Understanding Recession

by Michael S. Rozeff

In a recent short article, I explained that capital flees from government’s taxes and regulation. The other side of the coin is that capital is attracted by government’s subsidies.

The attraction of capital to activities that are being subsidized diverts production and employment into activities where they would not otherwise have gone had people been left free to decide the allocation of capital. This redirection of capital invariably lowers social welfare.

Examples abound because subsidies take many, many forms. The government subsidizes leisure and penalizes work using welfare and unemployment benefits. (Human capital is attracted into these programs.) It subsidizes visits to doctors and hospitals with Medicare and Medicaid programs. It subsidizes alternative fuels, space flights, and the production of weapons of mass destruction, thereby attracting human and physical capital into the associated industries. It subsidizes wars, attracting human and physical capital into destructive activities. The list goes on and on because government is big, and government’s main tool of social control is the subsidy.

Government subsidizes not only the production of certain items but also their financing. It shoots with a double-barreled shotgun. Government subsidizes loans. It often sees to it that there are low-interest loans available for selected activities such as making autos, attending college, agriculture, home buying, and so on. The list is very long.

The Federal Reserve, which is an arm of government, subsidizes the banking system. When the Fed buys bonds (or anything else), it provides banks with reserves that cost them nothing but which provide them the capability of making loans at interest. The system subsidizes bank lending and thus credit creation across the nation. This undermines other ways and means of channeling capital to borrowers, including capital markets.

Any government subsidy not only lowers social welfare but also creates production and financing imbalances. For this reason, every subsidy carries within it the seed of dislocations and unemployment. When subsidies ebb or are removed, the capital that has been unduly attracted to the subsidized activity must seek employment elsewhere. While the eventual result is healthy, the temporary transitional phase is often painful. If the subsidy for student loans is reduced, colleges and universities will experience a recession in demand. Some students will enter the job market. Some will borrow or obtain gifts from parents, who will then cut back on other purchases. The entire economy may not be noticeably affected, however. There will be no official "recession," but a partial recession in the education industry will have occurred.

A recession, as usually thought of, is a period of reduced business activity and higher unemployment that is widespread over the entire economy. One cause is the cessation or change in a subsidy or set of subsidies that have grown large enough to affect many parts of the economy. Recessions are temporary. If left alone, the capital, human and physical, moves toward other employment, and the recession disappears. Prolonged recessions are enabled and encouraged by government attempts to shorten them. They are prolonged when government restrictions of many kinds slow down and prevent labor mobility, discourage entrepreneurs from starting new businesses, prevent the unemployed from easily starting up new ventures, and prevent them from working at non-union jobs. Numerous business firms would hire more labor were it not for restrictions that they face that begin with the minimum wage and cover a vast range of other measures that act as taxes on their expansion.

If the recession is treated with more of the same government medicine, then any number of bad results can and will occur. If, for example, there are 2 million unemployed and government puts them to work building roads, social welfare will decline. Capital will be drawn from higher-valued uses into uses that society was not choosing. There will be too many roads, and not enough electricians or truck drivers or whatever other occupations would eventually be filled by the unemployed. The skills the unemployed learn will not be of as much value to them when the road building ceases as it would if they had spent the time in other jobs.

Another way to understand recessions is to begin with how production and employment work in a free market. Murray Rothbard gives a sound and clear explanation of production and the pricing of factors of production in Man, Economy, and State. The following is my simplified version of the process he explains there. Suppose we consider a single industry and good, which is the manufacture of pearls. These steps suggest how the industry reaches a free market equilibrium.

1. The potential pearl consumers are willing to pay particular prices for particular quantities of pearls. These are unobservable.
2. The pearl producers estimate what the consumers are willing to pay and how many pearls they will buy. They do not know these magnitudes for sure, but they have data from the past and other ways of predicting the future sales.
3. The pearl producers hire (or rent) factors (land, labor, capital) to produce the pearls. They compete with producers of all sorts of other goods in hiring these factors. The production takes time, during which the land, labor, and capital have to be paid rental fees.
4. In steps 2 and 3, the producers will pay for factors no more than what they think they can sell the pearls for to the pearl consumers. Since all producers of all products are doing the same, an economy-wide factor price and quantity demanded of the factors are established in the factor markets.
5. The factor price and quantity demanded (demands derived from estimates of what consumers demand of pearls) are such that the discounted marginal value products (DMVP) of the factors across various products tend to be equated. This equilibrizing occurs because if the DMVP in emerald production exceeds that in pearls, there is an incentive to shift production into emeralds and out of pearls. Discounting is in the calculation only because it takes time before the product is sold to consumers and payment received; discounting is a present value calculation that takes into account the time value of money. The marginal value product refers to the worth of what a factor produces at the margin (when one additional unit of product is produced).
6. The sum of factor prices paid to produce pearls (called the factor costs) tend to equate to the price that consumers pay for pearls. This is a second equilibrizing tendency. If this were not so, there would be an incentive either to produce fewer or to produce more pearls. If factor costs exceeded the price consumers pay, the business would be losing money and cut production back.
7. In step 6, costs come to equal price. This is not because costs determine price. It is because price determines costs that can be paid to produce at that price.
8. Capital gets paid the rate of interest in this process. It gets paid for "time," that is, deferring consumption and extending resources for the time it takes to produce the product.
9. The remaining price that is paid (beyond paying interest on capital) is paid for labor and land factors.

The labor theory of value does not describe the equilibration. All costs are not reducible to labor costs. There are land costs and also time (capital) costs. Labor costs roughly account for 50–70% of all revenues of all producers in modern economies.

From the point of view of this model, recessions are economy-wide events in which production in many markets is discovered to have gone into products that find no ready markets at the prices that entrepreneurs had estimated would be paid. The mix of goods produced and/or their amounts do not match what consumers are willing to or able to buy at the pre-production estimated prices (steps 1 and 2 above). Unemployment of several kinds is one result. Unemployed goods (seen as excess inventories) appear. Prices drop so that these can be sold. This reduces business income. If the government has subsidized roadbuilding by drawing resources from society, and if society wants ice cream rather than roads, the ice cream manufacturers will discover that the purchasing power to buy the ice cream they have produced is lacking. If the government has printed money to pay the roadbuilders, then prices will rise and the rest of society will find that they do not have enough purchasing power to pay for all the goods that other manufacturers have produced.

The reduced business earnings, once they are seen or foreseen by stock traders, cause stock prices to decline. The longer and deeper the expected decline in earnings, the greater the stock price decline, all else equal. The recession raises both business risk and uncertainty. Investors demand a higher premium for investing in securities. That too reduces stock prices. At a lower scale of operations, operating leverage rises as fixed costs loom larger. Uncertainty rises because of the added uncertainties involved in the economy reaching a new equilibrium with a changed product mix and changed production. Producers do not know how long the adjustments will take or what their effects will be.

Unemployment of labor occurs as workers are laid off. It takes time for them to shift to industries that are demanding labor. Businesses take time discovering what lines of business may be profitable to pursue. They have unemployed capital goods on their hands. They take time changing over or adding to different lines of production that employ different kinds or mixes of capital goods.

The labor unemployment lasts for a while. Under ordinary circumstances, it dissipates by itself as businesses discover products that consumers will buy and then hire workers to produce those products. There is nothing that government can do to alleviate the process except to remove whatever prior interferences it had instituted that influenced the markets. If it provides unemployment insurance, it slows the transition to new employment. If it increases deficit spending, it withdraws capital from the private sector and slows the recovery. If it pumps up the money supply, it can reduce unemployment but at the cost of distorting production, adding fuel to another eventual recession, and diverting labor into jobs and production that have low social value.

Shifts from one line of business to another that are caused by shifts in consumer demand occur continually in market economies. They do not cause recessions unless the economy is undiversified and focused narrowly on only a few kinds of goods. A recession is something that affects many industries simultaneously. Its cause cannot be a shift away from cigarettes to cigars, or from bicycles to automobiles. It has to have a source that affects many industries at once. Something that distorts the relative prices (or costs) of the basic factors will do the trick (see steps 3–6 above). Something that causes many businesses to make errors in forecasting prices and quantities will do it.

Correlated errors are a sign of a cause that affects the whole economy. One such source is a previous excess of credit introduced by the central bank and banking system through their ability to create money and credit. Money maintains value as long as there is sufficient backing behind it. An excess of money means money being created and circulated that lacks enough backing. A clear signal of this is that the money loses value relative to goods, or that the prices of goods rise. A less clear signal is that prices of goods do not decline when productivity improvements suggest they should. Either signal means inflation is occurring. The clearest signal of a prospective problem in the existing system is an excessive rise in credit issued by banks.

Credit creation by the central bank in conjunction with the banking system is not a free market process. The following description applies to central bank credit creation.

Many businesses finance their production processes (their rentals of land, labor, and capital (step 3)) by means of credit. With credit made more widely available (although its basis in money lacks sufficient backing), the cost of financing production falls. Businesses that were rationed out of the market prior to the central bank stimulus find that loanable funds are available to them. Businesses in general are induced to produce more product if they believe that their prospective profit margins are rising. They believe this because they observe that their cost of capital has declined.

This point is a great divide in economic theory. It is of critical importance for the Austrian trade cycle theory. The Misesian point, which is that the central bank’s money creation depresses the real rate of interest, is denied by economists who believe there is no money illusion. They believe that since the money creation is destined to raise prices, the rate of interest will immediately rise to reflect the anticipated price level increase. This is rational expectations applied to the money market. Irving Fisher, having studied the connection between prices and interest rates, did not believe this. Mises didn’t believe this. Like Fisher, he argued that money rates first fell and only rose when the actual price changes influenced expectations. Experimental evidence in support of Mises and for money illusion is provided here. Even when a person overcomes his own money illusion, he cannot predict what others persons will do, and therein lies the core of a persistent money illusion. The strongest argument presented by Mises is, I believe, the following, and it operates along similar lines:

"The price premium could counterpoise the effects of changes in the money relation upon the substantial importance and the economic significance of credit contracts only if its appearance were to precede the occurrence of the price changes generated by the alteration in the money relation. It would have to be the result of a reasoning by virtue of which the actors try to compute in advance the date and the extent of such price changes with regard to all commodities and services which directly or indirectly count for their own state of satisfaction. However, such computations cannot be established because their performance would require a perfect knowledge of future conditions and valuations. The emergence of the price premium is not the product of an arithmetical operation which could provide reliable knowledge and eliminate the uncertainty concerning the future. It is the outcome of the promoters' understanding of the future and their calculations based on such an understanding. It comes into existence step by step as soon as first a few and then successively more and more actors become aware of the fact that the market is faced with cash-induced changes in the money relation and consequently with a trend oriented in a definite direction. Only when people begin to buy or to sell in order to take advantage of this trend, does the price premium come into existence."

A rational expectations theorist would argue that "people will learn," and then they will impound inflation expectations more rapidly into interest rates and negate the efficacy of the Fed’s policies. Perhaps they will learn to some extent in a context of repeated trials with unchanged conditions. But that does not characterize real-world economies and markets. They are forever changing. If there is central bank money creation, no one ever knows who will take down the money, when this will happen, what they will use it for, and how it will eventually affect prices. Furthermore, computation of a price level is extremely difficult. For this reason, interest rates can be driven down by a central bank’s money creation.

Given then that businesses expand under the stimulus of credit creation by the central bank and banking system, and let us remember that this is not a free market scenario, the effects of these expansion decisions across different industries are not uniform. Those firms that require and use relatively more credit benefit more from its lowered cost and greater availability. Firms that are more capital-intensive in production benefit more as well. These types of firms expand more.

Duration is a financial measure of the sensitivity of a good’s value to a change in capital cost. The values of assets and liabilities of long duration are more sensitive to credit costs than those of shorter duration. Thus, long-term bonds fluctuate more in value for a given interest rate change than short-term bonds. Long-lived capital goods fluctuate more in value than short-lived capital goods.

Since easier money and credit affect the values of the long-duration assets and claims relatively more, they benefit relatively more from the increased credit flows. More credit therefore flows into the long-duration assets and claims like airplanes, factories, land, houses, and stocks. The effects of all this across factor prices, product prices, assets, liabilities, and securities are complex. No two companies have exactly the same mix of short- and long-term assets and liabilities. The durations of the two sides of the balance sheet vary greatly across firms. The responses of managements are hard to predict. This complexity is again the reason why a rational expectations model will fail to capture the reality of the credit-induced business cycle.

Greater use of financial leverage accompanies the boom. More firms expect profits from investing in long-term assets since the prices of this class of assets rise the most. By financing them with the cheapest debt, which is short-term debt, the credit creation encourages a duration mis-match: borrowing short and lending (or buying) long. This practice violates the standard and conservative financing rule, which is to match the maturities (or durations) of loans with the maturities (or durations) of the assets they finance.

It suffices to say that the U.S. has had two credit booms in the last 13 years. The first was centered in technology and other stocks. That bull market ended in 2000. The second focused on housing and other real estate. That bull market ended in 2005 for housing, with effects on stocks and other securities extending to the present.

Each of these episodes is associated with central bank money creation followed by banking system credit creation. Each has been followed by recession when neither the price structure nor the credit structure could be sustained.

OPEC Plans Supply Cut as Crude Oil Heads Toward $50

-- OPEC, the supplier of more than 40 percent of the world's oil, plans to cut output for the first time in almost two years as the worst financial crisis since the 1930s sends crude toward $50 a barrel.

Options contracts to sell oil at $50 by December soared 50- fold in the past two weeks on the New York Mercantile Exchange. Goldman Sachs Group Inc. and Merrill Lynch & Co. analysts say crude, which fell more than 50 percent from a record high in July to a 14-month low last week, may drop another 44 percent should the world economy slip into a recession.

The Organization of Petroleum Exporting Countries, which meets Oct. 24 in Vienna, three weeks earlier than planned, is facing the weakest growth in demand since 1993 just as new fields come on line from Angola to the Gulf of Mexico. Members may cut daily output by as much as 2 million barrels, President Chakib Khelil said yesterday.

``OPEC is going to try to prevent some of the price decline,'' Francisco Blanch, head of global commodities research at Merrill in London, said in a Bloomberg television interview. ``It's going to be very difficult to stem a price fall.''

Options contracts that allow holders to sell 1,000 barrels of oil for $50 each by December traded for $500 on the Nymex on today, up from $10 on Oct. 3. Oil rose a second day today, gaining 2.4 percent to $73.60 a barrel at 10:53 a.m. in London.

Budget Pressures

Even at today's prices, Venezuela and Iran, two of the organization's 13 members, may struggle to balance budgets because they rely on energy sales for more than half of their revenue, according to estimates compiled by the U.S. Central Intelligence Agency.

``Some countries like Venezuela and Iran need prices above $80 a barrel,'' said Leo Drollas, deputy director of the Centre for Global Energy Studies, a London-based consulting company. ``The Saudis have a bottom price of about $65 a barrel, but they might go ahead with a cut to keep solidarity within OPEC.''

Gross domestic product in the six-member Gulf Cooperation Council of Saudi Arabia, United Arab Emirates, Kuwait, Oman, Qatar and Bahrain would shrink 25 percent if oil averaged $50 next year, ING Bank NV estimates.

Multiple Cuts

Ministers from Algeria, Libya, Iran and Venezuela already called for a reduction in supplies from the current quota of 28.8 million barrels a day. Khelil, also Algeria's oil minister, said that while there is consensus for a cut, there is no agreement on its size. It may be necessary to make the cuts in two stages to ensure price stability, he told Algerian state television yesterday.

OPEC is likely to cut by a million barrels a day on Oct. 24 and will need to announce further reductions to prevent prices falling below $60 a barrel, Goldman Sachs said on Oct. 17. Merrill Lynch analysts said the group may trim supplies by 2.4 million barrels a day over 12 months if economic conditions deteriorate.

Qatari Oil Minister Abdullah bin Hamad al-Attiyah told Al Jazeera TV the cut will likely be 1 million barrels a day, or 14 percent more than his nation pumps. Saudi Arabia, which dominates OPEC proceedings as the group's largest producer, has yet to comment on its intentions.

Attempts to support prices when the Standard & Poor's 500- Index is down 36 percent this year may sour relations between OPEC and its customers. Both U.S. presidential candidates, John McCain and Barack Obama, have called for greater energy independence to limit reliance on foreign oil.

U.K. Prime Minister Gordon Brown described potential supply cuts as ``absolutely scandalous'' on Oct. 17, Agence France- Presse reported.

Reducing Estimates

The world's industrialized economies will expand next year at the slowest pace since 1982, the International Monetary Fund said Oct. 8. Growth will weaken to 0.5 percent in 2009, from 1.5 percent this year, sending U.S. unemployment to its highest level in 16 years, the agency said.

While OPEC already agreed to curb production by observing output quotas after a Sept. 10 meeting to lower supplies by 500,000 barrels a day, members routinely pump more than their allocation, according to data compiled by Bloomberg. Since that session, Credit Suisse Group pared its forecast for oil next year by 32 percent to $75 a barrel. Deutsche Bank AG cut its 2009 assessment by 23 percent to $92.50 on Sept. 29. BNP Paribas SA lowered its outlook by 18 percent to $92.50 on Oct. 10.

Oil Stocks Plunge

At the same time, Exxon Mobil Corp.'s Saxi-Batuque fields off Angola's shore started pumping in August, while BP Plc's Thunder Horse field in the Gulf of Mexico is scheduled to increase supplies by the end of the year. World oil capacity will rise 1.45 million barrels a day in 2009, twice the rate of growth in demand, according to the International Energy Agency.

``Prices could fall as low as $50 a barrel during the fourth quarter if OPEC can't find a way to offset the financial meltdown,'' said Michael Lynch, president of Strategic Energy & Economic Research in Winchester, Massachusetts.

The prospect of OPEC cuts, slowing economic growth and falling prices drove the Dow Jones Europe Stoxx Oil & Gas Index down 25 percent in the past five weeks. Irving, Texas-based Exxon Mobil, the world's biggest oil company, fell 37 percent this year, while The Hague-based Royal Dutch Shell Plc, the second-biggest, lost 33 percent.

Falling Demand

OPEC lowered its forecast for demand in 2009 last week, saying consumption will be 450,000 barrels a day less than expected at 87.21 million a day. The Paris-based International Energy Agency shaved its 2009 outlook the previous week and said this year's demand growth of 0.5 percent will be the weakest since 1993.

U.S. motorists are driving less after gasoline pump prices topped $4 a gallon in July. Vehicle-miles traveled on all U.S. roads that month were 3.7 percent lower than a year earlier, Federal Highway Administration data show. Prices fell to an average of $3.21 a gallon last week, according to the Department of Energy.

As demand declined, OPEC trimmed supplies 3.8 percent to 31.8 million barrels a day in September, according to Geneva- based tanker-tracking service PetroLogistics Ltd. Saudi Arabia's volume fell 520,000 barrels a day to 9.18 million, PetroLogistics said.

``This may be OPEC's toughest balancing act in their history,'' said Tetsu Emori, the fund manager at Astmax Co. in Tokyo, Japan's biggest commodities asset manager with $200 million under management. ``By the time OPEC announces a cut, they would be hoping to have seen the bottom of the price.''

The last time OPEC slashed quotas was at a December 2006 meeting in Abuja, Nigeria. That 500,000 barrel-a-day cut took effect in February 2007 and followed an earlier, 1.2 million- barrel reduction in October 2006. Those actions were reversed later in 2007 as prices rallied.

``The situation has gotten dire enough that they're willing to move and even become a topic of conversation'' during the U.S. election campaign, Ronald Smith, chief strategist at Alfa Bank in Moscow, said in a Bloomberg television interview. OPEC will cut by 1 million barrels a day ``at the very minimum'' and potentially ``wait until after the election, then add another million on top of it, or half a million,'' he said.

Get Ready for the New New Deal

Obama is much more dangerous to economic freedom than FDR.

PAUL H. RUBIN

In 1932, Democrat Franklin Delano Roosevelt was elected president as the nation was heading into a severe recession. The stock market had crashed in 1929, the world's economy was slowing down, and all economic indicators in the U.S. showed signs of trouble.

The new president's response was to restructure the economy with the New Deal -- an expansion of the role of government once unimaginable in America. We now know that FDR's policies likely prolonged the Great Depression because the economy never fully recovered in the 1930s, and actually got worse in the latter half of the decade. And we know that FDR got away with it (winning election four times) by blaming his predecessor, Herbert Hoover, for crashing the economy in the first place.

Today, the U.S. is in better shape than in 1932. But it faces similar circumstances. The stock market has been in a tail spin, credit markets have locked up, and a surging Democratic presidential candidate is running on expanding the role of government, laying the blame for the economic turmoil on the current occupant of the White House and his party's economic policies.

Barack Obama is one of the most liberal members of the Senate. His reaction to the financial crisis is to blame deregulation. He even leverages fear of deregulation onto other issues. For example, Sen. John McCain wants to allow consumers to buy health insurance across state lines. Mr. Obama likens this to the financial deregulation that he alleges got us into the current mess.

But a President Obama would also enjoy large Democratic majorities in Congress. His party might even win a 60-seat, filibuster-proof majority in the Senate, giving him more power than any president has had in decades to push a liberal agenda. And given the opportunity, Mr. Obama will likely radically increase government interference in the economy.

Until now, this election has been fought on the margins, over marginal issues. But it is important to understand how much a presidential candidate wants to move the needle on taxes, trade and other issues. Usually there isn't a chance for wholesale change. Now, however, it appears that this election will make more than a marginal difference. It might fundamentally change America.

Unlike FDR, Mr. Obama will not have to create the mechanisms government uses to interfere with the economy before imposing his policies. FDR had to get the Supreme Court to overturn a century's worth of precedents limiting the power of government before he could use the Constitution's commerce clause, among other things, to increase government control of the economy. Mr. Obama will have no such problem.

FDR also had to create agencies to implement regulations. Today, the Securities and Exchange Commission and the National Labor Relations Board (both created in the 1930s) as well as the Environmental Protection Agency and others created later are in place. Increasing their power will be easier than creating them from scratch.

Even before the current crisis, there was a great demand for increased government regulation to limit global warming. That gives the next president a ready-made box in which to place more regulation, and a legion of supports eager for it.

But if the coming wave of new regulation from an Obama administration is harmful to the economy, Mr. Obama will take a page from FDR's playbook. He'll blame Republicans for having caused the market crash in the first place, and so escape blame for the consequences of his policies. It worked for FDR and, so far in this campaign, blaming Republicans and George W. Bush has worked for Mr. Obama.

Democrats draw their political power from trial lawyers, unions, government bureaucrats, environmentalists, and, perhaps, my liberal colleagues in academia. All of these voting blocs seem to favor a larger, more intrusive government. If things proceed as they now appear likely to, we can expect major changes in policies that benefit these groups.

If those of us who favor free markets for the freedom and prosperity they bring are right, the political system may soon put our economy on track for a catastrophe.

Mr. Rubin is a professor of economics and law at Emory University. He held several senior economic positions in the Reagan administration, and is an unpaid adviser to the McCain campaign.

A survey of the world economy: When fortune frowned

U.S. Stocks Drop on Earnings; Texas Instruments, Freeport Fall

Oct. 21 (Bloomberg) -- U.S. stocks slid as companies from Texas Instruments Inc. to Freeport-McMoRan Copper & Gold Inc. reported profit and revenue that failed to meet analysts' estimates.

Texas Instruments, the second-largest U.S. semiconductor maker, declined 6.3 percent, while Sun Microsystems Inc. retreated 17 percent after reporting a loss and posting revenue that fell short of consensus projections. Freeport-McMoRan, the largest publicly traded copper producer, slumped 11 percent. Western Union Co. tumbled 18 percent after the world's biggest money-transfer business withdrew long-term profit targets because of uncertain global markets.

``Investors are focusing on the weakening economy,'' said Doug Peta, a market strategist at J&W Seligman & Co. in New York, which manages about $15 billion. ``The third-quarter earnings season is going to be a rough stretch for the market because just about every company is going to provide fourth- quarter guidance that's muted at best.''

The Standard & Poor's 500 Index lost 30.35 points, or 3.1 percent, to 955.05. The Dow Jones Industrial Average tumbled 231.77, or 2.5 percent, to 9,033.66. The Nasdaq Composite Index decreased 73.35, or 4.1 percent, to 1,696.68. More than five stocks fell for each that rose on the New York Stock Exchange.

Rebound Halted

The decline halted a rebound in the S&P 500 from an almost 5 1/2 year low on Oct. 10. The benchmark index for U.S. equities climbed 9.6 percent from then through yesterday as money-market interest rates declined and Federal Reserve Chairman Ben S. Bernanke endorsed another economic-stimulus package.

At least 139 S&P 500 companies report third-quarter earnings this week, including Apple Inc. after the market closes today and McDonald's Corp. tomorrow. Profits fell 27 percent on average for the 107 companies in the index that released results as of this morning, according to data compiled by Bloomberg.

Today's earnings reports overshadowed another retreat in money market rates. The London interbank offered rate, or Libor, that banks charge each other for three-month loans in dollars dropped 23 basis points to 4.06 percent, the British Bankers' Association said. The overnight rate slid 23 basis points to 1.28 percent, below the Federal Reserve's target of 1.5 percent for the first time since Oct. 3.

The dollar rose to a 19-month high against the euro on bets the European Central Bank will reduce interest rates at a faster pace than the Fed. The surge in the U.S. currency weighed on shares of commodity producers, technology companies and others that rely on overseas sales to boost earnings.

Money-Market Plan

Financial companies in the S&P 500 rose as much as 1.4 percent before joining the other nine main industry groups by declining. The Fed today said it would help finance purchases of up to $600 billion in assets from money-market mutual funds. The funds were hit with redemptions after the Sept. 15 bankruptcy filing by Lehman Brothers Holdings Inc. caused the first principal loss for investors in a money-market fund in 14 years.

``The liquidity infusions are so massive that at some point they'll take hold and make a difference,'' said Mike Allocco, partner at Brazos Capital Management LP in Dallas, which manages $400 million. ``I'm more worried about missing an upturn than about a significant downturn'' in stocks.

KeyCorp, Ohio's third-largest bank, surged 12 percent to $10.95 after saying it expects to apply for a portion of the $250 billion in funds being offered by the U.S. government to recapitalize the banking system. M&T Bank Corp., Regions Financial Corp. and National City Corp. rose at least 2.7 percent after they also said they're considering selling stakes to the government. Third-quarter profit slumped at M&T and Regions, while National City's loss widened.

Texas Instruments, Sun

Texas Instruments lost $1.13 to $16.85, a five-year low. Fourth-quarter sales will be $2.83 billion to $3.07 billion and profit will be 30 cents to 36 cents a share, the company said. Analysts in a Bloomberg survey predicted profit of 44 cents a share on sales of $3.36 billion.

Sun fell $1 to $4.78, its steepest loss since May and lowest price since 1995. The maker of server computers said fiscal first-quarter sales probably amounted to $2.95 billion to $3.05 billion. That missed the average of $3.15 billion expected by analysts surveyed by Bloomberg.

Western Union lost $3.63 to $16.75. The ``uncertainty'' in economies around the world and a weakening euro forced the Englewood, Colorado-based company to retract goals given in June of as much as 12 percent revenue growth and 18 percent earnings per share growth.

Tech Slump

Technology companies in the S&P 500 fell 5.6 percent as a group and were the biggest drag on the index among the 10 main industry groups. Energy companies lost 4.3 percent as crude oil resumed its slide, falling 4.5 percent to $70.89 a barrel in New York. Its close at $69.85 on Oct. 16 was the lowest since August 2007.

DuPont Co. led materials companies in the S&P 500 to a 5.7 percent retreat, falling $2.89 to $33.28. The third-biggest U.S. chemical maker forecast slowing sales in North America and Western Europe.

Freeport-McMoRan and AK Steel Holding Corp., the largest U.S.-based steelmaker by market value, fell after forecasting difficult economic conditions that may hurt profits. Freeport lost $3.98 to $32.74 and AK Steel tumbled 7.6 percent to $13.96.

`Further Deterioration'

Citigroup Inc. was the biggest drag on a gauge of financials, slumping 6 percent to $14.18 after Goldman Sachs Group Inc. said the bank may not report a profit until late next year as credit conditions worsen.

``It will be difficult for Citi to generate profitability over the next 12 months as additional writedowns, lower levels of capital markets activity, and further deterioration in credit quality trends will continue to weigh on the firm's operating results and capital ratios,'' William Tanona, a Goldman banking analyst, wrote in a note to clients.

Ford Motor Co. slid 6.9 percent to $2.17. Billionaire investor Kirk Kerkorian's Tracinda Corp. said it may sell all of its remaining 133.5 million shares in the second-largest U.S. auto company after divesting 7.3 million for an average price of $2.43. Since Kerkorian disclosed his initial investment, the value of what became a 6.4 percent stake fell by about two- thirds.

American Express, 3M

American Express Co. gained 8.4 percent to $26.39 for the biggest gain in the Dow average. The largest U.S. credit-card company by purchases reported third-quarter profit that beat analysts' estimates, and set aside less than expected for future loan losses. Cardholders failed to repay loans in the third quarter at almost twice the rate of a year earlier, American Express said.

3M Co. rose 4.4 percent to $60.04. The maker of more than 55,000 products from Post-it Notes to electronic road signs reported third-quarter earnings that topped analysts' average estimates, aided by overseas demand for safety gear.

Wall Street analysts forecast an 11 percent drop in third- quarter earnings in a Bloomberg survey. Profits for companies in the S&P 500 are expected to decline 5 percent this year, compared with a 2.7 percent decrease predicted a month ago, the data show.

The S&P 500, the benchmark for U.S. equities, trades at 11.8 times estimated earnings over the coming 12 months, compared with a price-to-earnings multiple of 16.6 at the end of last year.

`Too High'

``People are realizing that forward estimates are too high,'' said Noman Ali, a money manager at MCF Global Investment Management in Toronto, which oversees $6 billion of U.S. equities. ``The economy globally is going into recession. There's no guarantee all this capital being injected will ultimately result in higher lending.''

The Dow is down 32 percent this year and the S&P 500 is off 35 percent as credit losses and asset writedowns stemming from the collapse of the subprime mortgage market top $661 billion at financial firms worldwide.