Financial thoughts

Sprint Nextel Corp. said Tuesday it will buy out Virgin Mobile USA Inc. in a deal that values the small wireless carrier at $483 million and pushes Sprint deeper into the low-end prepaid mobile market.

Sprint (S, Fortune 500), which already owns 13.1% of Virgin Mobile, will pay a mix of shares and cash to buy the rest of the company from Richard Branson’s Virgin Group, South Korea’s SK Telecom and public shareholders.

The No. 3 U.S. mobile service also plans to retire all of Virgin Mobile USA’s debt, estimated to be no more than $205 million by Sept. 30.

Virgin Mobile USA (VM) shares jumped 23% to $5.18, close to the $5.50 per share that Sprint is paying in shares to public shareholders.

The price is a 31% premium over Virgin Mobile’s closing price of $4.21 Monday, though Sprint said the share swap ratio was subject to a collar of 1.0630 to 1.3668 Sprint shares per Virgin share.

While Sprint already rents space on its network to Virgin Mobile, some analysts were puzzled by its decision to buy the small carrier. Sprint already has its own prepaid unit, Boost, which offers consumers unlimited calls for a set monthly fee.

The deal will make Sprint more exposed to the toughest part of the prepaid market, in which customers pay in advance for calls on a per minute basis.

Analysts said the deal could be an indication that Sprint was having a difficult time turning around its main postpaid business, which serves high-value customers who pay monthly bills. Sprint is set to report quarterly results Wednesday.

"I think Sprint is looking to delve deeper into prepaid possibly because the postpaid segment remains extremely challenged," said Soleil Nelson Alpha Research analyst Michael Nelson. "It could be indicative of how tough things are in the postpaid side."

Boost, Leap Wireless and MetroPCS have seen strong growth in prepaid services that offer unlimited calls for a monthly fee business card.

Sprint, which has been struggling to stem customer defections from its own mobile service over the last few years, said the deal would increase its free cash flow.

"Sprint will continue to be challenged, as Virgin Mobile has been in the last few quarters, to retain their pay-per-minute subscribers," said Nelson.

Two brands

Sprint said it would manage Boost and Virgin as separate, complementary prepaid brands in one group led by Virgin Mobile (VM) CEO Dan Schulman, who will report to Sprint CEO Dan Hesse.

The deal follow’s the Virgin Group’s strategy of exiting more mature wireless markets but keeping a brand presence.

Earlier in July, Virgin sold its 50% stake in Virgin Mobile Canada to Bell Canada.

Sprint said the share exchange ratio for the Virgin Group, which own 28.3% of Virgin Mobile USA, will be 93.09% of the exchange ratio for public stockholders, or about $5.12 per share, including convertible preferred shares.

After the deal closes, Sprint will pay $12.7 million to license the Virgin Mobile USA brand from the Virgin Group through the end of 2021. It will have the option to renew the licensing agreement until 2047.

Sprint will also pay Virgin another $50 million for net operating losses available to be used in future for tax purposes.

The share exchange ratio for SK Telecom, which owns 15.3% of Virgin Mobile USA, will be 89.84% of the exchange ratio for public stockholders, or $4.94 per Virgin Mobile USA share, Sprint said.

Sprint said it expected the deal to close in the fourth quarter of 2009 or in early 2010.

Virgin Mobile shares jumped 22.8% to $5.17 in morning trading on New York Stock Exchange, where Sprint shares were down 1.54% at $4.48. 

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Federal Reserve Chairman Ben Bernanke said Sunday that lessons learned from the recession and the financial crisis will help make the economy stronger than it was before the crisis.

The Fed chairman answered questions from members of the public as well as moderator Jim Lehrer of PBS at a town hall event sponsored by the Federal Reserve Bank of Kansas City, Mo.

"The silver lining in this whole thing is that people are starting to save more, since they saw what happened with 401(k) investments," Bernanke said. "People are adopting good habits, so not only will we will be back on track, but the economy will be stronger than it had been before this started."

The Fed chairman also noted that government regulators are working to ensure that such a crisis can never happen again by addressing the issue of too big to fail and lobbying Congress to pass a regulatory reform bill.

"I don’t think we’ll ever completely eliminate financial crises, but there are ways to make sure one this severe never happens again," Bernanke said. "We need to have a council or group of regulators that look at the financial system as a whole and look for gaps. And ‘too big to fail’ has to go."

Bernanke suggested instituting a new kind of bankruptcy process for big non-bank financial institutions similar to what the Federal Deposit Insurance Corp. uses for banks.

"Sell [a large corporation] off, let it fail, but ensure that the whole financial system is not brought down with it," he said.

Slow recovery: Facing questions from many concerned consumers, Bernanke sought to assure the audience by noting that "recessions happen." Though he said this is the worst recession since the Great Depression, he also said that, like all prior economic downturns, this one will end too.

Bernanke said the economy is beginning to show signs of improvement, but recovery will be gradual. He said gross domestic product will likely rise by the end of the year into 2010, but job growth will lag. He conceded, "economic forecasts make weather forecasts look like physics," but said unemployment will top out above 10% before falling back in the second half of next year.

Taking heat: In addition to questions about timing of the recovery, Bernanke also took heat from some small business owners and people who had lost their jobs about how the Fed handled the crisis.

Many questioned whether it was problematic for the Fed to reward banks’ irresponsible behavior by bailing out financial institutions. But Bernanke said he was left with no choice.

"Nothing made me more frustrated than having to intervene in a couple cases where wild bets threatened to bring down the financial system," he said guaranteed approval payday loans. "But I was not going to be the Federal Reserve chairman who presided over the second Great Depression."

Though the Fed chairman mostly stood by the Fed’s decisions, on the subject of subprime lending regulation, he said the Fed deserved some criticism.

"We were late in addressing the subprime lending problem," Bernanke admitted. "We put together a set of rules that apply to all lenders, and I hope that solves the problem, but those weren’t in place early enough. We have to take some heat for that, I think that’s appropriate."

He declined to say outright that he opposes efforts by Congress and the Obama administration to create a separate consumer financial protection agency. But he said there were drawbacks to it, including possible "duplicative efforts" in monitoring. And he defended the Fed as being "very active" in the last three years on the consumer protection issue.

Bernanke was even more defiant about a congressional proposal to audit Fed monetary policy and actions. He said politics need to remain separate from the Fed to ensure that inflation and financial stability remain in balance.

"It is incredibly important that the Fed maintain its independence — it is so critical to the stability of economy," Bernanke said. "I don’t think people realize that Congress’ bill would allow the Government Accountability Office to be able to audit Fed decisions. That’s not congruent with independence."

There were lighter moments at the town hall, though.

When one particularly well-prepared questioner asked Bernanke a question about the Great Depression, Bernanke said, "I see you’ve read my book. I’m happy to autograph it for you after we’re done."

And when one audience member asked if he had any investing tips, Bernanke warned that he wasn’t licensed to do so. But he said to diversify investments between stocks and other instruments, and he added: "Don’t try to time the market. There might be a couple of people in the world who can time the market, but if there are, they’re not telling you."

How has President Obama’s $787 billion stimulus program affected you or your community? Are you seeing a benefit from the Making Work Pay tax cuts or the additional $25 in unemployment benefits? Are you seeing construction jobs or other stimulus-funded work in your neighborhood? Do you still have a job because of stimulus funds? We want to hear your experiences. E-mail your story to realstories@cnnmoney.comand you could be part of an upcoming article. For the CNNMoney.com Comment Policy, click here. 

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AT&T Inc. Thursday posted a smaller-than-expected drop in quarterly profit as strong sales of Apple Inc’s iPhone helped boost wireless subscriber growth.

The news sent AT&T shares up 2.5% in premarket trading, even as some analysts worried that the company’s dependence on the iPhone for much of its growth raised concerns about what would happen if it lost its exclusive rights to sell the phone in the U.S.

AT&T added 1.4 million net subscribers in the second quarter including 1.2 million retail monthly bill-paying customers. Six analysts surveyed by Reuters had, on average, expected 1.08 million subscriber additions.

The company activated more than 2.4 million iPhones in the quarter and more than a third of these were new customers.

Commresearch analyst Gregory Lundberg estimated that excluding iPhone, 25% fewer people signed up for AT&T’s service in the second quarter compared with the first quarter.

"Some of that’s seasonal, some of it is the market, but it really puts a magnifying glass on the risk of using the iPhone exclusivity," Lundberg said payday loan lenders.

Profit was $3.2 billion, or 54 cents per share, compared with $3.77 billion, or 63 cents per share, in the same quarter a year ago. This beat the average analyst estimate for earnings of 51 cents per share, according to Reuters Estimates.

Revenue fell 0.45% to $30.73 billion, and compared with the average analyst expectation for $30.64 billion.

AT&T said the June 19 launch date of the latest iPhone 3GS was the best sales day ever for AT&T retail stores and its online store.

It said that increased operating expenses reflected costs related to the success of the launch of iPhone 3GS, which AT&T heavily subsidizes.

AT&T (ATT) shares were up 19 cents at $26.09 in active trading. 

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A Chrysler Group executive, testifying before a Congressional committee hearing on Chrysler and General Motors’ auto dealership cuts, warned that being forced to reinstate dealers could force Chrysler out of business.

The House of Representatives recently passed a bill that would require GM and Chrysler to reinstate the contracts of dealers that were recently dropped as part of their separate bankruptcy proceedings.

Louann Van Der Wiele, Chrysler Group general counsel, testified Tuesday before a sub-committee of the House Judiciary Committee. She warned that forcing Chrysler to reinstate the 789 dealer contracts it had left behind in bankruptcy court earlier this year would force "new" Chrysler into bankruptcy again. This time with no buyer to bail the company out.

"Complete liquidation, with all of its dire consequences, could follow," she said, according to a transcript of her testimony.

Auto dealerships are separate businesses from auto manufacturers. Both GM and Chrysler have argued that having too many dealerships has hurt profitability by spreading sales too thinly and forcing dealers to compete with one another.

Chrysler announced in May that it was cutting off business ties with 789 dealerships, or about a quarter of its dealer network online life insurance quotes. According to Chrysler, the dealers being cut off accounted for only a fraction of the automaker’s actual sales.

Later, GM announced that it was severing ties to 1,100 of its 6,000 dealers.

While both GM and Chrysler have been working for years to trim their dealer networks, it’s usually a process that requires individual negotiation with each dealership and often hefty buy-out fees to end a contract. That’s because dealers are usually protected by strong state franchise laws.

Bankruptcy court allowed both GM and Chrysler to avoid those negotiations. The new companies that took over the Chrysler and GM names and businesses simply declined to purchase the unwanted dealer contracts as part of the new company’s assets.

A bill similar to the one the House passed faces stronger opposition in the Senate where Majority Leader Harry Reid said earlier this week the measure is not a priority.

President Obama has also voiced opposition to the bill, saying it would derail the administration’s hard work to save GM and Chrysler. 

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The top cop tracking the $700 billion bailout program said Monday that he’s concerned federal officials are ignoring his proposals for preventing tax dollars from being wasted or pilfered.

Neil Barofsky, the special inspector general overseeing the Troubled Asset Relief Program, released a 260-page report detailing a long list of concerns about government efforts to prop up hundreds of banks, Wall Street firms and auto companies.

The report criticizes the Treasury Department the most for its unwillingness to adopt some of his recommendations.

Barofsky cites two examples: He wants Treasury to force bailout recipients to keep track of how exactly they are spending TARP funds. He also wants officials to erect a "firewall" to prevent private investment managers — the kind hired to manage and invest taxpayer dollars — from taking advantage of insider knowledge.

"Although Treasury has taken some steps towards improving transparency in TARP programs, it has repeatedly failed to adopt recommendations that SIGTARP believes are essential to providing basic transparency and fulfill Treasury’s stated commitment to implement TARP ‘with the highest degree of accountability and transparency possible,’ " the report stated.

Barofsky is set to testify about the report Tuesday morning before a House Oversight panel.

The special IG’s office, which was established as part of the TARP program enacted last fall, has also launched 35 criminal and civil investigations into a range of allegations from accounting and securities fraud to insider trading and public corruption, the report said.

Some of Barofsky’s investigations have already led to criminal and civil charges against those accused of fraudulently benefiting from the government’s bailout program.

Risk in the trillions?

Some lawmakers are already squealing about one figure in Barofsky’s report, which assigns an eye-popping value of $23.7 trillion as the sum total of dozens of federal programs supporting companies, industries and consumers affected by the economic meltdown.

"Any assessment of the effectiveness or the cost of TARP should be made in the context of these broader efforts," Barofsky is expected to say to the House panel, according to testimony acquired by CNNMoney.com.

The $23.7 trillion number is a "staggering figure," said Rep. Darrell Issa, R-Calif., the ranking minority member of the House Oversight panel.

Yet, the aggregate figure contains programs that the government is no longer on the hook for. For example, it includes $12.9 billion bridge loan to JPMorgan Chase to buy failed investment bank Bear Stearns in March 2008 — that loan was repaid in full with taxpayers making $4 million in interest.

The aggregate figure also includes bank debt backed by the Federal Deposit Insurance Corp. Taxpayers are on the hook if the banks can’t make good on the debt, but so far taxpayers haven’t lost a dime and have in fact made billions in fees paid to the program, said industry analyst Jaret Seiberg, who generally supports transparency and disclosure of risk.

"You can start raising questions about lots of different components, but that’s throwing lighter fluid on an already politically-charged fight to produce nothing of substance," said Seiberg of Concept Capital’s Washington Research Group fast cash.

A Treasury official on Monday called the $23.7 trillion figure "inflated," saying it ignores fees and interest that regulators collect to compensate taxpayers for taking on risk. The official added that Barofsky’s estimate doesn’t take into account assets the federal government now owns that "offset the risk" in these programs.

"While quantity and quality of the assets backing all of these programs vary, ignoring that side of these programs misrepresents ‘potential exposure’ associated with them," the official said.

Ignoring recommendations

The report primarily focuses on pressing regulators to adopt suggestions Barofsky has made in previous reports, including asking all bailout recipients to account for their actual use of TARP funds.

Barofsky said he surveyed hundreds of TARP banks several months ago and all of them responded, saying they tended to use their bailout money to lend and to shore up their balance sheets. However, Treasury does not require banks to provide detailed and public reports on how they use the bailout dollars.

The report also pushes for a stronger conflicts walls inside firms that have been hired to pair private dollars with public investments to buy troubled securities from banks in so-called Public-Private Investment Funds.

The government recently announced that it has chosen nine firms to manage the public-private funds. The firms have 12 weeks to raise $500 million each from private investors willing to invest in toxic securities held by banks. Those investments will be matched by the Treasury and supplemented with debt financing from the agency.

Barofsky warns that allowing fund managers to work with taxpayer dollars while also serving other clients could tempt managers to use insider information to benefit other clients.

"The reputational risk that Treasury and the program could face if a PPIF manager should generate massive profits in its non-PPIF funds as a result of an unfair advantage … justifies the imposition of a wall," the report states.

Treasury officials, in correspondence that Barofsky includes in his report, say they believe they have put enough protections in place to prevent conflicts of interest. They feared that requiring such a wall would deter fund managers from partaking in the program and would also prevent government from getting access to firms’ "A-team."

"While using a segregated team to manage the PPIF might reduce the possibility that non-PPIF investors could benefit at the expense of taxpayers, Treasury concluded that such an arrangement is simply not practicable," wrote Herbert Allison, the assistant secretary for financial stability.

The report makes clear that Barofsky’s work is just beginning. He plans to release future reports on how bailed-out companies are complying with executive pay caps, whether outside parties influenced regulators in their bailout decisions and the process by which the first nine bailouts were bestowed — with a focus on Bank of America (BAC, Fortune 500). 

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Initial construction of U.S. homes and applications for building permits both surged in June, according to government figures released Friday.

Housing starts rose to a seasonally adjusted annual rate of 582,000, up 3.6% from a revised 562,000 in May, according to the Commerce Department.

Economists were expecting housing starts to increase to an annual rate of 524,000 units, according to a consensus estimate gathered by Briefing.com.

Single-family housing starts were especially strong, up 14.4% on a month-over-month basis. It was the biggest surge in that measure, considered the core of the housing market, since December 2004.

Friday’s report suggests that the battered housing market is gradually stabilizing, according to Mike Larson, real estate and interest rate analyst at Weiss Research.

"The new home industry has done a good job of reducing supply," Larson wrote in a research report. "But the existing home market is still vastly oversupplied, and we continue to be inundated with an influx of distressed and foreclosed properties car insurance quotes."

Applications for building permits, an indicator of future construction activity, rose 8.7% to a seasonally adjusted annual rate of 563,000 in June. It was the highest number of applications since December and more than the 530,000 annual rate that economists had forecast.

June marks the second month that starts have increased after the annual rate of new homes breaking ground fell to an all-time low of 454,000 units in April.

New home construction activity was strongest in the Midwest, where starts were up by 33.3% versus the previous month. In the Northeast, starts jumped 28.6% in June.

But the West and the South both saw declines in the number of new homes breaking ground last month. Starts were down 14.8% in the West and 1.4% in the South.  

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Dealers who have been muscled out at Chrysler Group and General Motors are trying to get Congress to force the automakers to take them back.

The push by the dealers to reverse the cuts has garnered strong bipartisan support, especially from powerful Democratic leaders Financial Service Committee Chairman Barney Frank and House Majority Leader Steny Hoyer.

The measure, which restores franchise rights that were stripped out as part of the bankruptcy process, was attached as an amendment to an appropriations bill to fund a variety of federal regulators, including the Securities and Exchange Commission. It is expected to easily pass the House Thursday.

It faces more opposition in the Senate, where Senate Majority Leader Harry Reid said earlier this week the measure is not a priority and that he was satisfied with the decision to have the automakers use bankruptcy to shed dealers.

"When you have a bankruptcy, there are winners and losers. That’s what happened. And there were some losers. It’s unfortunate, but that’s the way the bankruptcy courts operate," he said.

But Reid’s spokesperson backed away from those comments Thursday, saying that the majority leader was speaking off the cuff.

Even some of the measure’s supporters acknowledge that many of the dealers being cut are unlikely to stay in business for much longer or restart their businesses.

The Chrysler Group dealers cut during the bankruptcy process were forced to stop selling Chrysler, Dodge and Jeeps in June while virtually all GM dealers being cut lose will be phased out by between January and September 2010.

"I think a number of them can be reopened, but it’s not the goal of them to have them all reopen," said Rep. Rep. Steven LaTourette, the Ohio Republican who inserted the dealer language into the appropriations bill.

But if the franchise rights are restored, the automakers would have to spend millions of dollars to buyout the dealerships it wants to cut. When GM dropped the Oldsmobile brand at the start of the decade, for example, it spent about $1 billion to do so — most of it in payments to dealerships.

Dealers and their supporters argue that larger dealership networks do not cost the automakers any money, and that it can actually increase their sales. They say it is unfair for state franchise laws, which protected their investment in the dealerships, to be thrown out in the bankruptcy process.

They also argue that at a time of rising job losses, it doesn’t make sense to force dealerships to close, throwing more people out of work. The average dealership has about 50 employees, meaning the closing of 2,000 dealership could cost more than 100,000 jobs nationwide.

The dealers are well positioned to fight the battle in Congress. They are found in each congressional district, and many are successful business owners that have been supporting members of Congress since they first ran for for local elected office. Their influence in the Senate is generally acknowledged to be somewhat less than in the House, though payday loans guaranteed no fax.

The automakers and most auto industry experts argue that GM and Chrysler were hurt by a bloated dealership network that is a remnant of years gone by when they both had a much larger share of U.S. vehicle sales.

They say cutting the dealerships allows the surviving dealers to sell and service more vehicles, making them more profitable in a way that allows them to spend money on the advertising and their facilities needed to attract sales.

"If this legislation is enacted, it would put our viability at serious risk," said Greg Martin, spokesman for GM’s Washington office. "Having the right number of dealers in the right location is essential to our ability to compete."

The Obama administration, which pushed the automakers to make even deeper cuts in dealer networks than they originally proposed, is fighting the dealers’ efforts in Congress.

"The decision to invest taxpayer dollars into these companies required all stakeholders to make difficult sacrifices, and it would set a dangerous precedent, potentially raising legal concerns, to intervene into a closed Judicial bankruptcy proceeding on behalf of one particular group at this point," the administration said in a statement Wednesday.

The two automakers are also doing what they can to fight the dealers’ efforts in Congress.

GM CEO Fritz Henderson was on a conference call with the Michigan delegation Wednesday evening, during which he was pushed by some of the company’s greatest defenders in Congress to reach a deal with dealers to try to make them drop the legislative effort.

Some of the leading proponents of the measure in Congress say they also hope that the automakers can come up with a compromise solution to satisfy dealers and make the legislation unnecessary.

"Legislation is a hammer. I would prefer not to use a hammer," said LaTourette. "I’d rather use a scalpel. Let [the automakers] come in and work this thing out."

But a spokesman for the National Automobile Dealers Association said his group, which flooded Capitol Hill with more than 200 dealers visiting members of Congress earlier this week, said his group is committed to passing some form of the legislation to restore their rights.

"We are not interested in making a deal," said NADA’s Bailey Wood. "There is an immense amount of support and it is growing on a daily basis. There is absolutely no reason we need to make a deal."

Even if the language is stripped out of the appropriation bill when it goes to the Senate, a stand-alone version of the bill has been co-sponsored by more than half of the House members and 24 senators so far. NADA is pushing to bring more than two-thirds of the House on as co-sponsors to prove they have the votes to override a veto. 

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China looks set to hit its full-year growth target of 8% after a surprisingly strong second quarter notable for a surge in investment driven by powerful fiscal and monetary stimulus.

Annual gross domestic product growth accelerated in the second quarter to 7.9% from 6.1% in the first quarter, making China the best-performing major economy and reinforcing hopes that the world economy is pulling out of its deepest recession in 80 years.

Economists had forecast 7.5% growth, and several promptly responded to Thursday’s figures by raising their projections for this year and next.

"We see clear upside risks to our current GDP growth forecast of 8.3% for 2009," said Yu Song and Helen Qiao at Goldman Sachs. They said the second quarter’s 7.9% growth translated into a 16.5% pace compared with the first quarter when expressed as a seasonally adjusted annualized rate.

A string of accompanying data for June from the National Bureau of Statistics depicted an economy successfully making up for a slump in exports through domestic demand, especially capital spending, generated by a 4 trillion yuan ($585 billion) pump-priming package and record bank lending.

"It’s very encouraging: the 8% growth target is in sight," said Daniel Soh, an economist at Forecast in Singapore.

"It’s by now clear that the fiscal stimulus package has offset the contraction in export activity."

Tokyo shares hit a one-week high and shares elsewhere in Asia powered to their highest level in a month as the Chinese data buoyed hopes for a global recovery.

Investment surges: Factory output growth quickened to 10.7% in the year to date as of June, beating forecasts, from May’s 8.9% reading, while investment in fixed assets in urban areas grew 33.6% in the first half, up from 32.9% in the first five months.

"Investment growth will accelerate in the third quarter and become even faster in the last quarter of this year," said Hao Daming, a senior economist at Galaxy Securities in Beijing.

"The recovery is confirmed. The bottom was the fourth quarter last year," he said.

Li Xiaochao, a spokesman for the statistics office, said the data had laid a foundation for hitting the 2009 growth target, the minimum deemed necessary to hold down unemployment.

"Our economy is continuing to turn for the better, and there are more and more positive factors," Li told a news conference.

"We see more people shopping and prices beginning to rise. The economy is recovering and the recovery is intensifying payday loan. All the government’s policies have worked together to help us overcome the financial crisis," he said.

Li singled out strength in China’s car and property markets.

Retail sales, a proxy for consumption, rose 15% in June from a year earlier after May’s 15.2% increase.

But, in a signal that the government is not ready to wind back its pump-priming, Li said the recovery was not yet on a solid footing and the economy was growing below potential.

He said prices were still falling, overall demand was weak, some industries faced overcapacity; and the industry use rate was low.

"The recovery is not fully balanced, so there are some regions that have not done as well as others," Li said.

The lopsided nature of the economy was evident in a breakdown of the first-half GDP growth rate of 7.1%.

Investment accounted for a whopping 6.2 percentage points of overall growth, showing the emphasis on building roads, railways and other infrastructure in the government’s stimulus package.

Consumption contributed a positive 3.8 percentage points to GDP, but net exports subtracted 2.9 points — a reflection of the slump in demand for Chinese goods triggered by the global crisis.

Central bank vigilant: A few months ago, in the depths of the global recession, the strong growth reported on Thursday appeared fanciful to many.

Now, the central bank, nervous about the record pace of bank lending, has begun to tap gently on the monetary brakes, selling more of its paper to absorb excess cash in the banking system and nudging up money market rates.

Economists believe the political imperative of securing a copper-bottomed recovery is so great that the central bank will not run the risk of aggressively tightening policy any time soon.

Still, economists expect more "fine-tuning" of money market rates as well as sterner guidance to banks not to lend so much. Some are even talking about when interest rates might have to rise.

Tim Condon, head of Asia research at ING in Singapore, who raised his 2009 growth forecast to 8.3% from 7.5%, said he thought borrowing costs could now rise as soon as the first quarter of next year.

"The consensus is probably later than that," Condon said. "The consensus is that China can keep this very loose policy for a very long time." 

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U.S. producer prices jumped by twice as much as expected in June on a big rise in energy prices, a government report showed Tuesday.

The Producer Price Index, which measures prices received by farms, factories and refineries, increased by 1.8%, the steepest gain since November 2007, the Labor Department said.

Core prices, which strip out volatile food and energy costs, rose a much greater-than-expected 0.5%, boosted by car and truck sales.

Analysts polled by Reuters were expecting a 0.9 % rise in overall producer prices and a 0.1% increase in the core PPI health insurance companies.

Energy prices rose by 6.6% as gasoline costs surged 18.5 %. Both were the biggest rises since November 2007.

Light truck prices rose 3.4%, the largest gain since November 2006, while passenger car prices increased 2%, the steepest rise since September of that year.

Compared with the same period last year, however, producer prices fell 4.6%. 

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As if struggling to stay afloat during a faltering economy isn’t difficult enough, hundreds of small business vendors that rely on contracts with California are facing another hurdle: There’s a good chance the state won’t be paying any of their invoices this month.

After the state legislature failed to agree on budget solutions earlier this month to close a $26 billion gap, California started issuing IOUs for a variety of payments it owes — including most of its vendor bills, personal income tax refunds, and funding for local governments. "This means that the state is casting off its cash-flow problems onto hundreds of families and small businesses in California," says Jacob Roper, a spokesman for the state controller’s office.

So far, California has mailed $354 million worth of IOUs and plans to issue a total of $3 billion by the end of July. Around $140 million of the warrants are expected go to small business owners. While the state controller’s office won’t say exactly how many small companies will be hit, it’s likely to be a big number: The state’s department of general services says it holds $2.7 billion worth of annual contracts with at least 14,000 small companies, most of them California firms.

Affected business owners say they’re in uncharted territory.

"We’ve never seen this before — never had anything happen where we didn’t get money from the state," says Gary Button, vice president of Redwood Debris Box Service in Burlingame, Calif., a firm that provides garbage and recycling containers for the state’s department of transportation. State work only accounts for about 3% of Redwood Debris’ business, but Button is expecting an IOU any day, which he says he will hold on to until it matures.

"I’m not going to cash it in for less than it’s worth," says Button.

The state plans to redeem the IOUs, with a 3.75% annual interest rate, on October 2, or earlier if a budget deal is signed. But many small firms — especially those that do the majority of their business with California — can’t wait that long.

"We’ve already been delayed by six months in payment from the state — and now we’re expecting one of those IOUs," says Gloria Freeman, owner of Staff USA, a firm in Rocklin, Calif. Contracts with the state account for 80% of her firm’s annual revenue. "The real problem is not knowing how long it will take them to resolve this issue."

Staff USA provides medical staffing for various state-run divisions, and Freeman says that California owes her hundreds of thousands of dollars, much of that for services she rendered early this year. In anticipation of receiving an IOU instead of money, Freeman has laid off five employees. Searching for a new cash stream, she recently launched a new online auction business, Auction Ten, that helps consignors sell antiques and collectibles.

While she hopes that Auction Ten sales will help supplement her income, Freeman has found another use for the site. "I’ll be auctioning off IOUs for people who don’t want or can’t redeem them via the bank," she says.

Most small businesses hope to cash in their IOUs at a bank, a process that’s turning out to be difficult. Initially, all major California banks said they would honor the IOUs by charging customers a small processing fee, paying out the face value, then taking over the interest. However, the state’s largest banks, including Bank of America (BAC, Fortune 500) and Wells Fargo (WFC, Fortune 500), later imposed a deadline. They stopped accepting the IOUs on Saturday.

That’s a big problem for small vendors who had no hope of making the deadline because they haven’t yet received the warrants they’re owed fast cash online. The state controller’s office says there’s no pecking order for issuing them; the state pays them out as bills come due.

By enforcing a deadline, the big banks hope to pressure California to make progress fast. "The message that they’re sending is that the budget needs to be solved sooner rather than later," says Beth Mills, a spokeswoman for the California Bankers Association. "These banks don’t want to be seen as enabling the Legislature."

Redemption options

A number of California’s community banks and credit unions plan to accept the IOUs indefinitely, but in many cases, the terms are tough.

"My community bank will redeem the IOU for a fee, but I have no choice but to do it," says the owner of an 11-person firm who asked not to be named. "It’s not worth my while to wait for this thing to mature. I’d be losing money." His company, which does $10 million in annual business with the state, has been providing goods to prisons, state hospitals, and schools for more than 20 years. This is the first time he’s been confronted with an IOU.

"If this situation continues to force us to take losses, I’ll have to look into furloughing employees and laying some off," he says. Even before the latest crisis, California was firing off distress flares: Last month, he received a letter from the state asking if he would consider voluntarily reducing his company’s charges by 15%.

The California Credit Union League reports that most of its member unions are willing to honor the IOUs, but at many branches, new clients would have to open an account to be able to cash in the warrant. The unions say they’re offering as much flexibility as they can: Some are considering modifying the terms of loans they’re made to small businesses affected by the IOU situation.

"We’re a little different from banks," says Jim Ott, CEO of UNCLE Credit Union, a mid-size union based in Livermore, Calif. "We want to be able to help our members."

As a last resort, cash-strapped companies may be able to redeem the IOUs at check-cashing storefronts or via online marketplaces such as Craigslist or eBay (EBAY, Fortune 500), but small business advisors warn against that because of the large fees and face-value discounts that would be incurred.

"I would automatically find a bank that will redeem the IOU for 100 cents on the dollar rather than taking a haircut by going to a check-cashing facility," says Donna Childs, a business consultant and author of Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses. While businesses selling the IOUs might be able to haggle and receive close to face value, the California State Treasurer’s office has mandated that the transactions must be accompanied by a notarized bill of sale signed by the payee whose name appears on the IOU.

For vendors that need cash sooner rather than later, losing a few bucks due to exchange fees might be the least of their worries. If California doesn’t resolve its budget crisis soon, many more small companies will end up caught in the political crossfire.

"The level of rhetoric between the governor and the legislature has been very high," says Peter Iannone, a director at the Los Angeles office of CBIZ MHM, a national accounting firm that consults for many small businesses. "So far I haven’t seen a lot of indication that they know how to figure this out." 

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