The state says it paid bankrupt Lehman Brothers Holdings Inc. and other Wall Street banks at least $75.9 million since March to end interest-rate swap contracts that were supposed to lock in below-market rates. That money and the costs of issuing new debt to replace bonds linked to swaps gone awry are eroding the $207 million in savings New York budget officials say the derivatives produced since 2002.

New York isn’t alone. Lehman’s bankruptcy filing on Sept. 15 triggered the termination of similar contracts across the country, forcing state and local governments and other borrowers in the $2.67 trillion municipal-debt market to buy out the agreements. They suddenly find themselves making unexpected payments at a time when their revenue is already under pressure from the worst recession since World War II.

“People are fixing problems right now,” said Nat Singer, managing partner at Swap Financial Group in South Orange, New Jersey, and the former head of municipal derivatives at Bear Stearns Cos. The number of new deals has shrunk to a “fraction” of the amount a year ago as issuers unwind failed swaps with Lehman, Singer said.

Bentley University in Waltham, Massachusetts, and a school district in Pennsylvania vowed never to use swaps again after losing money. The added costs in New York come as the state faces a record $15.4 billion budget deficit over the coming 15 months.

Lowering Costs

In a swap, parties agree to exchange interest payments, usually a fixed payment for one that varies based on an index. Borrowers may benefit by using swaps to lower interest expenses or lock in rates for future bond sales.

New York agencies used them to lower the cost of almost $7 billion in bonds sold between 2002 and 2005, according to an Oct. 30 report from the budget division. The average fixed rate the agencies agreed to pay Lehman and other banks was 3.78 percent, compared with 4.5 percent if they had sold conventional tax-exempt debt, officials calculated.

The state failed to comprehend the extent of the risks involved in entering into the long-term contracts, which often last more than 20 years, the report said. They included the likelihood an investment bank would go out of business, triggering the termination of the agreement.

930,000 Contracts

“One of the main risks with swaps, which is that a sudden bankruptcy of a counterparty could terminate a swap in unfavorable mark-to-market conditions, was not effectively addressed in the existing laws and agreements,” the budget division wrote in its annual report.

A budget-division spokesman, Matt Anderson, said in an e- mail that “given the current volatility in the market, we currently don’t anticipate entering into further swap agreements at this time.”

Lehman had about 930,000 derivatives contracts of all types when it collapsed, according to bankruptcy filings. About 30,000 remain open, Robert Lemons, a Weil, Gotshal & Manges lawyer representing Lehman, said last week. The contracts are worth billions of dollars to Lehman’s creditors, though their exact value isn’t clear, he said.

The cost of ending a contract depends on current interest rates. Since New York and other issuers agreed to pay a fixed rate to Lehman when borrowing costs were higher, they must pay the bank to end the deals. The three-month dollar London interbank offered rate, or Libor, upon which many agreements are based has tumbled to 1.466 percent from 5.5725 percent in September 2007.

Swaps Approval

Because they are private agreements, no comprehensive data exist on how many municipalities are involved in the almost $400 trillion interest-rate derivatives market or the total paid to exit the contracts. Derivatives are contracts whose value is tied to assets including stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.

New York passed a law in 2002 expanding the ability of state agencies and authorities to use swaps. It was signed by then-Governor George Pataki, a Republican. New Jersey, California and other states also use derivatives in their public financing.

Bentley University entered into swaps with Lehman and Charlotte, North Carolina-based Bank of America Corp. on $85 million of debt between 2003 and 2006. The school also had to pay a fee to end the swaps when Lehman collapsed, based on its contracts with the bank.

Upfront Cash

“It’s going to take awhile for people to get comfortable again, if ever,” said Paul Clemente, the chief financial officer at Bentley, who declined to disclose the amount of the fee. “As far as the future for interest-rate swaps, for me there is no future.”

Some borrowers also use swaps as a way to generate upfront cash, an attractive feature as the recession eats into municipal finances. At least 31 states and the District of Columbia face a combined budget shortfall of $24 billion this fiscal year, the Center on Budget and Policy Priorities in Washington, a non- partisan budget and tax analysis group, said Nov. 12. The estimate on Oct. 10 was $8.9 billion.

The Butler Area School District in Pennsylvania decided in August to pay JPMorgan Chase & Co. $5.2 million to back out of such a deal, more than seven times what it was paid to enter the agreement, rather than risk losing even more money over the 18- year contract. The district superintendent, Edward Fink, said he now thinks it’s inappropriate for school systems to dabble in such trades, even though they were explicitly backed by the General Assembly in 2003.

Valuing Risk

JPMorgan said in September it would stop selling derivatives to states and local governments amid federal probes into financial advisers and investment bankers paying public officials for a role in swap agreements.

Borrowers “never put a value on the risks associated with the swaps,” said Joseph Fichera, president of New York-based Saber Partners LLC, a financial adviser to corporate and public sector borrowers. They only estimated the savings investment bankers and advisers were telling them they would get, he said.

The use of swaps began faltering in February when the market for auction-rate securities collapsed. States, local governments and nonprofits sold about $166 billion of the debt, and as much as 85 percent of that was then swapped to fixed rates, according to Fichera.

Bond Insurers

The collapse of the auction-rate market left issuers such as the Port Authority of New York and New Jersey paying weekly or monthly rates of up to 20 percent. The swap agreements failed to adjust to swings in the underlying variable rates, leaving New York and others exposed to higher borrowing costs.

Interest rates on other types of municipal variable-rate debt also rose this year as investors boycotted bonds backed by MBIA Inc., Ambac Financial Group Inc. and other insurers that lost their AAA ratings because of their expansion into subprime- linked credit markets.

Some borrowers entered into new swaps after Lehman’s collapse, agreeing to pay higher than market rates in exchange for upfront payments to help cover the termination fees they owed Lehman, according to Swap Financial’s Singer. London-based Barclays Plc, which acquired Lehman’s brokerage, is among the banks bidding on this business, he said.

“The combined message from all of that is you cannot have complete confidence in your counterparty,” said Milton Wakschlag, a municipal finance lawyer in Chicago at Katten Muchin Rosenman LLP. “People will be taking a hard look at some of the conventions of the marketplace” after they finish cleaning up from Lehman’s bankruptcy.

“I’ve been on the bench for 23 years, and I’ve never seen anything like this,” said David G. Sills, the presiding justice for the Fourth District Court of Appeals, Division Three, in a telephone interview.

California’s worst budget crisis has held up $3.8 billion in spending on public works, possibly including the courthouse adjacent to Santa Ana City Hall. Sills and his seven fellow jurists had planned to move in before the lease on their temporary offices expires June 30.

“Everyone will have to work from home,” said Sills, 70, “and we’ll have to rent a place for when we hear arguments.”

Republican Governor Arnold Schwarzenegger and the Democratic-controlled Legislature are deadlocked on how to close a two-year budget gap that grew to $42 billion as job losses and stalled consumer spending reduced income and sales taxes. Schwarzenegger and Democratic leaders met yesterday without a resolution and are scheduled to continue talks through the holidays.

The California Pooled Money Investment Board, a committee that manages state spending, voted Dec. 17 to halt construction outlays for six months, which could hurt an economy that has lost more than 118,000 construction jobs in the last two years.

“The infrastructure work so vital to getting our economy back on track will lie crippled,” California Treasurer Bill Lockyer said in a statement after the vote. The board’s members are Lockyer, state Controller John Chiang and the governor’s budget director, Michael C. Genest.

Adding to Unemployment

The decision to defer spending is forcing agencies to review their projects and decide which of 2,000 under way around the state should be delayed. Among them are highways, bridges, hospitals, levees and schools and other public buildings.

California can’t afford to finance all of them and pay for such everyday needs as debt service on bonds and salaries and health-care benefits for the state’s 238,816 employees, H.D. Palmer, a spokesman for the Department of Finance, said in an interview.

Schwarzenegger has said postponing so much construction may add to California’s unemployment rate, which at 8.4 percent is tied with South Carolina as the third-highest in the U.S. behind Michigan and Rhode Island. The national rate is 6.7 percent.

About 3,000 people are working on 20 projects that Hensel Phelps Construction Co. of Greeley, Colorado, is overseeing in California, including a $110 million medical facility at the San Quentin State Prison near San Rafael, said Wayne Lindholm, executive vice president of the privately held company’s two California offices.

Overcrowding and Safety

“These people are scared,” Lindholm said. “They don’t know if they’ll be working in three months, a year, or where they go from here.”

South of downtown Los Angeles, a delay finishing a school building could put children in danger, said German Cerda, principal of South Gate Middle School. About a third of his 2,900 students are scheduled to move into the new building a half-mile away in 2012, relieving overcrowding inside and making nearby streets safer, he said.

On Dec. 2, a 14-year-old South Gate student was killed when a car stuck him a block away, an accident Cerda attributed to congestion.

“The biggest complaint we get from parents is what happens when the bell rings at 2:42 p.m. each day,” Cerda said. That’s the time that his students are dismissed and 3,000 more are leaving a high school down the street. “They don’t want to see another tragedy.”

Poor Environment

The Los Angeles Unified School District, second largest in the country behind New York City’s, has $3 billion in construction projects under way, including 35 new schools and improvements to 1,500 buildings. The goal is to reduce bus rides of 60 minutes and more and eliminate schedules that deny some children 17 days of instruction a year.

“Without the money, we have a poor educational environment for a while longer,” said Guy Mehula, chief facilities executive of the school district.

In Santa Ana, the appeals court typically handles 800 to 900 cases a year, and each of three judges hearing an appeal needs full access to the lower court record.

Without a building, couriers will have to drive cartons of files from one judge’s house to the next before they can meet somewhere to rule, Sills said.

“I haven’t the vaguest idea how we’re going to orchestrate all that, he said.

“Lots of my friends have been laid off,” Peter Raulwing, a project manager for Microsoft Corp., said during lunch at a Starbucks in Palo Alto, California. “I absolutely watch what I spend. I feel lucky I’ve survived, but you never really know.”

He has reason for concern. Global spending on computers and software will slide 8 percent next year in the U.S., Western Europe and Japan, according to Goldman Sachs Group Inc. With a 7 percent unemployment rate, Silicon Valley has about 4,000 fewer jobs today than this time last year, the Center for the Continuing Study of the California Economy said last week.

“The recession finally reached Silicon Valley,” Stephen Levy, the Palo Alto-based research organization’s director, said in an interview. The center based its conclusions on government unemployment data.

Technology companies with headquarters in Silicon Valley — a corridor of office parks stretching between San Francisco and San Jose — have announced at least 38,000 job cuts since September. Hewlett-Packard Co., Yahoo! Inc., Adobe Systems Inc., Sun Microsystems Inc. and Palm Inc. are among the firms paring their workforces.

More Pain

The region will probably feel more pain starting next month, said Madeline McMenamin, a senior consultant for workforce consulting firm Watson Wyatt Worldwide Inc.

“People are finishing their forecasts and budgets for the next year, and those will reflect continued downsizing,” McMenamin said in an interview from Santa Clara, California. “We need to brace for tough times.”

Raulwing said he’s put off buying a 42-inch flat-screen television, has postponed vacations, and is dining out less to save money.

“It feels more scary,” said Lutz Haentzschel, a software developer sitting with his laptop at a coffee shop in Palo Alto. He moved to the Bay Area 17 years ago and works for Siemens AG, Europe’s largest engineering company. “I’m waiting for my shares to recover.”

Tighter credit and slumping home prices mean Stephen Johnston can’t get the refinancing he needs to consolidate his loans and save on taxes.

Saving Gas

A software engineer at Microsoft, Johnston and his wife own a house in Fremont and another in Hayward — across the San Francisco Bay from his Palo Alto office. Johnston said he went further into debt with an eight-month remodel of their Fremont home. To save $4,000 a year on gas and bridge tolls, the two-car family now drives only one, increasing Johnston’s commute time to two-and-a-half hours.

“I leave my house in Fremont, drop off my daughter at day care six miles away, commute with my wife across the bridge to Redwood City, and then drive to Palo Alto,” Johnston said.

While there isn’t much optimism in Silicon Valley right now, the slowdown will be less severe than the fallout after the dot-com bubble in 2000, said Doug Henton, chief executive officer of Collaborative Economics Inc., a consulting firm in Mountain View, California. About 200,000 jobs disappeared from the region in 2001 and 2002, he said.

“The last time around, whole swaths of the technology market vaporized,” John Challenger, CEO of executive search firm Challenger, Gray & Christmas Inc., said in an interview from Chicago. “We won’t have the same impact this time. This recession is from banks and others dragging technology down with it. And people in the Valley realize how important personal networking is.”

Job Networking

Trip O’Dell is counting on that network. He and 600 colleagues at Adobe, the biggest maker of graphic-design programs, lost their jobs this month. With a 2-year-old daughter and another baby on the way, O’Dell plans to create games for Apple Inc.’s iPhone or develop applications for Facebook Inc.’s social-networking site.

“The benefit of being on the wrong side of a layoff is you have access to all these others with talent who suddenly have a lot of time on their hands,” said O’Dell, 35. There are still opportunities for people who use personal networks to find new jobs and start companies, he said.

Silicon Valley’s workers will have to spend more time networking next year as companies continue to cut jobs, Challenger said.

“The first quarter is going to be rough waters,” Challenger said. “The strength of the workforce lies in their flexibility, and how they use their knowledge of each other.”

The other end is connected to a diesel tanker on the Egyptian side — a source of smuggled fuel for a market so parched some Palestinian drivers run their cars on oil used to fry falafel.

The beehive of tunnels beneath the tent city has become a vital lifeline for Gaza, giving its 1.4 million residents a way around an Israeli blockade that has choked off supplies of gasoline, fresh meat and consumer goods ranging from washing machines to iPods. It may also turn into a bombing target for the Israeli air force following the expiration of a six-month cease- fire with the Hamas leaders who rule Gaza, Israeli strategists say.

“There is hardly any economy left in Gaza without the tunnels,” says Omar Shaban, an economist who runs a consulting group in Gaza City. “It is distorted to have an economy that is so completely dependent on the black market, but it’s a natural result of the borders being closed.”

Ninety percent of all products entering Gaza each month –as much as $40 million worth of contraband — comes through the tunnels from Egypt, Shaban says. The underground network is also a crucial source of revenue and weapons for the militant Islamic Hamas movement, which charges a one-time digging fee of 11,000 shekels ($2,750) for each tunnel.

Tighter Restrictions

Israel tightened restrictions on the flow of goods into Gaza after Hamas seized control of the seaside enclave 18 months ago and Palestinians increased rocket attacks on Israeli towns and cities. Hamas and the Iranian-supported Islamic Jihad group are classified as terrorist organizations by Israel, the U.S. and European Union.

Since the cease-fire expired Dec. 19, Palestinians — mainly members of Islamic Jihad — have sent more than 100 rockets and mortar shells into Sderot and other border towns, causing minor injuries and some property damage.

About 70 rockets and mortar shells have been fired at Israel since midnight local time, an army spokesman said by telephone, adding that it was the largest barrage in at least six months.

Israel’s security cabinet approved today that several steps be taken against Hamas as the number of mortar shells and rockets shot into southern Israel climbed. An army spokesman declined to elaborate on the measures.

Border Incident

The latest attacks from Gaza followed a border incident yesterday in which Israeli soldiers clashed with three armed Palestinians trying to rig explosive devices along the fence between the seaside strip and Israel. The three gunmen were killed in the battle, an army spokesman said.

“It’s obvious that one of the first places the air force will bomb is the tunnels,” says Yiftach Shapir, an analyst at Tel Aviv University’s Institute for National Security Studies who edits the Middle East Military Balance yearbook. “They’re going to want to shut off access across the border.”

Egyptian President Hosni Mubarak is meeting with Israeli Foreign Minister Tzipi Livni tomorrow in Cairo to try to resurrect the truce, while his aides are in contact with Hamas. The group’s leaders have said they won’t support a renewal unless Israel agrees to let in food, fuel and construction materials, and address grievances such as the release of hundreds of prisoners.

Livestock, Refrigerators

Palestinians have been digging tunnels for years under Gaza’s tightly patrolled borders with Israel and Egypt. The largest are about 5 feet high and are accessed through a 4-foot square shaft reinforced with scrap wood. A triangular metal-pipe assembly braced above the opening holds a hoist attached to a cable that is lowered and raised by motor.

The goods that come through the tunnels include livestock, cement, steel rods, refrigerators and computer screens, along with Coca-Cola, cigarettes and pharmaceuticals such as the erectile-dysfunction drug, Viagra. At a mobile-telephone store in Gaza City, a smuggled Apple iPod Nano 4-gigabyte model sells for $500. It lists for $149.99 on Amazon.com.

Tunnel owners say they have nothing to do with arms shipments. Israel says weapons and missile parts continue to flow from Egypt, evidenced in part by the greater sophistication of rockets fired from the territory.

Tunnel Cafeteria

Before Israel evacuated its troops and thousands of Jewish settlers from Gaza in 2005, it often tried to shut the tunnels, which were dug through the foundations of people’s homes in the Rafah refugee camp near the border. The operations had little success as people excavated new tunnels to replace those that were found.

Now there are more than 1,000 by some estimates, sheltered under the white tents that form a virtual railway station. The Tunnel Cafeteria, serving chicken kebabs and hummus, is among the restaurants that have sprouted to serve the subterranean workforce that numbers as many as 6,000. Some tents have signs, including one advertising “Abu Jabal Co. for Selling Gasoline and Breaking the Siege.”

Owners of the tunnels go by nicknames because the trade remains illegal, even though Egypt tolerates it. One of the busiest operators calls himself “Mouse” because of his slight physique and agility at moving underground. A metal importer is known as Abu Hadid: father of iron.

10 Partners

Abu Albara, a 25-year-old Rafah resident who was unemployed six months ago, says he sold his wife’s jewelry to join a partnership of 10 people that owns three tunnels. Inside his tent, two scrawny cows rise to the surface after being poked and prodded through the tunnels by his staff. Next stop: the slaughterhouse.

“They didn’t really want to come to Gaza,” he jokes, touching off a storm of laughter from a dozen workers who had been snoozing on dusty mats before their tunnel shifts begin.

Mohammed, 28, a tall man with brown tobacco-stained teeth, owns the diesel pipeline. Wearing a black Pittsburgh Steelers jacket, he displays a ledger showing daily sales have fluctuated between 30,000 and 100,000 liters in the past three months. Demand and prices are sensitive to the unscheduled openings and closings of Israel’s Karni cargo crossing, where diesel fuel is transferred to Gaza, he says.

Next to the fuel line, he’s installed a pipe that carries compressed oxygen into the tunnel so his employees, who work eight-hour shifts, don’t pass out from the fumes and dust. At least 40 tunnel workers have died in the past year, many buried alive when the fragile walls collapsed.

“This is very hard and risky work,” Mohammed says. “I hope the borders will open and I can go into a different business because I don’t want to do this the rest of my life.”

Reserve Management Co. was told last week by the enforcement division of the U.S. Securities and Exchange Commission that it will recommend suing the company and Bent, its chairman, Reserve said yesterday in a statement. The closely held firm also expects the agency to file complaints against Bent’s sons, Bruce Bent II and Arthur Bent III.

Reserve Primary’s value fell below the $1-a-share price paid by investors on Sept. 16 because of losses from debt issued by bankrupt Lehman Brothers Holdings Inc., making it the first money-market fund in 14 years to break the buck. The fund’s demise sparked a run on money-market accounts and at least 19 lawsuits over how it was managed and how the losses should be divided among investors.

“The scrutiny to date has likely centered on valuation issues related to the Lehman paper and communications with shareholders,” Peter Crane, president of Crane Data LLC, a research firm in Westborough, Massachusetts, said in an interview.

The Bents and the company “expect to defend vigorously against the allegations,” Reserve said in the statement.

Kevin Callahan, an SEC spokesman in Washington, and Reserve spokeswoman Ming Lee Hatch declined to comment. SEC staff have been investigating the fund since it broke the buck.

Losses Loom

Some shareholders may lose as much as 3 percent of their investment. The company has so far returned about 78 percent of the $51.8 billion that was left in the fund on Sept. 16.

In the three weeks after Reserve Primary broke the buck, institutional investors yanked about $347 billion from money funds that can buy corporate debt. The run robbed companies of a crucial source of short-term funding, prompting the U.S. Treasury to roll out a temporary program insuring money-market fund holdings.

Bent is credited with having invented the money-market mutual fund in 1970, creating a safe and liquid place for retail investors to park cash. That year he opened Reserve Primary and his company with partner Henry B. R. Brown, who died in August. He was also known for lecturing fellow money-fund managers for taking on excessive risk.

In a November 2007 interview with Bloomberg News, he criticized those funds that suffered losses on debt linked to subprime mortgages.

“When you get involved in this contest to make 3 basis points more here or 2 basis points more there, that’s insane,” he said. “It’s not what I designed the money fund to do.”

More Bucks Broken

In addition to Reserve Primary, the company managed an offshore money fund, International Liquidity, and an enhanced cash fund, High Yield, that dropped below $1 a share because of Lehman holdings. The funds, which are in liquidation, weren’t regulated by the SEC. Client redemptions also forced the company to shut down another 15 money-market funds. Investors in those funds won’t suffer losses.

Under a Wells notice, the SEC’s staff attorneys inform investigation targets that they plan to recommend legal action in a case. Defendants are given a chance to respond in writing before the SEC’s commissioners vote on any sanctions. In 90 percent of the cases, the agency will proceed with the lawsuit, said George Newhouse, a defense lawyer with Brown White & Newhouse in Los Angeles.

Lehman Legacy

The Reserve fund’s trouble began when Lehman filed for bankruptcy early on Sept. 15. Reserve Primary held $785 million in Lehman-issued debt, about 1.5 percent of assets. That same morning, the fund’s trustees partially wrote down the debt by 20 percent. The partial writedown wasn’t disclosed until Nov. 26, when the company also announced it had miscalculated the fund’s net asset value for several hours on Sept. 16.

The miscalculation caused some investors who are now facing losses to believe initially that they were entitled to get back all their principal investment.

The lawsuits pending against the fund and Reserve Management allege separately that the company selectively disclosed information about its losses causing some clients to flee the fund before it broke the buck, improperly valued the Lehman holdings on Sept. 15 and violated its prospectus by buying risky assets.

According to Kirk Dillman with law firm Hennigan Bennett & Dorman in Los Angeles, the SEC may focus on the fund’s failure to writedown its Lehman holdings until the end of the trading day on Sept. 16, more than a day after Lehman filed for bankruptcy.

Sharing the Pain

Shareholders have also sued over how the Lehman losses should be divided. Shareholders who asked to withdraw before the fund broke the buck say they are entitled to all their money, while others claim that all account holders should share in the losses.

The fund is being liquidated as securities mature or can be sold without loss. Money returned has so far been distributed to shareholders on a pro-rata basis. Reserve Management has said it won’t distribute any disputed money and will hold back enough money to cover its expenses, including legal costs for the fund, the company and its managers.

Spending dropped 0.6 percent in November, and rose for the first time in six months after accounting for inflation, the Commerce Department said today in Washington. First-time unemployment benefit claims jumped to 586,000, and durable-goods orders declined less than anticipated, other reports showed.

The deteriorating job market means consumers will probably further rein in spending; economists including those at Morgan Stanley estimate more than 400,000 people will lose their jobs this month. The outlook forced Sears Holdings Corp., the largest U.S. department-store company, earlier this month to abandon its earnings forecast for the rest of the year.

“The economy continues to struggle and unfortunately the first half of 2009 does not look very good,” said Carl Riccadonna, a senior U.S. economist at Deutsche Bank Securities Inc. in New York. “We look for a further contraction and a continued acceleration in the pace of layoffs.”

Gasoline prices fell by a total of 50 percent in October and November, and discounts by retailers from Toys “R” Us Inc. to Wal-Mart Stores Inc. helped prevent a bigger drop in purchases last month. Today’s Commerce report also showed that the gain in spending adjusted for inflation was the biggest in almost two years.

Spending Outlook

“The increase in real spending is unlikely to be sustained with the job losses we are seeing,” said Benjamin Reitzes, an economist at BMO Capital Markets in Toronto. The gain last month “was more a technicality based on the drop in gasoline prices,” he said.

Stocks were little changed after today’s reports. The dollar remained lower, while Treasuries advanced. The Standard & Poor’s 500 Stock Index was up 0.2 percent at 864.56 at 10:14 a.m. in New York, benchmark 10-year note yields slipped to 2.17 percent from 2.18 percent late yesterday, and the dollar lost 0.5 percent against the euro to $1.3994.

A separate Commerce report showed orders for durable goods in November fell 1 percent, after an 8.4 percent decrease in October that was bigger than previously reported. Excluding a slump in transportation gear, orders for goods designed to last several years unexpectedly increased.

Capital Goods

Bookings for non-defense capital goods excluding aircraft, a measure of future business investment, increased 4.7 percent, the most since September 2006, after a 6.6 percent slump in October. Shipments of those items, used in calculating gross domestic product, rose 0.2 percent.

“Orders were so down in the previous months that there’s probably a little payback for that,” Robert Stein, senior economist at First Trust Advisors in Lisle, Illinois, said before the report.

Today’s Labor Department report showed that the four-week moving average of claims, a less volatile measure, also was the highest since 1982, at 558,000 for the week to Dec. 20. Initial claims were projected to increase to 558,000, according to the median of 32 forecasts in a Bloomberg News survey.

The number of people staying on benefit rolls fell to 4.37 million in the week ended Dec. 13 from 4.387 million.

Rising joblessness contributed to a drop in personal income last month. The Commerce figures showed income fell 0.2 percent in November after being unchanged the prior month.

Hit to Income

“Given the further increase in jobless claims,” wage and salary income “is likely to further decelerate in the near term,” Deutsche’s Riccadonna wrote in a note to clients.

The drop in consumer spending last month extended declines to a record fifth consecutive decline, the Commerce Department said. Economists forecast unadjusted spending would fall 0.7 percent, according to the median of 64 estimates in a Bloomberg News survey.

Today’s report also confirmed inflation is retreating as demand wanes. Prices plunged 1.1 percent, also the biggest since records began in 1992. The gauge increased 1.4 percent from November 2007, the smallest gain in six years. The Fed’s preferred price measure, which excludes food and fuel, was unchanged for the second consecutive month, the first time that’s happened since 1999.

Gasoline Price

The average price of unleaded regular gasoline at the pump fell by $1 to $2.11 in November from the prior month, according to AAA, leading the drop in overall prices.

The decrease in spending pushed the savings rate up to 2.8 percent from 2.4 percent in October. A positive rate suggests consumers are restraining spending to boost savings.

Even after the bump in November sales, retailers are concerned about the holiday shopping season, which brings in one- third or more of annual revenue. The International Council of Shopping Centers and Goldman Sachs Group Inc. said yesterday that November-December sales may fall as much as 2 percent. The ICSC had previously projected a drop of as much as 1 percent.

“Given the current economic and retail environment, we will carefully evaluate alternatives that provide financial flexibility in the near-term,” Sears’s interim Chief Executive Officer W. Bruce Johnson said in a statement.

Consumer spending dropped at a 3.8 percent annual pace in the third quarter, the biggest plunge since 1980, revised Commerce figures showed yesterday. The economy shrank 0.5 percent. Economists surveyed by Bloomberg forecast the economy will contract through the first half of 2009.

The ruble, down 18 percent against the dollar since the beginning of August, weakened 0.9 percent against the U.S. currency to 28.6905 and 1.4 percent versus the euro to 40.1773, near an all-time low.

The central bank allowed the ruble to fall about 1 percent against a basket of dollars and euros, accelerating the slide after spending 27 percent of reserves, or $162.7 billion, trying to defend the currency over four months. Oil, Russia’s biggest export earner, lost 4 percent to $37.43 on the New York Mercantile Exchange and is down nearly 75 percent since the July high. The government requires oil to average $70 to balance its 2009 budget.

“As long as oil remains depressed and at many year lows the central bank has no other choice but to carry on with its devaluation,” said Mikhail Galkin, head of fixed income research at MDM Bank in Moscow.

The currency has fallen 14 percent against the dollar and 11 percent versus the euro this year amid the plunge in oil, international condemnation of the country’s war with Georgia and the spreading global credit crisis. BNP Paribas SA estimates investors withdrew $211 billion from Russia since August. The nation’s oligarchs, who and took over assets of the biggest companies after the collapse of the Soviet Union in 1991, are vying for $78 billion of Kremlin loans to meet debt payments.

Recession

The economy, which recovered from the government’s 1998 debt default to expand an average 7 percent in the eight years to 2007, may slip into a recession in the first half of 2009, Kremlin economic adviser Arkady Dvorkovich told Bloomberg Television on Dec. 19.

The government will post a budget deficit next year for the first time in a decade and will use its $132.6 billion reserve fund, or extra oil revenue the government has set aside, to cover the financing gap, Dvorkovich told reporters in Moscow today.

An “accelerating” ruble devaluation is “detrimental” to economic growth because it stimulates currency speculation and limits new lending, Evgeny Gavrilenkov, chief economist at Troika Dialog in Moscow, wrote in a research note today. Troika Dialog earlier called for a one-time depreciation of as much as 20 percent.

“If in 2009 the oil price is between $30 and $40 and the state carries on with its strange policies on the money market, the possibility of an economic downturn will rise,” Gavrilenkov said.

Currency Basket

The ruble fell 1.2 percent against the basket of dollars and euros that the central bank uses to manage its fluctuations, and traded at 33.86 at 5:02 p.m. in Moscow.

Bank Rossii allowed the ruble to decline against its currency basket for the third time in four working days and the 10th time since Nov. 11, according to a central bank official who declined to be identified.

The Micex stock index fell for the first time in four days to 654.29, a drop of 1.1 percent.

The 53-year-old investor, who asked not to be identified to protect his stake, took out about $600,000 this year from his $1.5 million account, using some of it to pay down a mortgage. He and other Madoff clients who withdrew funds as long as six years ago may be sued on behalf of other victims to return profits and even principal, securities and bankruptcy lawyers say.

“Right now there are Madoff winners and Madoff losers,” said Lynn LoPucki, who teaches bankruptcy law at Harvard University. “Before this is over there will be nothing but Madoff losers.”

Clients of Madoff had about $36 billion with his firm, according to a Bloomberg tally that may include some double counting. Before his arrest on Dec. 11, Madoff, 70, confessed to employees that his “giant Ponzi scheme” may have cost as much as $50 billion, according to an FBI complaint. His misconduct may have stretched back to at least the 1970s, two people familiar with the government’s inquiry of Madoff said last week.

The Florida investor, who first gave his money to Madoff five years ago, said he had no hint of fraud and would go to jail rather than give up the amount he took out.

Irving Picard, the trustee appointed to liquidate Madoff’s brokerage, Bernard L. Madoff Investment Securities LLC, holds the fate of the restaurant owner and other investors in his hands.

Enough Funds Left?

Picard, who didn’t return a call seeking comment on plans to sue victims to recover funds, said in a court filing yesterday that “there has not been any showing or determination that there are sufficient funds” to satisfy victim claims.

A so-called clawback of paid-out funds in the Madoff liquidation could result in lawsuits against investors such as charities, hedge funds and individuals who redeemed profits and took out principal. Nonprofit institutions such as the Carl and Ruth Shapiro Family Foundation, a foundation controlled by Democratic U.S. Senator Frank Lautenberg of New Jersey, and Yeshiva University relied on funding from Madoff investments.

Lawyers and representatives of the Shapiro and Lautenberg foundations didn’t return calls seeking comment. In a statement, Rick Matthews, a Yeshiva University spokesman, said, “Our lawyers and accountants are in the process of an investigation.”

‘Further Risk’

“Charities are looking at their legal options as regarding their right to recoup money,” said Mark Charendoff, president of the New York-based Jewish Funders Network, whose 1,000 members fund Jewish causes and are assessing losses from Madoff investments. “I don’t know that they’ve been focused on or are aware that they may in fact be at further risk of loss.”

Bankruptcy laws authorize a trustee like Picard to recover money that was distributed as part of a fraud and share it among the victims, LoPucki said.

“The purpose of these laws is to balance the losses among the various investors, but how that balance is supposed to be struck is not clear,” LoPucki said.

Under New York state law, which can be invoked for Madoff recoveries, a trustee can seek redemptions going back six years, said Tracy Klestadt, a New York bankruptcy lawyer.

In a similar case, U.S. Bankruptcy Judge Adlai Hardin in White Plains, New York, ordered investors of defunct hedge-fund manager Bayou Group LLC in October to disgorge profits they’d taken out. Investors were required to pay back any gains they’d redeemed involving “fictitious profits.” Before the fraud was discovered, Bayou paid out more than $135 million, according to court papers.

‘Good Faith’ Rule

Hardin also ruled some investors would have to hand back their principal. Only investors who acted in “good faith” — a legal standard that makes investors prove they didn’t have knowledge or suspicion of fraud — could protect their initial stake, Hardin ruled. He said investors could show they had good faith if they didn’t see any “red flags” when they withdrew the funds.

That decision could be a guide for Picard, Klestadt said.

The Bayou decision set a high bar for investors who hope to protect their principal, said Carole Neville, a lawyer representing Bayou investors.

“What the Bayou case holds at the moment, is, if you had any reason to feel uncomfortable about your investment and took your money out, you don’t have good faith,” Neville said.

‘Almost Impossible’ Standard

“On the surface it seems a standard that’s almost impossible for people to meet,” said Robert Crane, president of New York’s JEHT Foundation, a group dedicated to criminal justice matters that relied on donors who invested with Madoff and said it’s closing in January.

Seeking money from investors who say they were defrauded can result in protracted litigation. In the Bayou case, which is being appealed, $20 million of the $33 million recovered from redeeming investors went to pay legal fees, Neville said.

“It’s a very unattractive position to be in,” said Marvin Pickholz, a litigation attorney at Duane Morris and former Securities and Exchange Commission enforcement official. “You are now going against your fellow shareholders who are in the same situation you are in.”

The trustee would have to prove that the money was redeemed while the alleged fraud was occurring and would have to puzzle through Madoff’s books and records to prove the amounts that were redeemed, Pickholz said.

“It could be a nightmare,” he said.

Bankruptcy trustees “spend huge amounts of money trying to get money from some investors and give it back to other investors,” LoPucki said. “The incentive of the trustee and the lawyers is to churn, to bring lots of cases, spend lots of time and charge lots of fees.”

Purchases of both new and existing houses dropped 7.6 percent from the prior month, the biggest decline since January 1989, to an annual rate of 4.43 million, government and industry figures showed today. A 13 percent drop in the median resale price from a year earlier was the most since records began in 1968 and was likely the largest since the 1930s, the National Association of Realtors said.

“Housing is still in a freefall,” said Nariman Behravesh, chief economist at IHS Global Insight in Lexington, Massachusetts.

The figures were worse than economists had forecast and signal that the battered housing market that led the economy into a recession may be taking another lurch down. Sliding property values mean more Americans will be under water on their mortgages, destroying household wealth and undermining consumers’ purchasing power.

President-elect Barack Obama plans an unprecedented economic stimulus to restore growth, and pledged on Dec. 13 to limit foreclosures. One tenth of U.S. families who own a home are in financial distress, Obama said.

“We need desperately to get this economy moving,” Vice President-elect Joseph Biden, who is leading the incoming administration’s initiative to bolster the middle class, told reporters before a meeting with Obama’s economic advisers today. Transition officials are “getting very close” to an agreement with lawmakers on the size of the stimulus, Biden said.

Below Estimates

The Realtors’ figures showed home resales, including condos, fell 8.6 percent to an annual rate of 4.49 million, below all but one estimate in a Bloomberg News survey of 63 economists. The median resale price dropped to $181,300.

Separately, the Commerce Department reported that new-home sales fell 2.9 percent last month to a 17-year low of 407,000. The median sales price declined 11.5 percent from a year earlier to $220,400.

The Standard & Poor’s supercomposite of homebuilder stocks fell 2 percent to close at 205.44 in New York, the fourth straight decline. The index is down a third so far this year. The S&P 500 Stock Index, which fell as much as 22 percent in November, dropped 1 percent today.

Buyers Scared Off

Last month’s stock market collapse combined with rising unemployment to scare off home buyers, Lawrence Yun, the Realtors’ chief economist, said at a press conference.

“The economy was really starting to feel the smack-in-the- face blow from the financial crisis” during November, said David Resler, chief economist at Nomura Securities International Inc. in New York.

U.S. household wealth already fell in the third quarter by the most on record, Federal Reserve figures showed earlier this month. Net worth for households and non-profit groups decreased by $2.81 trillion, the most since the Fed’s data began in 1952.

The number of previously owned unsold homes on the market at the end of November represented 11.2 months’ worth at the current sales pace, up from 10.3 months’ at the end of the prior month.

Foreclosures and short sales accounted for 45 percent of last month’s home purchases, Yun said.

Regional Breakdown

Purchases of total existing homes declined in all regions of the country, led by drops of 12 percent in the Northeast and 10.9 percent in the South. Prices also fell throughout the country, led by a decline of 25.5 percent in the West.

Resales account for about 90 percent of the housing market. Sales of existing homes are compiled from contract closings and may reflect contracts signed one or two months earlier. New-home sales, recorded when a contract is signed, are considered by economists to be a more timely barometer.

The hew-home sales report showed builders succeeded in trimming inventories even faster than sales dropped. The number of new homes for sale fell a record 7 percent to a seasonally adjusted 374,000, the fewest since February 2004.

The supply of new homes at the current sales rate dropped to 11.5 months’ worth from 11.8 months the prior month.

Resler said today’s figures show the housing market has “not yet seen any of the impact from the drop in mortgage rates.”

The Fed on Dec. 16 cut its benchmark interest rate target to a range of zero to 0.25 percent and reiterated it stands ready to expand purchases of Fannie Mae, Freddie Mac and Federal Home Loan Bank debt under a program aimed at reducing mortgage costs. That program has helped drive mortgage rates lower.

Mortgage Rate

The average rate on a 30-year fixed-rate loan fell to 5.18 percent in the week ended Dec. 12, the lowest in more than five years, according to the Mortgage Bankers Association.

Ara Hovnanian, chief executive officer of Hovnanian Enterprises Inc., New Jersey’s biggest homebuilder, called on the government to provide an economic stimulus for the housing industry.

“If government wants to get to the root of the problem they need to fix housing first,” Hovnanian said in a conference call on Dec. 17. Hovnanian, whose company reported a fiscal fourth quarter loss, didn’t specify what type of government intervention he wants in the housing market.

“It’s better than putting money in the stock market right now and it’s better than investing with Madoff,” said Stromberg, 63, who works for Citi Habitats.

Investors who lost millions in Bernard Madoff’s alleged Ponzi scheme may join the list of shoppers searching for bargains at high-end consignment shops, which sell previously owned designer clothes and other secondhand luxury items brought in by people who no longer need or want them.

If the goods are sold, usually for a fraction of the regular retail price, profits are split between the consignor and the store.

Here’s a look at some of New York’s best luxury bargain shops:

Fisch for the Hip

Chelsea’s Fisch for the Hip is logo heaven with an impressive array of Gucci, Louis Vuitton, Chanel and Hermes handbags, wallets and clutches.

A brand new Phillip Lim cocktail dress is on sale for $350, about half the retail price. There’s also a slew of trendy Herve Leger bandage dresses in various colors, with prices ranging from $300 to $500.

During the holiday season, Fisch is offering a 15 percent discount on fall merchandise if you purchase two items worth at least $100 each. It’s 20 percent off for three items or more costing at least $100 apiece.

153 West 18th St. +1-212-633-9053; http://fischforthehip.com.

Gentlemen’s Resale

A classic Burberry coat with thick navy wool, tartan-lined hood and toggle buttons for $195? You bet.

A buttery brown Miu Miu leather coat sells for $375 at Gentlemen’s Resale, and a Paul Smith pinstripe suit goes for the same price. Pair it with a Thomas Pink broadcloth button-down shirt ($60) and black leather Valentino dress shoes ($135) and you have yourself a smart outfit for the next important meeting.

Helpful (and sharply dressed) employees move about the well- lit space on the Upper East Side, one of a trio of related consignment shops on the same block. The original Designer Resale and Designer Resale Too cater to female shoppers, while Gentlemen’s Resale offers an impressive collection of menswear and accessories.

Keep an eye out for color-coded stickers at all three stores, which flag older inventory that’s been reduced.

Designer Resale, 324 East 81st St., and Designer Resale Too, 311 East 81st St. +1-212-734-3639 for both stores. Gentlemen’s Resale, 322 East 81st St. +1-212-734-2739; http://www.designerresaleconsignment.com.

Michael’s

Michael’s, a two-level fixture on Madison Avenue, has been welcoming tourists and neighborhood regulars for 54 years. It accepts and resells only the best of gently used designer names.

A black Chanel wool pantsuit was recently reduced to $595 from $695. Brown leather Manolo Blahnik slingbacks ($175) and Christian Louboutin ($125) suede pumps are also a bargain. So is the blue-and-black Diane von Furstenberg wrap dress for $109.

Need an outfit for the holiday-party circuit? How about a black taffeta cocktail dress from Oscar de la Renta ($395) or a Carolina Herrera two-piece suit with rhinestone accents and beaded trim? A small Hermes Birkin, safely stored in a glass display case, is available for $8,500, less than half the usual price.

Merchandise must be no more than 2 years old and have either a label or stamp intact.

1041 Madison Ave., between 79th and 80th Streets. +1-212- 737-7273; http://www.michaelsconsignment.com.

A Second Chance

A Second Chance Designer Resale Boutique also sells designer wear at non-designer prices.

Space is tight, but brand names abound at this store, where the entrance walls are painted cotton-candy pink. Ignore the Lexington Avenue subway line rumbling underground; instead, turn your attention to the Chanel collection that takes up half of one wall.

You can indulge your inner lady with a classic tweed jacket ($750) and two-tone ballet flats ($199), about one-third of the retail price. A Louis Vuitton monogram petite bucket bag ($499) never goes out of style and an orange Goyard hobo-style bag ($750) is a fun piece of arm candy. Finish the look with an Hermes silk scarf ($199).

1109 Lexington Ave., between 77th and 78th Streets. +1-212- 744-6041; http://www.asecondchanceresale.com.

INA

INA, which has four branches in downtown Manhattan, carries a wide range of deeply discounted designer duds. Whether it’s an Oscar de la Renta wool sweater or a Rag & Bone blazer, the store appeals to designer connoisseurs of all ages.

A current highlight in the Noho store is a shiny Alexander McQueen black patent-leather bag selling for $1,250. Tables are stacked with jeans, organized by size, and upscale brands include True Religion and Seven for All Mankind. INA also carries his and hers shoes, accessories, and bags.

Sellers work with INA to decide on price and keep about 45 percent of the sale price.

INA Noho, 15 Bleecker St., +1-212-228-8511; INA Soho, 101 Thompson St., +1-212-941-4757; INA Nolita Women, 21 Prince St., +1-212-334-9048; INA Nolita Men, 262 Mott St., +1-212-334-2210; INA Uptown, 208 East 73rd St., +1-212-249-0014; http://www.inanyc.com.

At most stores, prices are reduced by 20 percent after one month and 50 percent after two months. If an item remains unsold after 90 days, it is returned to the consignor or marked down further.