicles and $6,000 on 2008 models.

The Dodge Sprinter work van is the only vehicle specifically excluded from the program, according to Chrysler’s announcement.

An additional $1,000 rebate is also available on vehicles financed through Chrysler Financial, Chrysler’s financing arm, or through a customer’s local credit union.

These latest incentives come on top of a 0% financing program Chrysler announced last Friday, just hours after the U.S. Treasury Department said it would lend Chrysler Financial $1.5 billion. The 0% offer applies to select Chrysler, Dodge and Jeep vehicles for loans of not more than four years.

The $1.5 billion low-interest loan to Chrysler Financial was separate from the Treasury Department’s $4 billion loan to Chrysler LLC itself payday loan lenders.

The financing portion of this plan will be crucial to its success, said Jesse Toprak, a vehicle pricing analyst with the automotive Website Edmunds.com. The inability to get a car loan has driven many potential buyers out of the car market, he said.

"Employee pricing will get people into showrooms," he said, "but financing will sell cars."

Chrysler recently announced a planned alliance with Italy’s Fiat under which Fiat will take a 35% ownership stake in Chrysler LLC. Although no cash will change hands, Chrysler will get access to Fiat engineering and Fiat will be able to use Chrysler factories and its dealer network in the United States.

Ford has been offering a similar program, also called "Employee Pricing Plus," since Nov. 19, 2008. Under its incentive program, Ford is also offering vehicles at Ford employee prices with additional cash rebates of up to $6,000 on some 2008 models and $2,500 on some 2009 models. 

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Russian gas reached Europe via Ukraine for the first time in two weeks on Tuesday after Moscow and Kiev ended a contract row that cut supplies to about 20 European countries.

Slovakia and Hungary said they had begun receiving gas, though pipeline operators said it could be Wednesday before supplies reach other parts of Europe, where the cut-off forced some countries to ration supplies to customers in mid-winter.

“Gas is not only flowing in the direction of Europe but it is flowing to Europe,” said Alexander Medvedev, deputy chief executive of Russian gas export monopoly Gazprom.

Ukraine confirmed it was receiving gas from Russia and said it would deliver it to Europe as quickly as possible.

The gas transmission arm of Hungarian oil and gas group MOL said it started receiving gas at 1220 GMT. Slovakian Economy Minister Lubomir Jahnatek said gas had arrived there too, while Romania’s pipeline operator said flows would restart “within hours.”

The dispute had reflected political tension between Moscow and Kiev on a range of issues. Russia strongly opposes a bid by its former Soviet neighbor to join the NATO military alliance.

Even when gas flows return to normal, the effects will linger. Russia’s reliability as an energy source, as well as Ukraine’s transit credentials, are under renewed scrutiny and Europe is anxious to diversify supply so it cannot become hostage again to local disputes cheap payday advance.

“This bilateral dispute has harmed the confidence placed in the two countries,” the Czech EU presidency said in a statement.

European Commission President Jose Manuel Barroso said he was considering taking legal action over the dispute.

“We must not allow ourselves to be placed in this position in future. This cannot become an annual event. We have to stop simply talking about energy security in Europe, and start doing something about it,” he told a news conference in Brussels.

Gazprom said that, under the new contract, Ukraine would pay $360 per 1,000 cubic meters of gas (tcm) in the first quarter of this year, double the $179.50 Kiev was paying in 2008.

The price is likely to come down later this year as gas tracks falling oil prices, but it could still be a huge burden for a Ukrainian economy struggling with debt and sharp falls in the hryvnia currency.

Ukrainian Prime Minister Yulia Tymoshenko said she expected the average price over this year to be around $230-250 per tcm, and that Ukraine would limit immediate purchases.

“In the first quarter, when the price is highest, there is no need to buy large quantities of gas because we have gas in reserves remaining from last year,” she told a news briefing. 

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Honda joined fellow Japanese carmaker Toyota in cutting output further on Friday, as a top European official warned some of the region’s manufacturers might not survive a “brutal” 2009 for the industry.

Honda said it will scale back domestic output hours after Toyota announced new production cuts of its own at its North American plants, while Nissan was seen shifting some Japanese assembly lines abroad to cut costs.

As EU business ministers gathered in Brussels to discuss support for the flagging industry and French manufacturers prepared to lobby their government for aid, European Union industry commissioner Guenter Verheugen said some carmakers faced an uncertain future.

“There is no guarantee that all the main European manufacturers can survive the crisis,” he told BBC radio.

Verheugen forecast a further 20 percent drop in sales in 2009 and said the industry’s outlook was “to say the least, brutal” as cash-strapped consumers hit by the credit crunch and a deteriorating economic climate continue to defer big-ticket purchases.

In Asia, Subaru maker Fuji Heavy became the latest auto firm to forecast losses this fiscal year as the spreading global recession dampens demand in mature markets and puts the brakes on sales in emerging ones.

News of Toyota’s cuts in North America followed General Motors’ warning that its U online payday loans.S. auto sales would this year sink to a 27-year low.

Toyota, which expects to post its first ever annual operating loss, said its inventory of North American-built vehicles was 80-90 days, having doubled in the past year. It hopes to cut that by half in the second quarter.

The world’s biggest automaker had already cut North American production and suspended work on a new plant in Mississippi that was due to produce the Prius hybrid from 2010.

“The current inventory level is a record high for Toyota,” said Okasan Securities analyst Yasuaki Iwamoto.

“Sales are falling 30-40 percent every month, and this pace of fall is unheard of … Automakers have to cope with it through production cuts as quickly as possible.”

HONDA, NISSAN SCALE BACK

Honda said it would reduce domestic output by an additional 56,000 units.

Nissan announced further cuts in Japan on Thursday and a source said it would book an annual operating loss.

The Nikkei newspaper reported on Friday that Nissan was aiming to cut production costs by 30 percent by making its March subcompact in Thailand instead of Japan. 

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Thousands of U.S. banks are waiting for federal investment dollars, but the Obama administration needs to set aside cash for “one-off” rescues of major institutions, the man who runs the Treasury’s $700 billion bailout fund said on Tuesday.

Neel Kashkari, who will stay on for several more weeks as the administrator of the Troubled Asset Relief Program (TARP) said the program should stay focused on shoring up the financial sector.

The Bush administration has requested that Congress release the second $350 billion in funding for the program to give President-elect Barack Obama a head start in dealing with financial system stress.

Speaking to students at Georgetown University’s McDonough School of Business, Kashkari said his phone has been “ringing off the hook” from a wide range of companies, industries and municipalities seeking a piece of the aid money.

“We believe the TARP should be focused on the financial system. It’s designed for that, our programs are set up around that,” Kashkari said. “And we think if there are contingencies for other industries that those are best dealt with in legislation specifically geared toward those.”

Congress can reject the TARP funding request and many lawmakers have said they want the next $350 billion to include aid to stem foreclosures and wider benefits for American consumers.

Obama’s top economic adviser, Lawrence Summers, assured top lawmakers in a letter on Monday that the aid would get to smaller banks, businesses and municipalities and would help Americans buy cars or get college loans cheap payday loans.

MORE CAPITAL INVESTMENTS

Kashkari said the next phase of TARP funding could include a second round of capital investments into banks, which could be achieved by a matching program, under which the federal government matches private capital raisings.

But TARP needs to be able to deal with “systemically important” institutions, he said. The Treasury devoted about $85 billion of the first phase of TARP to shore up American International Group and Citigroup.

“It’s impossible to predict what’s going to happen. We hope that the actions that we’ve taken are sufficient, but we are also going to have enough dry powder on the side to deal with any one-offs that arise,” Kashkari said.

Thus far, the Treasury has disbursed $265.3 billion of the first $350 billion to financial institutions and struggling Detroit automakers.

In addition to the Citigroup and AIG rescues, the Treasury has made capital investments in 257 banks totaling $189 billion, but thousands more institutions have applied for government cash through their federal regulators.

Kashkari said it will take time for the capital investments to have the desired effect of making credit more available.

The Treasury still has around $60 billion to invest in banks under TARP, before moving to the second $350 billion. 

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Democratic President-elect Barack Obama intends to retain Federal Deposit Insurance Corp. head Sheila Bair, who has pushed for fast mortgage modifications, according to a report Wednesday.

Citing Democratic officials, The Wall Street Journal said Obama plans to keep Bair, a Republican who has clashed with the Bush administration on how to stem home foreclosures and who was won support from key Democrats in the Congress.

Bair is chairman of a five-member FDIC board that includes two other banking regulators, the U.S. Comptroller of the Currency John Dugan and Office of Thrift Supervision Director John Reich - both Republicans.

Reich, whose agency regulated failed mortgage lenders Washington Mutual (WAMUQ) andIndyMac (IDMCQ), plans to retire within weeks, soon after Obama is sworn in; and Dugan, the regulator of some of the biggest national banks, plans to serve out his term.

Scott Polakoff, Reich’s deputy, is expected to be the acting director.

The two Democrats on the FDIC board are Vice Chairman Martin Gruenberg, who was senior counsel to former Senator Paul Sarbanes, and Thomas Curry, a former state banking regulator cash loans.

A self-described moderate Republican, Bair was early in calling on institutions to quickly modify troubled mortgages in order to help borrowers and the financial markets get back on their feet.

Her calls were largely met with resistance from the Bush administration and from banks, which complained about legal and accounting issues that prohibited them from restructuring mortgages.

But her standing was on the ropes with Obama’s pick for Treasury secretary, Timothy Geithner, who is president of the Federal Reserve Bank of New York.

According to congressional sources, tension has developed between Bair and Geithner, who was instrumental in the talks involving financial firm Bear Stearns and rescuing American International Group (AIG, Fortune 500) and Citigroup. (C, Fortune 500)

The tension centers on how Bair handled the recent tailspinning of financial institutions, especially Citigroup, which received more government aid. The two also differ on loan modifications, the sources said.  

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A key index of the nation’s manufacturing activity fell to a 28-year low in December, according to a report released Friday.

The Institute for Supply Management, a purchasing management group based in Tempe, Ariz., said its manufacturing index was 32.4 for December. That’s the lowest reading since June 1980, when it stood at 30.3.

An index of 35.4 was expected for December, according to a consensus of economist opinions provided by Briefing.com. That’s down from November, when the index was 36.2.

"Manufacturing activity continued to decline at a rapid rate during the month of December," said Norbert Ore, chair of the ISM’s Manufacturing Business Survey Committee, in a press release. "The decline covers the full breadth of manufacturing industries, as none of the industries in the sector report growth at this time."

Manufacturing activity failed to grow for the fifth consecutive month, according to the ISM, while the overall economy contracted for the third month running faxless cash advance.

An index reading above 50 indicates growth, while a reading below 50 indicates a slowdown. A reading below 41 is typically associated with recession in the broader economy.

The ISM report is a national survey of purchasing managers in the manufacturing sector. The monthly survey tracks new orders, production, employment, deliveries, inventories and other aspects of the sector.

New orders have experienced the lengthiest contraction thus far - 13 months - and plunged to 22.7 in December from 27.9 the prior month. Ore said this is the lowest figure since January 1948.

Production fell to 25.5 from 31.5, in its fourth month of declines. Employment fell to 29.9 from 34.2, in its fifth month of declines. 

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