http://www.msnbc.msn.com/id/14153846/from/ET/

....Debt levels have been much higher than in the Roaring Twenties; the new-fangled tools of structured credit are more opaque: the $415 trillion nexus of derivative contracts is untested. Nobody knows for sure if the counter-parties are able to deliver on vast IOUs, or whether the construct is built on sand.

What keeps Federal Reserve officials turning at night is fear that the "financial accelerator" will now set off a vicious downward spiral. There is a risk of "very adverse economic outcomes," said Fed vice-chair Don Kohn.

Albert Edwards, global strategist at Societe Generale, said the toppling banks are merely a symptom of a deeper rot. "The banks are not the problem. Nor even the grotesquely leveraged funds. The problem is that an economic bubble financed by ridiculously loose monetary policy is unravelling," he said.

"US house prices have a lot further to fall, which will simply crush the global economy. The lesson from Japan in the early 1990s is that the death dance goes on and on and on," he said.

The Fed blundered badly in the Slump, delaying rate cuts for too long. It allowed the money supply to implode.

It is acting with breath-taking speed this time. Rates have already been cut from 5.25pc to 3pc, and will be slashed again this week. New means of showering liquidity on the banking system are being devised each weak.

As luck would have it, the world's greatest expert on the financial causes of depressions - Ben Bernanke - happens to be chairman of the Federal Reserve.

LIKE Noah building his ark as thunderheads gathered, Bill Gross has spent the last two years anticipating the flood that swamped Bear Stearns about 10 days ago. As manager of the world’s biggest bond fund and custodian of nearly a trillion dollars in assets, Mr. Gross amassed a cash hoard of $50 billion in case trading partners suddenly demanded payment from his firm, Pimco.

And every day for the last three weeks he has convened meetings in a war room in Pimco’s headquarters in Newport Beach, Calif., “to make sure the ark doesn’t have any leaks,” Mr. Gross said. “We come in every day at 3:30 a.m. and leave at 6 p.m. I’m not used to setting my alarm for 2:45 a.m., but these are extraordinary times.”

Even though Mr. Gross, 63, is a market veteran who has lived through the collapse of other banks and brokerage firms, the 1987 stock market crash, and the near meltdown of the Long-Term Capital Management hedge fund a decade ago, he says the current crisis feels different — in both size and significance.

The Federal Reserve not only taken has action unprecedented since the Great Depression — by lending money directly to major investment banks — but also has put taxpayers on the hook for billions of dollars in questionable trades these same bankers made when the good times were rolling.....

U.S. consumer confidence fell more than forecast in March as Americans' outlook on the economy dropped to the lowest level since Richard Nixon was in the White House.

The Conference Board's confidence index fell to 64.5, a five-year low, from a revised 76.4 in February, the New York- based research group said today. A separate report showed home prices in January fell by the most on record.

Declining stock and property values have unnerved Americans, heightening concern spending will falter. Without consumers, which account for more than two-thirds of the economy, the slowdown triggered by the collapse in housing and credit markets is likely to deepen in coming months.

``It's a discouraging environment,'' Pierre Ellis, a senior economist at Decision Economics Inc. in New York, said in a Bloomberg Television interview. ``We are almost certainly in a recession. The question is how deep and how long it will be.''

The Conference Board's gauge of expectations for the next six months slumped to 47.9, the lowest since December 1973, when the Watergate scandal rocked the Nixon administration and an embargo by a group of Arab oil exporters was in effect, the report showed.....

CAPITALISM without bankruptcy, it is said, is like Christianity without hell. With recession looming, the air in America's bankruptcy courts is thick with brimstone and the coals are being heated in readiness for the many sad souls whose sin was to borrow too much. After several heavenly years, in which bankruptcies fell to record lows, going bust is back. How bad will things get?

If the debt markets are to be believed, companies could be in at least as much trouble as they were in the previous two downturns, in the early 1990s and at the start of this decade, after the dotcom bubble burst. A leading indicator is the spread between yields on speculative “junk” bonds and American Treasury bonds. A year ago, the spread was only about 280 basis points; the long-term average is around 500 points. This month the spread exceeded 800 points for the first time since March 2003, reaching 862 on March 17th.

The bankruptcy rate (in the previous 12 months) for high-yielding bonds has so far edged only modestly higher, to 1.28% from a record low of 0.87% in November. But most forecasters expect it to rise sharply over the coming months. For instance, Moody's, a ratings agency, predicts that the default rate will rise to 5.4% by the end of this year, mostly due to problems in America. (Moody's also expects a rise in European bankruptcies this year, but only to 3.4%, thanks to lower levels of borrowing and less exposure to economic weakness.)

That is a relatively optimistic prediction, for it would merely return the bankruptcy rate close to its long-term average after an abnormally trouble-free period, and it assumes only a mild recession in America. But if there is a severe recession, the default rate “could go to double figures,” admits Kenneth Emery, head of corporate-default research at Moody's.....

For 20 years, George Soros has challenged the theory that markets, however choppy, always move toward equilibrium.

Now a meltdown has handed him rich evidence that the hypothesis isn't just flawed, it's dangerous.

We are facing the worst financial crisis since the Great Depression, Soros writes in ``The New Paradigm for Financial Markets,'' a book rushed online this week. The culprit, he says, is a misconception that markets can correct themselves, no matter how we short-circuit them with easy money, massive leverage and brain-bending synthetic instruments.

``The belief that markets tend towards equilibrium is directly responsible for the current turmoil,'' the billionaire philanthropist writes. ``It encouraged the regulators to abandon their responsibility and rely on the market mechanism to correct its own excesses.''

His solutions, laid out here in uncluttered prose, range from abandoning some financial instruments to curbing lending to creating an exchange or clearing house for credit-default swaps.

Soros also gives glimpses of the trading strategies he's using to shield his wealth: He has bet against U.S. and European stocks, the dollar and 10-year Treasuries, preferring non-U.S. currencies and equities in China, India and the Gulf states.

This is a deeply philosophical, often frustrating book that refines ideas that Soros has written about before. Parts of it are, by his own admission, hard going.

Credit Godzilla

Yet bankers, hedge-fund managers and regulators should pay heed. For Soros is raising questions that cut to the core of how a credit bubble became a Godzilla that pushed the financial system to the brink, damaged the U.S. dollar and made a recession inevitable.

``This will have far-reaching consequences,'' writes Soros, 77. ``It is not business as usual but the end of an era.''

What we are witnessing isn't your ordinary boom and bust, he says.....

As the U.S. grapples with perhaps the worst financial crisis since the 1930s, many eyes are on Japan. Some analysts suggest that Japan's ``lost decade'' will offer a blueprint to officials in Washington.

More insights may be gleaned from South Korea.

Korea? What in the world could the 12th-biggest economy teach the biggest? Spend some time with Kim Yong Duk, a former deputy Korean finance minister, and it will become clear how Asia's experiences in the late 1990s could inform U.S. officials.

``A lot of the features are similar between the U.S.'s problems and the Asian crisis,'' Kim says. ``In Asia we had reckless lending, reckless investment and excess liquidity spilling over into the economy, bailouts and moral hazard risks. This time we see those same factors in the subprime crisis.''

Kim knows a thing or two about crisis. He recently stepped down from his job as chairman of Korea's Financial Supervisory Commission and was a top Finance Ministry official when the crisis began in 1997. He was nicknamed ``Mr. Won'' for his ability to move currency markets.

After Korea received a $57 billion bailout from the International Monetary Fund there was no time to waste. Weak companies and commercial banks were allowed to fail. Several merchant banks were closed and their employees were fired.....

Many boat owners struggling to jump ship
Weak economy, fuel costs are keeping buyers at bay

Twenty years ago, Ted Forstmann contributed a scathing – and prescient – op-ed to this newspaper warning that the junk-bond craze was about to end badly: "Today's financial age has become a period of unbridled excess with accepted risk soaring out of proportion to possible reward," he wrote in October 1988. "Every week, with ever-increasing levels of irresponsibility, many billions of dollars in American assets are being saddled with debt that has virtually no chance of being repaid."

Within a year, the junk-bond market had collapsed, and within 18 months Drexel Burnham Lambert, the leading firm of the junk-bond world, was bankrupt. Mr. Forstmann sees even worse trouble coming today.

For a curmudgeon, he is a cheerful man. When we met for lunch recently in a tony midtown restaurant, he was wearing a well-tailored suit, a blue shirt and a yellow tie. He spoke with the calm self-assurance of someone who has something to say but nothing left to prove.

"We are in a credit crisis the likes of which I've never seen in my lifetime," Mr. Forstmann warns. He adds: "The credit problems in this country are considerably worse than people have said or know. I didn't even know subprime mortgages existed and I was worried about the credit crisis."

Mr. Forstmann denies being an expert in the capital markets. But he does have some experience with them. He was present at the creation of the private-equity business. The firm he co-founded, Forstmann Little, rode the original private-equity boom in the 1980s while skirting the excesses of the junk-bond craze in the later years. It was for a time the most successful private-equity firm in the world, renowned for both its outsize returns and its caution. For two years after Mr. Forstmann wrote his 1988 op-ed, Forstmann Little sat on $2 billion in uninvested funds, waiting for the right opportunities. Savvy investments in Dr. Pepper and Gulfstream, among others over the years, helped make Mr. Forstmann a billionaire.

These days, he devotes most of his professional attention to IMG, the sports and entertainment agency. But the economy has him worried.....

You have heard that Fannie and Freddie, their gentle names notwithstanding, may cripple the financial system without a large infusion of taxpayer money. You have gleaned that jobs are disappearing, housing prices are plummeting, and paychecks are effectively shrinking as food and energy prices soar. You have noted the disturbing talk of crisis hovering over Wall Street.

Something has clearly gone wrong with the economy. But how bad are things, really? And how bad might they get before better days return? Even to many economists who recently thought the gloom was overblown, the situation looks grim. The economy is in the midst of a very rough patch. The worst is probably still ahead.

Job losses will probably accelerate through this year and into 2009, and the job market will probably stay weak even longer. Home prices will probably keep falling, shrinking household wealth and eroding spending power.....

(Fortune Magazine) -- These are the dog days of summer, the height of our national vacation season. But instead of hitting the beach, people in Washington and on Wall Street are spending their days all atwitter with ideas of what new regulations and rules and controls we need to deal with our financial market meltdowns, the worst since the Great Depression almost 80 years ago.

But let me tell you a little secret, folks. Even though they're scurrying around like everyone else in this game, I think the crisis managers at the Federal Reserve Board and the Treasury have quietly adopted a technique that has helped us deal with previous financial crises - what I call the "play and pray" approach.

They don't teach it in Economics 101, and none of the players dealing with the current meltdown will talk about it on the record. But it's a time-tested strategy - think of the mortgage crisis of the late 1970s and early 1980s, the bank problems in the early 1990s, and the Asian contagion of the late 1990s. The idea: You play for time by keeping things afloat long enough for your prayers to be answered by the markets' turning in the right direction.....

On Sept. 7, 2006, Nouriel Roubini, an economics professor at New York University, stood before an audience of economists at the International Monetary Fund and announced that a crisis was brewing. In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession. He laid out a bleak sequence of events: homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt. These developments, he went on, could cripple or destroy hedge funds, investment banks and other major financial institutions like Fannie Mae and Freddie Mac.

The audience seemed skeptical, even dismissive. As Roubini stepped down from the lectern after his talk, the moderator of the event quipped, “I think perhaps we will need a stiff drink after that.” People laughed — and not without reason. At the time, unemployment and inflation remained low, and the economy, while weak, was still growing, despite rising oil prices and a softening housing market. And then there was the espouser of doom himself: Roubini was known to be a perpetual pessimist, what economists call a “permabear.” When the economist Anirvan Banerji delivered his response to Roubini’s talk, he noted that Roubini’s predictions did not make use of mathematical models and dismissed his hunches as those of a career naysayer.

But Roubini was soon vindicated. In the year that followed, subprime lenders began entering bankruptcy, hedge funds began going under and the stock market plunged. There was declining employment, a deteriorating dollar, ever-increasing evidence of a huge housing bust and a growing air of panic in financial markets as the credit crisis deepened. By late summer, the Federal Reserve was rushing to the rescue, making the first of many unorthodox interventions in the economy, including cutting the lending rate by 50 basis points and buying up tens of billions of dollars in mortgage-backed securities. When Roubini returned to the I.M.F. last September, he delivered a second talk, predicting a growing crisis of solvency that would infect every sector of the financial system. This time, no one laughed. “He sounded like a madman in 2006,” recalls the I.M.F. economist Prakash Loungani, who invited Roubini on both occasions. “He was a prophet when he returned in 2007.”

Over the past year, whenever optimists have declared the worst of the economic crisis behind us, Roubini has countered with steadfast pessimism.....

The global economic decline has only just begun, with the U.S. heading into a recession and the impact of the credit crunch still to be fully felt, said Stephen Roach, Morgan Stanley's Asia chairman.

``There's more to this macro event than just the credit- market contagion itself,'' Roach said in an interview with Bloomberg Television in New York today. ``Maybe two-thirds of that is behind us, but the impacts on the real side of the U.S. economy and the global economy are at an early stage.''

Expansion in the U.S., the world's largest economy, will probably weaken in the second half after a stronger-than- forecast second quarter as rising unemployment and falling home values curb consumer spending. That will slow European and Asian exports and hamper global growth, according to Roach.

``We're in the early stages of the downturn in the U.S. and global business cycle,'' he said. ``As the U.S. consumer goes into post-bubble funk, Asian exporters will feel it. That's certainly evident now in China and it's spreading through developing Asia.''

Roach was proved right earlier this year as weakening expansions in Europe and Japan justified his questioning of the theory that such economies could ``decouple'' from the U.S.'s slowdown. ``The global economy is likely to be a good deal weaker than the decoupling crowd would lead you to believe,'' Roach said in April 2007.....

The U.S. government needs to start using more of its money to support markets to stem a burgeoning ``financial tsunami,'' according to Bill Gross, manager of the world's biggest bond fund.

Banks, securities firms and hedge funds are dumping assets, driving down prices of bonds, real estate, stocks and commodities, Gross, co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co., said in commentary posted on the firm's Web site today.

``Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami,'' Gross said. ``If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury.''

The government needs to replace private investors who either don't have the money to buy new assets or have been burned by losses, Gross said. Pimco, sovereign wealth funds and central banks are reluctant to fund financial firms after losses on investments they made to support the companies, Gross said. The world's biggest banks and brokers have raised $364.4 billion in new capital after more than $500 billion in writedowns and credit losses since the beginning of last year.....

HONG KONG — Tremors from Wall Street are rattling Asian confidence, leading many investors to question the wisdom of being invested in the United States to the tune of trillions of dollars.

Asian investors were starting to show hesitation even before the financial earthquake of the last week. Now, a wariness toward the United States is setting in that is unprecedented in recent memory, reaching from central banks to industrial corporations, from hedge funds to the individuals who lined up here to withdraw money from the American International Group on Wednesday.

Asia’s savings have, in essence, bankrolled American spending for decades, and an Asian loss of confidence in American financial institutions and assets would have dire consequences for both the United States government and American taxpayers.

The potential for panic is stoked by Asian news organizations, which tend to focus more on business and economics than on politics, which can be touchy here. Their coverage has been obsessive and unrelentingly negative about the bankruptcy of Lehman Brothers, Merrill Lynch’s rush to find a buyer and the turmoil at A.I.G.

The nonstop deluge of bad publicity for American investments seems to be seeping into the consciousnesses of the rich and middle class across Asia.....

“THINGS are frankly getting out of hand and ridiculous rumours are being repeated, some of which if I wrote down today and re-read tomorrow, I’d probably think I was dreaming.” So said an exasperated Colm Kelleher, Morgan Stanley’s finance chief, during a hastily arranged conference call on September 16th.

The carnage of the past fortnight may have an unreal air to it, but the damage is all too tangible—whether the seizure of Fannie Mae and Freddie Mac by their regulator, the record-breaking bankruptcy of Lehman Brothers (and the sale of its capital-markets arm to Barclays), Merrill Lynch’s shotgun marriage to Bank of America or, most shocking of all, the government takeover of a desperately illiquid American International Group (AIG).

The rescue of the giant insurer was justified on the grounds that letting it fail would have been catastrophic for financial markets. As it happened, even AIG’s rescue did not stop the bloodletting. On September 17th shares in Morgan Stanley and the other remaining big investment bank, Goldman Sachs, took a hammering. Even though both had posted better-than-expected results a day earlier, confidence ebbed in their stand-alone model, with its reliance on flighty wholesale funding. An index that reflects the risk of failure among large Wall Street dealers has climbed far above its previous high, during Bear Stearns’s collapse in March (see chart)....

James Grant, whose cluttered office at Two Wall Street overlooks Trinity Church, has been warning about financial disaster of one form or another for nearly 25 years. Two years ago, for example, when the now-beleaguered Morgan Stanley was trumpeting a 61 percent jump in profits, Grant wrote a pessimistic analysis titled "over the cliff with Morgan Stanley."

Now much of the financial industry has gone over the cliff. And as one of the most incorrigible bears on the street, the editor and author of the gloomy Grant's Interest Rate Observer should be doing a victory lap and saying "I told you so."

When reached by phone yesterday, Grant tried not to gloat. "What are the costliest words in finance?" he said. "One is 'it's different this time' and the other is 'I told you so.' It brings down the wrath of the gods."

The gods have sent down plenty of wrath already, so much that even Grant admits he has been surprised by the "ferocity and violence" of events that have shaken the financial world over the past two weeks.....

The market was 500 trades away from Armageddon on Thursday, traders inside two large custodial banks tell The Post.

Had the Treasury and Fed not quickly stepped into the fray that morning with a quick $105 billion injection of liquidity, the Dow could have collapsed to the 8,300-level - a 22 percent decline! - while the clang of the opening bell was still echoing around the cavernous exchange floor.

According to traders, who spoke on the condition of anonymity, money market funds were inundated with $500 billion in sell orders prior to the opening. The total money-market capitalization was roughly $4 trillion that morning.

The panicked selling was directly linked to the seizing up of the credit markets - including a $52 billion constriction in commercial paper - and the rumors of additional money market funds "breaking the buck," or dropping below $1 net asset value.

The Fed's dramatic $105 billion liquidity injection on Thursday (pre-market) was just enough to keep key institutional accounts from following through on the sell orders and starting a stampede of cash that could have brought large tracts of the US economy to a halt.....