Saturday, March 15, 2008

New Blog

As the housing bubble and the credit bubble have clearly popped, and the Federal Government is throwing good money after bad to try and support asset prices and the wall street elite, I have decided to post under a new blog name that I believe aptly describes the current policy attitudes/behaviors of our government. This is no longer a free-market, capitalistic society. Our society has turned back to a new version of feudalism. Financial Feudalism:

Financial Feudalism

Friday, March 14, 2008

An Old World Order!

Today's Fed actions led me to further think about the current state of our economic system. I have gone over in my mind numerous time about one fundamental question. Under what kind of system are we living? Is it Capitalism, Totalitarianism, Fascism, Communism or Socialism? Today's action provides the most direct evidence that our system has devolved back to FEUDALISM, or FEDALISM as it could be more aptly called today. This remarkable act of bailing out one investment bank so that their derivatives wouldn't have to be marked to market proves the oligarchical nature of our society. The Lords of Wall Street are under the protectarate of the FEDal system. We the fifes must go about our daily lives and hand over increasingly large sums of our hard earned "money" to ensure the "stability of the markets". What bonus should Mr. Schwartz receive from the taxpayers largesse? As the new Sheriff of Nottingham, Ben Bernanke, and his sidekick, Hank Paulson, go about their daily adventures in destruction of our savings by debasing our currency, we the fifes can only look upon these actions with disbelief. This is a supposed to be a democracy, yet all these decision take place behind closed door under dubious circumstances and have unknown future consequences. This has gone far enough. We should demand the immediate resignation of Ben Bernanke and Hank Paulson, and start having some transparency in our markets. These ridiculous anti-Capitalism, anti-competitive, anti-free market, Save our Crony friends at any cost policies MUST STOP! Robin Hood, where are you?

Henry Blodget on the Bear Stearns Bailout

Pathetic Bear Stearns Bailout: Who to Blame

Posted Mar 14, 2008 11:44am EDT by Henry Blodget in Newsmakers, Recession
Related: BSC, JPM

From Silicon Alley Insider, March 14, 2008:

Get ready. Now that Bear Stearns (BSC) has been forced to run hat in hand to the Fed and whimper that it's "too big to fail," the mewling is about to begin:

• It's not our fault! It's a run on the bank!

• We never could have seen this coming!

• Blame those jerks who stopped lending us money!

Give us a break. If Bear Stearns goes to zero, there will only be one party to blame: Bear Stearns management.

Yes, companies that live and die on short-term loans (such as every brokerage firm on earth, along with Enron) depend on the cooperation of third-parties. And, yes, when those companies can't roll over their short-term paper, the folks who actually deliver the death-blow are those that refuse to lend them any more money.

But the first responsibility of any brokerage firm management team is to ensure that under no circumstances can the firm be put in a position where its short-term financiers might lose confidence. This is why there is ultimately only one person who is responsible for the Bear firesale: Bear's CEO Alan D. Schwartz.

Meanwhile, who will pay for this bailout? Do you really have to ask?


The Fed has promised Bear Stearns savior JP Morgan (JPM) that it will guarantee the value of whatever crap Bear has piled onto its balance sheet. In other words, the Fed is effectively assuming the liabilities of Bear Stearns. And the Fed's source of capital, ultimately, is you.

London Calling, your credit is not good here. No honor among thieves.

LONDON (Reuters) - Financial market traders across London have been told by their firms to stop dealing with Bear Stearns, sources in several dealing rooms said on Friday.

At least six major institutions in London -- including Commerzbank, Royal Bank of Scotland and JPMorgan -- had stopped giving prices to the U.S. bank, a credit trader at one European institution in London, who declined to be identified, told Reuters.

Credit Suisse had also stopped trading with Bear Stearns, a London-based equities broker said.

None of the institutions named by the traders would comment on the subject when contacted by Reuters.

A London-based government bond trader said banks had been withdrawing from transactions with Bear Stearns since Thursday.

But the London Metal Exchange said that Bear Stearns remains entitled to trade on its electronic trading system Select.

"For as long as Bear Stearns remains a member of the LME and in good standing at the LME's clearing house, LCH. Clearnet, Bear Stearns will remain entitled to trade on LME Select," the LME said in a note circulated to its clearing members. Bear Stearns has more exposure to the U.S. bond markets than its competitors, and has a large mortgage-backed securities business. It was among the first to disclose the impact of the subprime mortgage market meltdown when two of its leveraged hedge funds collapsed last summer, losing $1.6 billion.

Counterparty risks have been steadily rising among the world's major financial institutions for months, distorting prices and leading to fears that other institutions could find themselves unable to trade securities they need to survive.

"You can safely assume that Bear is not alone here," said an interest rate strategist at one European investment bank in London, who declined to be identified.

"We have been setting prices in swaps markets in recent days that were designed to say 'no deal' and at least one other U.S. investment bank -- not Bear -- dealt. That is very worrying if they needed the cash that badly. We have been forced to review our counterparty limits ever since."

(Reporting by Natalie Harrison, Christina Fincher, Mike Dolan and Anna Stablum in London and Peter Starck in Frankfurt; writing by Nick Edwards)


WASHINGTON - The Federal Reserve said Friday that it has voted to endorse an arrangement to bolster troubled Bear Stearns Cos. and stands ready to provide extra resources to combat a serious credit crisis.

The Fed announcement came in a brief two-sentence statement that was issued as stocks were plunging on Wall Street over worries that a plan to ease a liquidity crisis at Bear Stearns Cos. might not work.

"The Federal Reserve is monitoring market developments closely and will continue to provide liquidity as necessary to promote the orderly functioning of the financial system," the board said.

The statement said that the board had voted unanimously to approve the arrangment announced by JP Morgan Chase and Bear Stearns earlier on Friday.

The plan will provide secured funding to Bear Stearns for an initial period of 28 days, seeking to provide short-term relief for Bear Stearns.

Treasury Secretary Henry Paulson praised the Fed's leadership and said that the country's financial system would be able to weather the problems.

"As we have been saying for some time, there are challenges in our financial markets and we continue to address them," Paulson said in a statement. "This is another challenge that market participants and regulators are addressing. We are working closely with the Federal Reserve" and the Securities and Exchange Commission.

Paulson said he appreciated the leadership of the Fed "in enhancing the stability and orderliness of our markets."

The action by the Fed board in Washington represented an endorsement of a rescue effort for Bear Stearns that had already been arranged by JPMorgan and the Federal Reserve's New York regional bank.

It was seen as a last-ditch effort to save the investment bank, which on Friday acknowledged its serious financial problems after a week of denials.

JPMorgan Chase is providing an undisclosed amount of secured funding to Bear for 28 days, backstopped by the Federal Reserve Bank of New York.

The Securities and Exchange Commission issued a statement saying it has been "in close contact" with Treasury, the Federal Reserve and the Federal Reserve Bank of New York during discussions concerning an agreement by J.P. Morgan Chase & Co. to provide a secured loan facility to The Bear Stearns Companies.

"We will continue to work closely together in a way that contributes to orderly and liquid markets," the SEC said.


Feldstein: Bad Recession to come (with inflation).

The United States has entered a recession that could be "substantially more severe" than recent ones, former National Bureau of Economic Research President Martin Feldstein said

"The situation is very bad, the situation is getting worse, and the risks are that it could get very bad," Feldstein said in a speech at the Futures Industry Association meeting in Boca Raton, Florida.

NBER is a private sector group that is considered the arbiter of U.S. business cycles.

Feldstein said the federal funds rate is headed for 2 percent from the current 3 percent. He added that lower short-term rates from the Federal Reserve would not have the same impact in the current downturn, in terms of reviving economic activity.

"There isn't much traction in monetary policy these days, I'm afraid, because of a lack of liquidity in the credit markets," he said.

The Fed's new credit facility, announced on Tuesday, "can help in a rather small way ... but the underlying risks will remain with the institutions that borrow from the Fed, and this does nothing to change their capital," Feldstein noted.

Feldstein noted "powerful forces (that) will continue to drive inflation higher." And while inflation expectations are still relatively well contained, "you wonder how long that's going to last," he said.

Thursday, March 13, 2008

Recession talk on WSJ, plus a few snipes at B.B. at end of story

March 13, 2008
The U.S. has finally slid into recession, according to the majority of economists in the latest Wall Street Journal economic-forecasting survey, a view that was reinforced by new data showing a sharp drop in retail sales last month.

"The evidence is now beyond a reasonable doubt," said Scott Anderson of Wells Fargo & Co., who was among the 71% of 51 respondents to say that the economy is now in a recession.

The Commerce Department said Thursday that retail sales tumbled 0.6% in February; sales excluding volatile auto and parts decreased 0.2%. The decline reflected a sharp slowdown in consumer spending, the primary driver of U.S. economic growth, as Americans grapple with high gasoline prices and the credit crunch, as well as drops in home values and other asset prices.

The survey, conducted March 7 through March 11, marked a precipitous shift to the negative from the previous survey conducted five weeks earlier. For example, the economists now expect nonfarm payrolls to grow by an average of only 9,000 jobs a month for the next 12 months -- down from an expected 48,500 in the previous survey. Twenty economists now expect payrolls to shrink outright. And the average forecast for the unemployment rate was raised to 5.5% by December from 4.8% in the previous survey.

Much of the gloom stemmed from last Friday's employment report, which showed a loss of 63,000 jobs in February, the second consecutive monthly decline. "My recession call comes from the employment data," said Stephen Stanley of RBS Greenwich Capital. "It struck me as a recessionary number."

Twenty-nine of 55 respondents said they expect the economy to contract in the current quarter and 25 expect it to do so in the second. The average of all the forecasts is for meager growth -- just 0.1% at an annual rate in the current quarter and 0.4% in the second.

The Wall Street Journal surveys a group of 55 economists throughout the year. Broad surveys on more than 10 major economic indicators are conducted every month. Once a year, economists are ranked on how well their forecasts have fared. For prior installments of the surveys, see:
Although the classic definition of recession is two consecutive quarters of declines in the gross domestic product, Mr. Stanley pointed out that the National Bureau of Economic Research, the nonpartisan organization that is the official arbiter of when recessions begin and end, doesn't necessarily follow that definition. "If you go back to the 2001 recession, there was only one negative GDP quarter, and there might not even be one negative quarter in this recession," he said.

A WSJ survey of economists reveals that 71% of those surveyed believe Americans are currently in a recession. WSJ's Phil Izzo discusses the findings with Kelsey Hubbard.
The economists also expressed growing concerns that a 2008 recession could be worse than both the 2001 and 1990-91 downturns. They put the odds of a deeper downturn at an average 48%, up from 39% in the previous survey. Mark Nielson of MacroEcon Global Advisors said that "we recognize the previous two recessions were mild and, if a recession does occur, it is likely to be slightly worse than the previous two."

Amid the concerns about the economy, respondents expect more action from the government and the Federal Reserve. Some 63% said the use of public money to deal with the housing crisis is now likely or certain, while on average they expect the Fed to lower its benchmark federal-funds rate to 2% by June from the current 3%.

Futures markets Thursday priced in certainty of at least a 0.5 percentage point cut in the Fed's rate target and up to 90% probability of a 0.75 point cut. Officials had, prior to this week, appeared unconvinced a 0.75 point cut was needed, given signs that inflation psychology is worsening. But those views may have been affected by continued upheaval in credit markets and the weak retail sales and employment data. Market participants say this would be a risky time to cut less than investors expect. The Fed will have to weigh the urgency of addressing the continued credit crunch against the risk of appearing unconcerned about inflation.

However, the Fed's job may be complicated by inflation concerns. The economists raised their average forecast for consumer-price increases to 3.5% by June, up from 2.7% in the prior survey. The change reflects persistently high oil prices and a 4.3% jump in prices last month from the year before. February's CPI data will be released Friday, and economists surveyed by Dow Jones Newswires expect a 4.5% increase from a year ago.

Even as the Fed has made clear that it is most focused at the moment on threats to economic growth, some central bank policy makers have continued to voice concerns about the possibility of resurgent inflation. The central bank has used unconventional methods to boost liquidity in the market; its goal is to limit the use of its bluntest weapon, interest-rate reductions, which can fuel price pressures.

Meanwhile, most forecasters expect a recovery to begin in the second half of this year, as the government's stimulus package and the Fed's interest-rate cuts begin to spur the economy. By the end of the year, the economists expect inflation still to be hovering at an uncomfortably high 2.7%, raising the question of when the Fed will start raising rates.

Some 84% of economists in the survey said the Fed was too slow to raise interest rates in 2003, and policy makers don't want to repeat that mistake. But "it's going to take some time even under the best of circumstances before the Fed can be comfortable that the economic situation has stabilized," said Bruce Kasman of J.P. Morgan Chase.

One thing is clear: The darkening economic outlook has made Ben Bernanke's job less secure, especially with a new president about to enter the White House. The economists gave the Fed chairman just a 59% chance of being reappointed in 2010. "If a Democrat is elected he won't be reappointed, and [presumptive Republican presidential nominee John] McCain may opt for another, too," said David Resler of Nomura Securities. "The problems occurred on his watch," added Ram Bhagavatula of Combinatorics Capital.

Some Critique of Chopper Ben

How a lender bailout hurts the economy
The Federal Reserve's efforts to ease the credit crunch risk stoking inflation - and letting reckless, well-paid execs off the hook. By Colin Barr, senior writer

Bernanke's efforts to shore up troubled lenders may have some negative side effects.
Slippery oil politics

NEW YORK (Fortune) -- The government is showing considerable ingenuity in devising new tactics to fight the credit crunch. But some observers fear that the innovations risk making matters worse - by fueling inflation and insulating executives who made reckless bets from the full wrath of the market.

The Federal Reserve set off a ferocious stock market rally Tuesday with its plan to lend banks as much as $200 billion over 28 days later this month. The plan sent shares of hard-hit lenders such as Fannie Mae (FNM), Freddie Mac (FRE, Fortune 500) and Washington Mutual (WM, Fortune 500) soaring, because the Fed will allow borrowers to use privately issued mortgage-backed securities as collateral. Investors have fled those securities because they see a rising risk that mortgage bonds will become impaired as housing prices slide and defaults tick higher.

Tuesday's plan, dubbed the Term Securities Lending Facility, wasn't the first Fed move aimed at loosening up the debt markets. Late last year the Fed rolled out a similar plan called the Term Auction Facility that briefly succeeded in bringing down the interest rates banks charge one another for overnight loans.

"Think of Ben Bernanke as action hero," Felix Salmon wrote this week at "Every time the credit markets seize up and threaten to bring down the U.S. financial system, he pulls out a new weapon."

Not quite a fan club
Not everyone is a fan of Action Ben, however. David Rosenberg, chief North American economist at Merrill Lynch (MER, Fortune 500), wrote Wednesday that this week's Fed action will do little to counter the impression that Bernanke & Co. is struggling with problems that the Fed ultimately has little control over.

"This latest experiment, as with the others undertaken thus far, does not address underlying credit problems, does not materially improve the solvency of the institutions exposed to assets under stress, does nothing to put a floor under home prices," Rosenberg wrote in a note to clients. "We see no reason based on this for anyone to change their economic or earnings outlook despite the stock market's initial reaction to this latest initiative."

Rosenberg, who has been predicting for some time that the economy will slip into recession this year, expects the Fed to cut its fed funds rate to as low as 1% later in 2008, down from 3% now and 5.25% back in August. Observers expect the rate cuts to continue next week, with a cut as deep as 75 basis points at the Fed's regularly scheduled meeting. But there's little optimism that the cuts will do anything to stimulate demand for houses, which remain pricey by historical measures, or even bring down mortgage rates, which have been rising since the Fed's slashed rate by more than a percentage point over eight days at the end of January.

The fear is that by expanding its emergency lending programs and sharply cutting rates, the Fed will turbocharge already healthy parts of the economy - at the cost of reduced purchasing power by dollar holders. Meanwhile, the big problem - bad loans tied to houses whose value is now declining - continues to fester.

"We're in the helicopter phase now," says Howard Simons, a strategist at Bianco Research in Chicago. He references the nickname Helicopter Ben, which Bernanke got tagged with after a 2002 speech on how central banks can steer away from deflation by dropping money into the economy.

Simons says he appreciates the Fed's need to make sure the economy has sufficient liquidity. But with gasoline prices approaching an all-time inflation-adjusted high and the price of milk having jumped 12% last year, inflation "is a very real concern," Simons says.

Betting on inflation
He points to the action in Treasury Inflation Protected Securities - bonds whose principal amount is adjusted upward when the consumer price index shows inflation and drops when it shows deflation. The yield on five-year TIPS recently turned negative - meaning that investors buying the securities now are accepting a lower interest rater than they would get on comparable Treasury notes, in the expectation of making up the difference in coming years via the inflation adjustment. In essence, they are betting that buying TIPS will shield them from the loss of purchasing power they would suffer over time by holding nominal Treasurys.

David Merkel, chief economist at broker-dealer Finacorp Securities, agrees that inflation is worrisome but adds that the makeup of the current board of governors ensures the Fed will "err on the side of inflation." Along with Bernanke, Fed Vice Chairman Donald Kohn and governor Frederic Mishkin "are students of the Great Depression," Merkel says. "So you're going to see more loosening" of monetary policy when the economy runs into trouble.

Inflation isn't the only worry on the minds of Fed critics. Dean Baker, co-director of the Center for Economic and Policy Research in Washington, says the Term Securities Lending Facility and moves like it amount to a government bailout of corporate executives who made reckless bets - and who should be made to pay the tab with their jobs.

"The Fed's actions are keeping banks from having to write down large losses and quite likely go into bankruptcy," he writes on his blog at the American Prospect. "The result is that the bank executives, whose inept management pushed them into bankruptcy, get to keep their jobs and their salaries, which run into the tens of millions a year." Meanwhile, homeowners facing foreclosure - not to mention ordinary savers who are watching inflation erode the value of their nest eggs - remain quite unbailed-out.

Simons says the whole mess points up the limitations of the Fed. "They're not crisis managers," he says. "There's no playbook for this."

California Home Prices Plunge!

LOS ANGELES - Median home prices plunged in many of California's most populous counties in February, with Southern California leading the slide with an overall drop of 17.9 percent compared to a year earlier, according to new housing data released Thursday.

The drops reflect a deepening housing crisis in the state, which saw home values soar during the housing boom then decline sharply in most areas.

Median home prices fell this year in 15 major counties, DataQuick Information Systems said.

The median price in a six-county area of Southern California fell to $408,000 — the lowest level since October 2004, when it was $402,500. That median is 19.2 percent below the region's peak price of $505,000 last summer, and it's 1.7 percent below January's median, the firm said.

In the nine counties of the San Francisco Bay Area, the median price fell 11.6 percent to $548,000 compared to a year earlier and 17.6 percent from the region's peak median price of $665,000 last summer. Bay Area prices were essentially flat from January.

Home sales volume also kept sliding last month.

Sales fell 39 percent from a year earlier in Los Angeles, Orange, San Diego, Riverside, San Bernardino and Ventura counties. In all, 10,777 homes were sold in February in those six counties, up 8 percent from January, DataQuick said.

Southern California's home sales volume has hit new lows every month since September.

The nine San Francisco area counties saw a similar slowdown, as sales dropped 36.7 percent last month from February 2007.

Some 3,989 homes were sold in San Francisco, Marin, San Mateo, Napa, Alameda, Sonoma, Contra Costa, Santa Clara and Solano counties. That was up 11.2 percent from January.

Even as prices fall, buyers remain slow to dive into the market, with many waiting for prices to fall further.

Others have been unable to find affordable financing because lenders stung by soaring mortgage defaults and foreclosures have cut back on the easy lending that helped propel the housing boom.

The dynamic has worsened the prospects for many homeowners desperate to sell as falling home values drain their equity.

Statewide figures were expected later Thursday.

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Wednesday, March 12, 2008

What financial market participant will act in today's credit markets without transparency? Only a fool!

By Walden Siew

NEW YORK (Reuters) - This week's central bank efforts to unfreeze credit markets will offer only temporary relief and more pain can be expected before a market recovery, analysts said at a credit conference on Wednesday.

The U.S. Federal Reserve announced on Tuesday that it would inject up to $200 billion to strained credit markets as part of a coordinated effort with other central banks, including the Bank of Canada, Bank of England, European Central Bank and the Swiss National Bank.

That effort is likely a short-term solution. Credit markets will likely stay frozen until banks fully realize more losses as they write down their holdings of mortgage-related bonds after years of inflated values for loan and debt securities, panelists said at a credit conference in New York.

Buyers are unwilling to return to credit markets due to a mistrust of credit ratings and a lack of experience among managers of collateralized debt and loan obligations, which is contributing to opaque pricing, according to Janet Tavakoli, president of Tavakoli Structured Finance.

"Most CDO managers aren't worth what they are being paid," said Tavakoli, who referenced billionaire investor Warren Buffett's description of credit derivatives as "weapons of mass destruction" that have wiped out billions of dollars of value.

In addition, too many investors failed to properly analyze assets in collateralized debt structures that are now crumbling, she said during a conference sponsored by the Information Management Network.

Richard Field, founder of financial consulting firm TYI LLC based in Needham, Massachusetts, said greater transparency in pricing is needed before any recovery takes shape.

"Transparency will be the catalyst driving profitable trades," Field said. "The gold standard for transparency is easily accessible and usable real time, standardized loan details, over the life of the deal." While many market observers anticipate that loans may be the first market to recover, James Finkel, chief executive officer of Dynamic Credit Partners, mentioned some trader speculation that the next surprise may come from defaults in the loan market.

None of the speakers on a loan panel said they had immediate concerns about loan defaults.

Steve Odesser, a managing director at Sheridan Capital, however, said it might take years for stability to return to the bond insurer industry, which has been roiled by fears that the sector will be swamped by the collapse of structured debt that it guaranteed.

"My guess is that it will be a couple year process," Odesser said.

Dean Baker with a scathing criticism of Bernanke's Fed Cronies (The American Prospect)

Media Overlook Fed Bailout in Plain View

Can’t the media find any economists who don’t think that handing hundreds of billions of taxpayer dollars to the big banks and the incredibly rich people who own and manage them is a good idea? Apparently not, given the coverage so far to the Fed’s proposal to lend $200 billion to the banks using mortgage backed securities as collateral.

The workings of the Fed and the financial markets can appear complicated, so let’s simplify matters a bit to make it more clear what is going on here. Suppose that it was suddenly discovered that much of the wealth held by the country’s leading financial institutions was in fact counterfeit. Instead of having hundreds of billions of dollars of real currency in their vaults, institutions like Citigroup, Merrill Lynch, and Bears Stearns actually had hundreds of billions of dollars of counterfeit currency. Suppose further that the public did not know exactly who held what in terms of counterfeit currency, only that all of them had a lot of it. (The point here is that these banks hold mortgage backed securities, many of which are only worth a fraction of their face value, and therefore can be viewed as the equivalent of counterfeit currency.)

In such circumstances, investors would be very reluctant to accept the credit of any of the major financial institutions. They couldn’t know whether most of their assets were in fact counterfeit, and they were dealing with a bankrupt institution, or whether the counterfeit currency was only a limited share of the wealth, which would not jeopardize the institution’s ability to meet its obligations.

This is in fact the credit squeeze that we’ve have recently witnessed. The spread between the interest rates on a wide variety of assets and the interest rate on safe assets (U.S. government debt) has soared. As a result, the Fed’s effort to stimulate the economy, by lowering the federal funds rate, has been largely unsuccessful because other interest rates have remained high.

In response to this situation the Fed today announced that it would lend $200 billion to banks and other financial firms, accepting mortgage backed securities as collateral. This is effectively the same as saying that the Fed is going to lend money to banks and accept the counterfeit currency as collateral, treating it just as though it were real money.

The intended effect of this policy is to convince other investors that the counterfeit currency is in fact real currency, or at the very least that there is a really huge sucker out there (the Fed) which is prepared to treat the counterfeit currency as real currency.

So how does this story play out? Well, insofar as the Fed is successful, the counterfeit currency retains its value for a while longer. This allows Citigroup, Merrill Lynch, Bears Stearns and the rest of the big boys more time to dump their counterfeit currency on suckers who haven’t figured out how the game is played.

It is possible that they won’t be able to find enough suckers, in which case these banks will end up defaulting on their loans and the Fed (i.e. the government ) has lost tens or hundreds of billions dollars paying good money for counterfeit currency. Alternatively, perhaps the big boys are successful and can offload enough of their counterfeit money to restore themselves to solvency before the music stops. Then the Fed is repaid, but the counterfeit money now sits in the hands of other, less informed, or less inside, investors.

Either way, this is a policy of dubious merit. Why wouldn’t we want the banks to be forced to come clean and eat their losses? This is always the policy that the economists advocate when the parties in question are not the big New York banks. Does anyone remember the East Asian financial crisis when the media was full of condemnations of crony capitalism and the IMF insisted imposed stringent conditions on South Korea, Thailand, and Indonesia as a condition of getting bailed out? At that time, everyone insisted on transparency. Aren’t there any economists who still have this perspective? If so, why aren’t their views appearing anywhere in the news?

There is one other issue that is extremely important that has been completely omitted from the media’s discussion of the Fed’s actions. There are people who have shorted the counterfeit notes (mortgage backed securities and related assets) because they recognized that these assets were in fact going to lose much of their value. While these short sellers were trying to make money, they were actually performing a valuable public service. They were pushing down the price of these assets towards their true level. If we had many such short sellers in the market we would not have seen the housing bubble grow to such dangerous proportions. The same holds true of the stock bubble.

However, if the Fed acts to sustain bubbles even after they have started to collapse under the pressure of their own weight, it makes it far more risky for short sellers. This means that even investors who realize that Citigroup has nothing but counterfeit currency will be reluctant to short its stock or other assets supported by counterfeit currency. As a result we can expect to see even bigger more dangerous bubbles in the future.

This is not a pretty story and there are economists who can make this point. The media should be talking to them, not just the cheerleaders for the housing bubble.

--Dean Baker

Bernanke and Paulson should let some banks fail, instead of propping them up and regulating them, as they are already heavily regulated.

Paulson, Bernanke to Propose Tougher Scrutiny of U.S. Banks
By Jesse Westbrook

March 12 (Bloomberg) -- Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke and other U.S. regulators will propose tougher scrutiny of banks' capital in a report on lessons from the mortgage crisis, a government official said.

The results of the review by the President's Working Group on Financial Markets may be released as soon as tomorrow, two officials said on condition of anonymity. Paulson is scheduled to speak on financial markets at 10 a.m. in Washington.

Policy makers have said they aim to address deficiencies in how lenders make loans to homebuyers, then package the mortgages into bonds rated by credit ratings firms and sold by securities companies. Consumer advocates and legislators argue that the system failed to ensure that borrowers could repay the loans, and helped deepen a slump that has led to record foreclosures.

``There definitely needs to be broader oversight of the mortgage lending process,'' Paulson said in an interview with Bloomberg Television in Arlington, Virginia, on March 3. Last month, he said ``we need a strong policy response.''

One official, who read drafts of the report, said it will include proposals to strengthen supervision of banks' capital, amid concern they failed to protect against the risks they took investing in subprime securities.

Banks and securities firms posted more than $188 billion of credit losses since the start of last year as the mortgage meltdown rippled through financial markets. As lenders made it tougher to get loans and home values slid, delinquencies climbed.

Casting Blame

Blame for the debacle will be spread among bank supervisors, ratings companies and large banks and securities companies, the official said. Consumer advocates and congressional Democrats have blamed regulators for failing to halt abusive lending practices during the 2004 to 2006 mortgage boom that has now turned to bust.

The President's Working Group is chaired by Paulson and includes Bernanke, Securities and Exchange Commission Chairman Christopher Cox and Walter Lukken, acting chairman of the Commodity Futures Trading Commission.

Fed spokesman David Skidmore declined to comment, as did Treasury spokeswoman Brookly McLaughlin, SEC spokesman John Nester and Dennis Holden at the CFTC.

Marketing Securities

As the housing boom approached its peak, Wall Street firms marketed a new type of security backed by high-interest subprime mortgages issued to borrowers with poor or scant credit history. Standard & Poor's, Moody's Investors Service and Fitch Ratings often gave the assets top AAA ratings.

Investment banks including Bear Stearns Cos., Deutsche Bank AG and Lehman Brothers Holdings Inc. sold $1.2 trillion of the securities in 2005 and 2006, according to estimates by Brian Bethune, director of financial economics for Global Insight Inc. in Waltham, Massachusetts.

The working group will echo a report by U.S. and European regulators released last week, the official said. That release said supervisors are ``critically evaluating'' weaknesses in banks' risk management practices.

``Each supervisor is ensuring that firms are making appropriate changes,'' William Rutledge, head of bank supervision at the Federal Reserve Bank of New York, said in a statement March 6.

To contact the reporter on this story: Jesse Westbrook in Washington at

ECB on Eurozone Inflation.

BERLIN, March 12 (Reuters) - European Central Bank policymakers are "particularly concerned" about inflation and do not see a serious slowdown in the euro zone economy, ECB Executive Board member Juergen Stark said on Wednesday.

Stark said the ECB's main priority was to deliver stable prices and that it did not cooperate with other central banks on monetary policy. "We don't have a double mandate. We have a mandate to guarantee price stability," he said.

"I and the Governing Council of the ECB are particularly concerned about the rate of inflation. This is a very unsatisfactory state of affairs," Stark said in a speech in Berlin on the economic and monetary outlook in the euro zone.

"Our highest priority remains maintaining price stability."

Euro zone inflation is running at a record high of 3.2 percent and the ECB, unlike its U.S. and British counterparts, has kept its interest rates unchanged since U.S. credit troubles started to spill across the Atlantic last summer.

Under its mandate, the ECB aims to keep inflation below but close to 2 percent.

Stark said the U.S. credit woes were rippling out from the United States but not hitting the euro zone too hard.

"So far there has only been a limited impact on the euro zone economy from the turbulence on financial markets," he said. "There is no credit squeeze." Last week, ECB staff raised their forecasts for euro zone inflation and cut the outlook for economic growth.

New staff projections put the Harmonised Index of Consumer Inflation for this year in a 2.6-3.2 percent range, raising the midpoint to 2.9 percent, from 2.5 percent in the last round of forecasts in December.

Growth in the 15-nation region was seen at 1.3-2.1 percent, for a midpoint of 1.7 percent in 2008.

"We are experiencing a slowdown in growth, but not a serious one," Stark said.

Most private-sector economists expect a worsening euro zone growth outlook to cause the ECB to cut rates to 3.75 percent from 4 percent currently before the end of June.

Stark urged trade unions and employers to show wage moderation in the latest pay negotiations and not to react to price rises by agreeing large raises.

"So the appeal to wage negotiators is not to generate second-round effects as this would lead to a wage-price spiral. In any case, the ECB would not tolerate such second-round effects," he said.

Berthold Huber, leader of German industrial union IG Metall, has dubbed 2008 "mega wage year" for Europe's largest economy.

Germany enjoyed its strongest growth in six years in 2006 and slowed only slightly last year, but it has seen virtually no real wage growth in the last two years. Stark took a swipe at politicians who question the ECB's independence.

"I certainly would like to warn against a continuation of any discussion among politicians that calls the independence of the ECB into question," he said.

"Some politicians are at different stages of the learning curve. There is always hope that they will make some progress."

Evolutionary Biologist's take on Spitzer and human monogamy. LA Times.

Want a man, or a worm?

Among mammals, expecting monogamy tends to run against the grain of nature.
By David P. Barash
March 12, 2008
As an evolutionary biologist, I look at New York Gov. Eliot Spitzer's now-public sexual indiscretions and feel justified in saying, "I told you so."

One of the most startling discoveries of the last 15 years has been the extent of sexual infidelity (scientists call it "extra-pair copulations" or EPCs) among animals long thought to be monogamous. It's clear that social monogamy -- physical association and child rearing between a male and a female -- and sexual monogamy are very different things. The former is common; the latter is rare.

At one point in the movie "Heartburn," Nora Ephron's barely fictionalized account of her marriage to reporter Carl Bernstein, the heroine tearfully tells her father about her husband's infidelities, only to be advised, "You want monogamy? Marry a swan." Yet thanks to DNA evidence, we know now that even those famously loyal swans aren't sexually monogamous.

One species that is, and, significantly, perhaps the only one that could be reliably designated as such, is Diplozöon paradoxum, a parasitic worm that inhabits the intestines of fish. Among these animals, male and female pair up while adolescents; their bodies literally fuse together, whereupon they remain sexually faithful until death does not them part.

One of the most important insights of modern evolutionary biology has been an enhanced understanding of male-female differences, deriving especially from the production of sperm versus eggs. Because sperm are produced in vast numbers, with little if any required parental follow-through, males of most species are aggressive sexual adventurers, inclined to engage in sex with multiple partners when they can. Males who succeed in doing so leave more descendants.

A story is told in New Zealand about the early 19th century visit of an Episcopal bishop to an isolated Maori village. As everyone was about to retire after an evening of high-spirited feasting and dancing, the village headman -- wanting to show sincere hospitality to his honored guest -- called out, "A woman for the bishop." Seeing a scowl of disapproval on the prelate's face, the host roared even louder, "Two women for the bishop!"

On balance, the Maori headman had an acute understanding of men. He also reflected a powerful cross-cultural universal: Around the world, high-ranking men have long enjoyed sexual access to comparatively large numbers of women, typically young and attractive. Moreover, women have by and large found such men appealing beyond what may be predicted from their immediate physical traits. "Power," wrote Henry Kissinger, "is the ultimate aphrodisiac."

Power-as-pheromone is pretty much the default among mammals. Elk, elephant seal, baboon or chimpanzee, in a wide array of species, females eagerly mate with dominant males while disdaining subordinates. And they do so, more or less, in harems.

Not surprisingly, before the homogenization of cultures that resulted from Western colonialism, more than 85% of human societies unabashedly favored polygamy. In such societies, men who accumulate power, wealth and status gain additional wives and consorts. In avowedly monogamous cultures, successful males accumulate a wife and often additional girlfriends. Even if, thanks to birth control technology, they do not actually reproduce as a result (and thus enhance their evolutionary "fitness"), they are responding to the biological pressures that whisper within men.

Part of being successful, moreover, is a tendency to feel entitled and often to be uninhibited -- in part because one outcome of our species-wide polygamous history is that successful men have been those who took risks, which paid off. The losers were mostly found among the unsuccessful bachelors who, by definition, did not contribute very much to succeeding generations of men, or to their inclinations.

All of which contributes to the apparent sex appeal of such less-than-stunning physical specimens as Kissinger, Woody Allen and Bill Clinton, not to mention the persistence of sex scandals among the popular and powerful across the political and ideological spectrum, including Thomas Jefferson, JFK, Hugh Grant, Newt Gingrich, Larry Craig and a long list, receding almost to the infinite past as well as likely into the indefinite future. For men at the top -- rock stars, successful athletes, politicians, wealthy CEOs, the jet-set glitterati -- such opportunities are exceedingly numerous, not so much because they have insatiable sex drives but because they are dominant males in a biologically randy species.

Some readers may bridle at this characterization of Homo sapiens as EPC-inclined, but the evidence is overwhelming. That doesn't justify adultery, by either sex, especially because human beings -- even those burdened by a Y chromosome and suffering from testosterone poisoning -- are presumed capable of exercising control over their impulses. Especially if, via wedding vows, they have promised to do so. After all, "doing what comes naturally" is what nonhuman animals do. People, most of us like to think, have the unique capacity to act contrary to their biologically given inclinations. Maybe, in fact, it is what makes us human.

But even a smidgen of evolutionary insight suggests that maleness plus money plus political power isn't likely to add up to the kind of sexual restraint that the public expects. A concluding word, therefore, to the outraged voters of New York state: You want monogamy? Elect a swan. Or better yet, a Diplozöon paradoxum.

David P. Barash, an evolutionary biologist, is professor of psychology at the University of Washington.

Interesting Op-Ed in Washington Post by Steven Pearlstein. P.S. I did not request a bailout at this time.

A Bailout. For Everyone.
Transcript: Pearlstein: Credit Turmoil
This week, it was a $200 billion bond-for-bond swap for the big investment houses.

If they keep this up, pretty soon you'll be able to walk into any Federal Reserve bank and hock that diamond brooch you inherited from Aunt Mildred.

Forget all that nonsense about the Bernanke Fed being too timid or behind the curve. In the face of what is turning into the most serious financial market crisis since the Great Depression, the Fed has been more aggressive and more creative in using its limitless balance sheet -- in effect, its ability to print money -- than at any time in history.

We can argue till the cows come home about whether this is a bailout for Wall Street. It is -- but only to the extent that it is also a bailout for all of us, meant to prevent a financial and economic meltdown that drags everyone down with it. In broad strokes, we're going through a massive "de-leveraging" of the economy, wringing out trillions of dollars of debt that had artificially driven up the price of real estate and financial assets, and, more generally, allowed Americans to live beyond their means. The Fed's goal has not been to impede that process, simply to make sure that it proceeds in an orderly fashion. But even that has required central bank intervention that is unprecedented in scale and scope. And despite yesterday's huge rally in the stock market, Fed officials warn that this de-leveraging is nowhere near finished.

The real action is on the credit markets, where, for the third time since last summer, the price of bonds and other complex securities fell and interest rates rose on everything but U.S. Treasury bonds.

Over the previous month, there had been fresh signs that the economy was sinking into recession: a slowing of the growth in corporate sales and profits, a decline in payroll employment and further deterioration in a housing market already in deep distress. Deeper cracks began to appear in the commercial real estate market. And out of the blue, municipalities and nonprofit institutions found that they could no longer roll over their short-term debt on the auction-rate market.

But the real problem began in late February, as several of Wall Street's biggest investment banks prepared to close their books for the quarter and realized they were looking not only at big declines in profit from issuance of new stocks and bonds and fees from mergers and acquisitions, but also another round of write-offs in the value of their holdings. In response, the banks began to hunker down, instructing their trading desks to raise margin requirements for hedge funds and other customers, requiring them, in effect, to post more collateral on their heavy borrowings.

Thus began a chain reaction in which hedge funds began selling what they could -- largely mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae -- to raise the cash to meet their new margin calls. That wave of forced selling drove down the price of those bonds, which prompted more margin calls and more forced selling. By the end of last week, the interest rate spread on those securities -- the difference between their yield and that of risk-free U.S. Treasury bonds -- had jumped four, five, even 10 times the normal rate.

Among those caught up in the vicious cycle were hedge funds run by such blue-chip names as KKR and Carlyle Group, along with Thornburg Mortgage, a big mortgage lender. News of their troubles swept through Wall Street, heightening the sense of panic, as did rumors that Goldman Sachs was about to post big losses and Bear Stearns was about to run out of cash. Meanwhile, Lehman Brothers announced that it would lay off 5 percent of its staff in what was viewed by many as a first installment of a consolidation that would eventually eliminate 20 percent of the jobs on Wall Street. Analysts began to warn that financial-sector losses from mortgages, commercial real estate, failed takeover loans and other bad gets could reach as high as $1 trillion.

It was against this backdrop that the Fed announced Friday that it would auction $200 billion in additional loans to banks looking for cash to lend or use as reserve capital. By accepting AAA-rated mortgage-backed securities as collateral for the loans, the Fed aimed to restore confidence and trading in that beleaguered market and begin to put a floor under prices.

Then yesterday, the Fed announced that it would swap $200 billion worth of Treasury bills for $200 billion worth of mortgage-backed securities held by the major investment banks that are members of its "prime broker" network on Wall Street. The aim is to take some pressure off the investment banks to raise their margin requirements even more and put a halt to the vicious cycle of selling that begets more selling.

While all this may seem rather remote to most Americans, it has already had a profound effect on the real economy. It has reduced the value of the homes and stock portfolios of millions of American investors, led to a pullback in consumer spending and caused U.S. businesses to cut back on hiring and new investment.

The Fed hopes that by injecting $400 billion of liquidity, it can help restore the more normal functioning of credit markets and encourage banks to lend again rather than hoard their cash. For it is only when bank lending and credit markets have returned to more normal operations, say Fed officials, that the beneficial impact of their interest rate cuts can be transmitted to the economy. And they leave little doubt that, despite a heavy dose of monetary medicine already in the pipeline, they intend to add another dose at their meeting next week.

It's anyone's guess how long this credit crunch will last, but the chances are that we'll have several more market meltdowns and Fed rescues before it's over, probably in the fall. Until then, the dollar will continue to get hammered and stocks will continue their fitful decline. And if the last two financially induced recessions are any guide, it will be well into 2009 before the economy hits bottom, followed a couple of years of slow growth and "jobless" recovery.

Monday, March 10, 2008

Inflation Alert in WSJ

Inflation Alert
March 10, 2008; Page A14
The 1970s was a decade of stagflation -- the concurrence of a rising inflation rate and stagnant economic growth. The U.S. economy has not now reached the double-digit inflation rate (almost 15% by 1981), or the 9% unemployment rate, experienced back then. But the early '70s, not the decade's end, offer the more ominous parallels to today's situation.

With "headline" consumer price inflation (CPI) at 4.3% for the last 12 months, we have now reached the inflation rate that spurred Richard Nixon to impose wage and price controls on Aug. 15, 1971. The controls were certainly the wrong remedy, but the intuition that such a high inflation rate cannot long be tolerated was correct.

Nixon acted because the inflation rate, though declining, remained stubbornly above 4%. What has changed to render 4% inflation tolerable today?

Nothing for those who earn, spend and save the dollar. What is different today is that the Fed now takes food and energy prices out of the inflation measure and instead reports what it calls "core inflation." Thus we're told inflation is only 2.7%.

The original rationale to exclude food was that the Fed should not try to offset weather-induced supply shocks. Energy prices were also excluded because the Fed decided it should not try to offset OPEC-induced supply shocks. The Fed wanted an inflation measure that excluded temporary changes and focused on persistent movements. But arbitrarily excluding major components is not the accepted way to remove volatility, and there is a lively debate among economists within the Fed on alternative techniques. Regardless of the outcome of that technical exercise, the core inflation measure has become a misleading statistic at best. The global food trade mitigates the effects of localized weather events. Rising energy prices are not the effects of one-time supply shocks, but the systematic result of global demand.

Dollar users do not experience "core" inflation. What people purchase every day is precisely what is excluded from the core measure. For parents with growing children, milk, eggs and bread are not optional purchases. For millions of Americans, especially in the West, a long daily commute by car is a reality.

The Bush administration and its supporters have long pondered why it has not received credit for good economic policies. Perhaps this is in part because the benefit of tax cuts has been offset by rising energy prices, and now rising food prices.

The use of the core rate has lulled both the administration and the Fed into complacency, disconnecting them from the experience of ordinary consumers. Until recently, inflation doves pointed to the flat yield curve (long-term interest rates close to short-term ones) to buttress their case that inflation and inflationary expectations are low. But the bond market was slow to pick up on the new era of inflation in the 1970s. Not until 1974-75 did the long-bond yield and the yield curve finally flash an inflation warning signal. From July 1974 to May 1975, the Fed funds/long bond yield spread went from negative 466 basis points to a positive 300 basis points.

Economists Manuel H. Johnson and Robert E. Keleher found that only in late 1977 and early 1978 were "all the key market price indicators [commodity prices, exchange rates and bond yields]" signaling "a significant deterioration of the value of money."

The bond market was late to the game in the 1970s and may once again be a lagging indicator. The retirement savings of millions are meanwhile gradually being confiscated.

The Federal Reserve now confronts a serious economic problem with limited scope for action. Asset prices, especially those linked to housing, are falling. Financial institutions are capital-constrained and risk-averse, and are not lending. Economic growth is flagging. The classic response would be first to reflate the banking system and then the economy. But current inflation is rising. Excess money creation will translate quickly into even higher inflation.

Yet Fed Chairman Ben Bernanke has in recent days promised further interest-rate cuts and monetary largesse. San Francisco Fed President Janet Yellen promised the Fed will tighten later at the right moment -- easier said than done. Charles Plosser, Philadelphia Fed president, was closer to the mark when he recently said "once the public loses confidence in the Fed's commitment to price stability, it is very costly to the economy for the Fed to regain that confidence."

The Fed needs to return to its mandate of controlling inflation. The first step is for the Fed to shed an inflation measure that misleads itself, other policy makers, and the markets. We do not need a rerun of the 1970s. Once is enough.

Mr. O'Driscoll, a senior fellow at the Cato Institute, was formerly vice president of the Federal Reserve Bank of Dallas.

Sunday, March 09, 2008

TIPS investors don't trust the fed on inflation.

TIPS Show Fed Loses Control of Inflation as Yields Go Negative
By Sandra Hernandez and Deborah Finestone

March 10 (Bloomberg) -- Bond investors have never been so sure that the Federal Reserve will lose control of inflation. They're so convinced that they're giving up yields just to buy debt securities that protect against rising consumer prices.

The yield on the five-year Treasury Inflation-Protected Security due in 2012 has been negative since Feb. 29, ending last week at minus 0.16 percent. The notes, which were first sold in 1997, have never before traded below zero. Even so, firms from Deutsche Asset Management to Vanguard Group Inc., the second-biggest U.S. mutual fund company, say TIPS are a bargain.

For the first time in a generation, money managers must come to grips with a central bank that's more intent on spurring the economy than restraining price increases. With oil above $100 a barrel, gold approaching $1,000 an ounce and the dollar at a record low against the euro, TIPS show investors aren't convinced Fed Chairman Ben S. Bernanke will be able to tame inflation once policy makers stop cutting interest rates.

``The way TIPS are trading now, investors believe headline inflation will stay lofty and are willing to give up the real yield for that,'' said Brian Brennan, a money manager who helps oversee $11 billion in fixed-income assets at T. Rowe Price Group Inc. in Baltimore. Prices for the securities indicate ``a real concern of a recession and high headline inflation,'' he said.

Because TIPS pay a principal amount that rises in tandem with the consumer price index, buyers accept lower yields in a bet the inflation adjustment will make up the difference.

Volcker Fed

Investors typically determine what they are willing to receive in interest by deducting the rate of inflation expected over the life of the securities from the rate on a comparable Treasury. Investors can still earn money from TIPS with sub-zero rates because the principal rises with the CPI.

Five-year TIPS yield 2.38 percentage points less than similar-maturity Treasuries. The so-called breakeven rate has risen from a four-and-a-half-month low of 1.89 percent on Jan. 23, the day after policy makers cut their target lending rate by three-quarters of a point to 3.50 percent in an emergency move.

The last time investors were so worried about faster inflation amid slowing growth, Paul A. Volcker presided over a Fed that would raise rates as high as 20 percent to end the stagflation crisis of the 1970s, according to Seth Plunkett, a bond fund manager at American Century Investment Management in Mountain View, California. The firm manages $20 billion.

Fed Forecast

Inflation ``is going to be higher than the Fed's targeted area,'' said Plunkett, whose fund owns a greater percentage of TIPS than contained in the index he uses to measure performance.

In forecasts released last month, the Fed said it expects inflation to accelerate 2.1 percent to 2.4 percent this year, and 1.7 percent to 2 percent in 2009.

TIPS have returned 6.2 percent this year, compared with 3.7 percent from regular Treasuries, according to indexes compiled by Merrill Lynch & Co. Mutual funds that specialize in inflation-linked debt attracted a net $2.87 billion in January, boosting their assets to $47.6 billion, according the latest data available from Financial Research Corp. in Boston. In all of 2007, the funds added a net $3.54 billion.

``TIPS are a really good buy,'' said Bill Chepolis, a money manager who helps oversee $9 billion at Deutsche Asset Management in New York. He bought five-year TIPS in the last six months. ``They're cheap with the Fed continuing to emphasize growth over inflation and inflation continuing to come in higher.''

Too Expensive

Investors seeking a haven from credit-market losses have pushed yields on all Treasuries lower, including TIPS. Five-year nominal notes have dropped 2.07 percentage points since Feb. 1 to 1.52 percent.

``It's crazy,'' said Richard Schlanger, a portfolio manager at Boston-based Pioneer Asset Management, which oversees $44 billion in fixed income. ``You're paying the government to buy five-year TIPS. People are hiding in Treasuries for liquidity's sake because of a lack of liquidity in other markets. Eventually this will pass.''

Record-low TIPS yields also reflect bets on surging commodities. Crude oil futures rose to $106.54 last week and are up 70 percent this year.

Growth in countries such as China and India mean that rising prices for goods including wheat, gold, and oil ``may be a permanent thing,'' said Paul Samuelson, the second recipient of the Nobel Prize in economics who helped popularize the term ``stagflation.'' ``This time it's primarily not made-in-America inflation.''

The Treasury stopped selling five-year TIPS between 1998 and 2003, and resumed auctions in October 2004. In addition to the current five-year security, seven other inflation-indexed notes with up to four years to maturity currently yield less than zero.

Should five-year TIPS continue to have negative yields when the Treasury holds its next sale April 22, federal rules state investors would receive a coupon of zero percent, said Stephen Meyerhardt, a Bureau of Public Debt spokesman in Washington.

``TIPS have performed really well for the right reasons and they will continue to perform well for the right reason,'' said Kenneth Volpert, a fund manager overseeing $14.7 billion in inflation-linked debt at Vanguard in Valley Forge, Pennsylvania.

To contact the reporters on this story: Sandra Hernandez in New York at; Deborah Finestone in New York at

Saturday, March 08, 2008

Double Bubble Trouble by Stephen Roach in NYT op-ed.

AMID increasingly turbulent credit markets and ever-weaker reports on the economy, the Federal Reserve has been unusually swift and determined in its lowering of the overnight lending rate. The White House and Congress have moved quickly as well, approving rebates for families and tax breaks for businesses. And more monetary easing from the Fed could well be on the way.

The central question for the economy is this: Will this medicine work? The same question was asked repeatedly in Japan during its “lost decade” of the 1990s. Unfortunately, as was the case in Japan, the answer may be no.

If the American economy were entering a standard cyclical downturn, there would be good reason to believe that a timely countercyclical stimulus like that devised by Washington would be effective. But this is not a standard cyclical downturn. It is a post-bubble recession.

The United States is now going through its second post-bubble downturn in seven years. Yet this one stands in sharp contrast to the post-bubble shakeout in the stock market during 2000 and 2001. Back then, there was a collapse in business capital spending, a sector that peaked at only 13 percent of real gross domestic product.

The current recession has been set off by the simultaneous bursting of property and credit bubbles. The unwinding of these excesses is likely to exact a lasting toll on both homebuilders and American consumers. Those two economic sectors collectively peaked at 78 percent of gross domestic product, or fully six times the share of the sector that pushed the country into recession seven years ago.

For asset-dependent, bubble-prone economies, a cyclical recovery — even when assisted by aggressive monetary and fiscal accommodation — isn’t a given. Over the past six years, income-short consumers made up for the weak increases in their paychecks by extracting equity from the housing bubble through cut-rate borrowing that was subsidized by the credit bubble. That game is now over.

Washington policymakers may not be able to arrest this post-bubble downturn. Interest rate cuts are unlikely to halt the decline in nationwide home prices. Given the outsize imbalance between supply and demand for new homes, housing prices may need to fall an additional 20 percent to clear the market.

Aggressive interest rate cuts have not done much to contain the lethal contagion spreading in credit and capital markets. Now that their houses are worth less and loans are harder to come by, hard-pressed consumers are unlikely to be helped by lower interest rates.

Japan’s experience demonstrates how difficult it may be for traditional policies to ignite recovery after a bubble. In the early 1990s, Japan’s property and stock market bubbles burst. That implosion was worsened by a banking crisis and excess corporate debt. Nearly 20 years later, Japan is still struggling.

There are eerie similarities between the United States now and Japan then. The Bank of Japan ran an excessively accommodative monetary policy for most of the 1980s. In the United States, the Federal Reserve did the same thing beginning in the late 1990s. In both cases, loose money fueled liquidity booms that led to major bubbles.

Moreover, Japan’s central bank initially denied the perils caused by the bubbles. Similarly, it’s hard to forget the Fed’s blasé approach to the asset bubbles of the past decade, especially as the subprime mortgage crisis exploded last August.

In Japan, a banking crisis constricted lending for years. In the United States, a full-blown credit crisis could do the same.

The unwinding of excessive corporate indebtedness in Japan and a “keiretsu” culture of companies buying one another’s equity shares put extraordinary pressures on business spending. In America, an excess of household indebtedness could put equally serious and lasting restrictions on consumer spending.

Like their counterparts in Japan in the 1990s, American authorities may be deluding themselves into believing they can forestall the endgame of post-bubble adjustments. Government aid is being aimed, mistakenly, at maintaining unsustainably high rates of personal consumption. Yet that’s precisely what got the United States into this mess in the first place — pushing down the savings rate, fostering a huge trade deficit and stretching consumers to take on an untenable amount of debt.

A more effective strategy would be to try to tilt the economy away from consumption and toward exports and long-needed investments in infrastructure.

That won’t be easy to achieve. Such a shift in the mix of the economy will require export-friendly measures like a weaker dollar and increased consumption by the rest of the world, which would strengthen demand for American-made goods. Fiscal initiatives should be directed at laying the groundwork for future growth, especially by upgrading the nation’s antiquated highways, bridges and ports.

That’s not to say Washington shouldn’t help the innocent victims of the bubble’s aftermath — especially lower- and middle-income families. But the emphasis should be on providing income support for those who have been blindsided by this credit crisis rather than on rekindling excess spending by overextended consumers.

By focusing on exports and on infrastructure spending, we might be able to limit the recession. Such an approach might also set the stage for a more balanced and sustainable economic upturn in the next cycle. A stimulus package aimed at exports and infrastructure investment would be an important step in that direction.

The toughest, and potentially most relevant, lesson to take from Japan’s economy in the 1990s was that the interplay between financial and real economic bubbles causes serious damage. An equally lethal interplay between the bursting of housing and credit bubbles is now at work in the United States.

American authorities, especially Federal Reserve officials, harbor the mistaken belief that swift action can forestall a Japan-like collapse. The greater imperative is to avoid toxic asset bubbles in the first place. Steeped in denial and engulfed by election-year myopia, Washington remains oblivious of the dangers ahead.

Stephen S. Roach is the chairman of Morgan Stanley Asia.