While the major indices moved around considerably, they generally ended the holiday-shortened week little changed. For the week, the Dow, S&P500, Utilities, and Morgan Stanley Consumer index were largely unchanged. The Morgan Stanley Cyclical index added 2%. The broader market was stronger, with the small-cap Russell 2000 and the S&P400 Mid-Cap indices up about 1%. Technology stocks were mixed, with the NASDAQ 100 declining 1% and the Morgan Stanley High Tech and Semiconductors adding 1%. With cash-flow concerns remaining at the forefront, The Street.com Internet and NASDAQ telecommunications indices dropped 3%. The Biotechs were hit with a 5% decline. Financial stocks were relatively quiet, with the AMEX Securities Broker/Dealer and the S&P Banking indices largely unchanged. With bullion jumping $5, the HUI Gold index surged 7%.

Dovish Fed comments helped the Credit market early in the week, although the rally gave way to a barrage of strong data by week's end. For the week, two-year Treasury yields declined 7 basis points to 3.64%. Five-year yields declined 2 basis points to 4.80%, while 10-year yields declined 1 basis point to 5.39%. The long-bond saw its yield decline 1 basis point to 5.80%. Benchmark mortgage-back yields declined 3 basis points and implied yields on agency futures were largely unchanged. The spread on Fannie Mae's 5 3/8% 2011 note narrowed 3 to 70. The benchmark 10-year dollar swap spread was unchanged. The implied yield on the December eurodollar contract declined 8 basis points to 3.92%. The dollar index enjoyed a small gain for the week. UK 10-year government yields declined 2 basis points, with bonds throughout Europe generally outperforming those in the U.S. and UK. Australian bond yields declined 5 basis points to 6.32% and New Zealand yields sank 12 basis points to 6.87%.

Broad money supply had its strongest weekly jump in more than a month, increasing $19.6 billion. Demand deposits were up $6.7 billion, savings deposits added $12.1 billion, and institutional money fund deposits increased $16.6 billion. Repurchase agreements declined $8.4 billion, eurodollars were down $2.8 billion and retail money market funds declined $3.7 billion. This week's same-store retail reports are consistent with recent strength. Bank of Tokyo-Mitsubishi UBSW had year-over-year comparable sales up 4.9%, with Instinet Redbook a bit stronger at up 5.2% y-o-y. The Mortgage Bankers Association's weekly index of purchase applications jumped 6.3% to 330.4, up 13% from one year ago and about 25% above the corresponding week from 1999.

Today's personal income and spending data, once again, came in stronger than expected. Both came in up 0.6%, with expectation of personal income up 0.2% and spending rising 0.5%. For the past twelve months, income is up 2.8%, with income in the services and government sectors up 3.7% and 6.1%, while dropping 4.2% in manufacturing. Spending is up 4% over the past year, with expenditures on services up 4.6% to $4.275 trillion.

The Chicago Purchasing Manager's index increased from 53.1 to 55.7, a stronger than expected performance and the highest level since April 2000. This composite index was at 41.4 in December after reaching its low at 35.6 last March. The New Orders component surged from 59.5 to 62.6 (up 18.7 points in three month) to the highest level since January 2000. Production increased from 55.6 to 57.2, the highest since August 2000. The backlog component has increased 18.5 points in three months to 52.8, the highest level since August 1999. Consistent with other indications of depleted inventories, the Inventory component jumped better than 10 points to 47.9, the highest level since July 2000. The Supplier Delivery component jumped almost 5 points to 52.8, the highest since November 1999. A couple of quotes are worth highlighting what is evolving into a major change in sentiment. This week from a Wall Street analyst: "The manufacturing sector is going to be a driver and a stabilizer pushing the economy upward. The numbers are going to be very strong." Bloomberg quoted the president of Management Recruiters International: "In the last 30 to 60 days, we have seen just a huge increase in activity as far as manufacturing is concerned."

The University of Michigan final March consumer confidence index was reported at 95.7, up 5 points from February to the highest level since December 2000. The expectations component jumped to 92.7, the highest level since November 2000 and up strongly from September's reading of 73.5. Current Conditions rose to 100.4, the strongest reading since last August and up from October's 94. The Conference Board's confidence report was even stronger. Expectations surged from 94 to 109.3 (off of October's low of 70.7), the highest level since September 2000. The Current Situation component jumped from 96.4 to 111.5, the highest level since last September. It is worth describing how expectations shifted during the 1998 financial crisis. Reaching a high of 118.3 in December 1997, the Expectations component then sank to a low of 88.7 during October 1998. Expectations then recovered all the way back to 114.9 by June of 1999 as the economy quickly recovered and overheated.

The confidence numbers are even impressive when viewed by each region. Consumer confidence in New England jumped to 101.5 from 98.3; Middle Atlantic 93.3 from 81.6; East North Central 103.8 from 83.8; West North Central 106.0 from 99.5; South Atlantic 121.0 from 100.8; East South Central 110.1 from 97.0; West South Central 117.6 from 100.8; Mountain 120.7 from 106.6; and Pacific 113.0 from 105.4.

Interesting data was reported from our nation's largest ports in Los Angeles. For the month, 436,681 total inbound containers were received at the Port of Los Angeles and the Port of Long Beach, up 41% year-over-year. The strong jump in business during the month is worth monitoring, as February is normally one of the slowest months of shipments during the year (February 2001 was an unusually slow month for inbound shipments). February inbound shipments were up 13% from January and were the strongest since the pre-holiday shipping rush back in October. For comparison, a combined total of 309,172 containers were received during February 2001, 345,192 in February 2000, and 306,763 in February 1999. Exports jumped 14% month-to-month to 175,734, and were up 13% from Feb. 2001. For comparison, combined container exports were 155,860 during Feb. 2001, 158,454 during Feb. 2000, and 141,074 during February 1999. Comparing February 2002 to February 1999, containers imports have increased 129,918 (42%), while container exports have increased 34,660 (25%). Port of Long Beach data goes back further, and it is interesting to note that containers shipped out empty have increased from 35,884 during February 1997 to last month's 77,374. A total of 185,576 containers were shipped out empty from the two L.A. ports last month, more than were shipped with contents and fully 42% of inbound containers received during the month.

When January's existing home sales data was reported at an annualized rate of 6.5 million I had to force myself not to over-react. Not only was this number basically an "off the charts" new record, it was up 16% from December's level and 13% year-over year. And while this week's number elicited headlines of a 2.8% decline from January, until proven otherwise these numbers are signaling the housing Bubble has gathered even greater momentum. Being cognizant that recent extreme money and Credit excess will fuel this year's inflationary manifestations, it is looking increasingly likely that the housing Bubble could be this year's big story - The Terminal State of Mortgage Finance Excess.

I will admit that the existing home sales data is my favorite economic release each month. For one reason, the data goes back to the 1970s so we have much history to learn from. For example, last month's annualized rate of 5.88 million units can be compared to the 2.2 million pace back in February 1972. An inflationary housing boom then saw sales surge to a rate of about 4 million units from mid-1978 through the third-quarter of 1979. The Fed was forced to slam on the brakes and existing home sales dropped precipitously to a pace between about 1.9 million and 2.3 million during 1982. By late 1986 sales had recovered back to almost 4 million units, and then swung between about 3.1 million and 3.8 million through the end of the decade. The Fed was again forced to hit the brakes. This time the low in housing transactions was established in December 1990 at a rate of 2.8 million units, as the country was preparing for the war with Iraq. The housing market then recovered steadily if unevenly, surpassing 4 million units by late 1993. Average prices posted solid gains, ending 1993 at $130,000, up about 16% from December 1990.

It has since been an incredible housing boom. February's report of 5.88 million was second only to January's, with annualized sales up 10% from last year's strong levels. To put this level of sales activity into perspective, for the first eight "Pre-Bubble" years of the Nineties (1990-1997) existing homes sold during February at an average rate of 3.7 million units. The Bubble Years 1998 to 2001 then saw sales average 5.14 million units, up almost 40% from pre-Bubble volume. February's 5.88 million units, then, was up 57% from the Pre-Bubble years and even 13% above Bubble Years volume.

Also noteworthy, sales are basically at record levels in all regions. Year-over-year, sales are up 16.2% in the Northeast, 13.4% in the Midwest, 8.9% in the South, and 13.2% in the West. Annualized sales of 720,000 units in the East compare to average "Pre-Bubble" volume of 526,250 and average "Bubble" volume of 655,000. In the Midwest, 1.3 million compares to average "Pre-Bubble" volume of 926,250 and average "Bubble" volume of 1.135 million. The numbers in the South and West are worth particularly careful inspection. The South's current 2.29 million rate compares to average "Pre-Bubble" volume of 1.34 million and average "Bubble" volume of 2.003 million. And in the West, 1.58 million compares to average "Pre-Bubble" volume of 911,250 and average "Bubble" volume of 1.35 million. Comparing February's pace of sales to average February "Pre-Bubble" volumes in percentage terms, we see that sales were up 37% in the Northeast, 40% in the Midwest, 71% in the South, and 73% in the West.

Housing inflation is also systemic. February year-over-year prices were up 12.2% to $208,200 in the East, 9.9% to $155,600 in the Midwest, 10.1% in the South, and 6.9% in the West. For the nation, prices were up 9.3% to $190,900. As in the past, we will make our "transaction dollar volume" (TDV) calculation (annualized sales multiplied by average price), providing what we view as the best indication of the monetary impact of the mortgage Credit boom. Multiplying $190,000 by 5.88 million units comes to TDV of a stunning $1.122 trillion. To put this number in perspective, TDV was calculated at $313 billion for December 1990.

National TDV then averaged $473 billion during the "Pre-Bubble" years (3.704 million units at $127,038), only to jump 77% to the February average $840 billion (5.138 million units at $163,125) during the Bubble Years 1998 to 2001. Hopefully, the historic nature of current mortgage Credit Bubble excess is clearly illuminated by comparing current TDV to past calculations. February's annualized transaction dollar volume of $1.122 trillion is up 137% from average "Pre-Bubble" TDV and up almost one-third from the "Bubble Years." Moreover, it really is amazing to see that TDV is up 22% year over year (volume up 11.6% and prices up 9.3%). February's TDV is more than double that from February 1996. I can say no more than what these numbers make obvious: this mortgage Credit Bubble is completely out of control.

Anecdotal signs that real estate markets are strong, and in some cases "on fire", in communities throughout the country is being confirmed by official data. From the Florida Association of Realtors: "Signs of a recovering economy and continued low interest rates contributed to the brisk sales of single-family exiting homes in Florida in February." The number of homes sold was up 10% y-o-y, with median prices up 8% statewide to $131,800. "In 1997, the statewide median sales price was $91,200, resulting in [a] 37.9 percent increase over the five-year period…" Median prices in Miami were up 12% y-o-y to $164,000, 12% in Fort Lauderdale to $179,800, 9% in Naples to $257,000, and 14% to $158,300 in West Palm Beach-Boca Raton.

Recent data from California is alarming. From the president of the California Realtors Association: "The residential real estate market is clearly the bedrock of the California economy. Both sales and the median home price soared to record levels last month." For the month, annualized sales of 610,380 units were up 4.5% from January and an eye-opening 25.5% y-o-y. Conspicuous evidence of an out of control real estate Bubble is found with median prices jumping $47,860 year-over-year, or almost 20% to $289,550. California's February TDV was up a stunning 44% y-o-y. The number of homes listed for sale dropped 14% y-o-y to only 3.2 months supply. Condo prices were up 17.2% year-over-year, with the number of sales jumping 8% from January.

Of the 19 regions reporting, 12 enjoyed double-digit price gains. Central Valley prices were up 17.4%, High Desert 13.7%, Los Angeles 18.8% (to $266,940), Monterey County 13.6% (to $405,000), Northern California 15.1%, Orange County 12.3% (to $369,760), Riverside/San Bernardino 16.9%, Santa Barbara County 35.8% (to $426,670), North Santa Barbara County 32.1% and Ventura 16.5% (to $337,370). Two regions experienced marginal price declines, with prices in Santa Cruz County down 1% to $480,100 and San Francisco Bay prices down a mere 1.8% to $477,130.

The San Francisco Chronicle is reporting a 20% surge in sales activity in the Bay Area. February y-o-y sales activity jumped almost 38% in San Mateo County, 75% in Napa County, 28% in Santa Clara County, and 37% in San Francisco County. "There's obviously been a revival of interest in buying houses in the Bay Area. People have gotten over their concerns and know that interest rates may start to rise. Basically, they want to get off the fence." The median price in San Francisco Country declined 2% to $504,000. The median price throughout the greater San Francisco metropolitan area was $373,000, down 3.4% from the peak established in March of last year. From Kelly Zito's article in the SF Chronicle: "In March 1996, the median home price was $225,000; five years later, in March 2001, the Bay Area median price peaked at $386,000."

From Sue McAllister's article in the San Jose Mercury News: "'We're looking at multiple offers on just about every house that's priced right, said Kathie Kingston, a Coldwell Banker agent in San Jose. 'Between $400,000 and $500,000 they're just flying. I can't keep them on for more than a week.' … "Broker Richard Calhoun of Creekside Realty in San Jose, who crunches home listing data daily, said that the average number of sales a day is higher now than during any March since 1999… Fifty-one homes priced at more than $1 million went into escrow last week… Tales of multiple offers and buyers bidding over a home's asking price are becoming more common. …the brisk sales pace in Palo Alto is in part being driven by 'lots of people from 2000 who sold their stock but they didn't get their house. They were waiting for the market to go down.' About 2,300 houses and condos were for sale in Santa Clara County this week…about 1,000 fewer than last year at this time…"

More confirmation comes from yesterday's article at BayArea.com from Kelly Smolen: Luxury Homes are Selling Briskly in East Bay as Housing Boom Spreads to High End of Market. " '…the trend erupted in San Francisco, where the market's upper echelon 'is going nuts once again with multiple offers.' The surge in interest headed east, to upscale addresses close to San Francisco." Quoting a regional economist from Berkeley: "This is not what I would have predicted."

The San Francisco Chronicle's Kelly Zito quoted a long-time real estate executive: "Real estate has been the No. 1 cocktail conversation here for 25 years. In the last four to five years, it took a backseat to talk about stock options and IPOs. But I guess it's back up in the front seat, because people like to talk about how smart they are for essentially doing nothing, for buying in the right place at the right time."

From Robert Bruss's Q&A column in the San Francisco Chronicle. Question from reader: "My wife and I have bad credit and average income. My FICO score is only 590, and my wife doesn't have much credit, but we are now current on all our bills. However, we realize there is no future in wasting our money by renting an apartment. Is there any hope for us to get a mortgage and buy a modest condo or small house? Answer from Bruss: "Yes. Almost anyone with a decent income can qualify for a home loan. Of course, with your credit problems you won't get the lowest interest rate and best terms, but you can get a home loan to buy a modest starter residence. At the recent National Association of Home Builders convention in Atlanta, both Leland Brendsel, chairman of Freddie Mac, and Franklin Raines, chairman of Fannie Mae (the nation's largest home loan lenders), emphasized how eager they are to make loans to buyers with less than perfect credit. Fannie Mae, for example, has a program for applicants like you. The starting interest rate is a bit high, but if you make your payments on time, the rate and payments will be reduced."

And as long as ultra-easy money stokes the booming nationwide real estate Bubble, we should expect spending to continue to surprise on the upside. Final fourth-quarter GDP was reported yesterday at a stronger than expected annual rate of 1.7%. While numbers look fine on the surface, the detail provides unmistakable evidence of an extraordinarily maladjusted economy. Comparing 4th quarter to 4th quarter, we see that GDP increased a nominal 2.3%. Personal consumption of $7.178 trillion was up 4.5%. By category, spending on "durables" of $909.8 billion was up 11.1%, led by a 22% increase in "autos and parts." "Non-durable" spending of $2.054 trillion was up 1.4%. At the same time, spending on "services" was up 4.7% to $4.215 trillion. By "services" subcategory, "housing" was up 6.3%, "medical care" was also up 6.3%, "recreation" was up 5.4% and "other" services was up 5.3%. While spending on consumption and services was buoyant, "private domestic investment" dropped 14.7% fourth-quarter over fourth-quarter to $1.518 trillion. By category, "non-residential" fixed-investment was down 10.4% (to $1.182 trillion), with "structures" down 8.6% (to $302.5 billion), "equipment and software" down 11.0% (to $879.1 billion). "Residential" investment, however, was up 6.4% to $450.4 billion, with "single family" up 6.6% and "multifamily" up 19.4%. "Government" spending was also very strong, up 6.4% fourth q-o-q to $1.880 trillion. "Federal" spending was up 6.3% to $631.7 billion, while "state and local" spending jumped 6.5% to $1.249 trillion.

Trying to make sense of these numbers, let's keep in mind that spending increased $235 billion fourth-quarter 2001 over fourth-quarter 2000. Personal consumption increased $307 billion, as spending on "durables" increased $91 billion, "non-durables" $28 billion, and "services" surged $187 billion. Government spending increased $114 billion q-o-q. These increases offset a $262 billion decline in "private domestic investment," with "non-residential" down $137 billion and "equipment and software" down $108 billion. It is important to recognize that the past year's weakness was, in fact, quite isolated to capital investment, an area that has become a significantly smaller portion of the overall U.S. economy over the years. If one factors in meaningful increases in consumption and government spending, and then adds in even a moderate recovery in private investment spending, it is then not too difficult to see how growth could easily reach or surpass 4% estimates. I am not saying it is healthy growth; it is clearly anything but.

The bullish consensus is now celebrating the wonderment of the economy's resiliency. Recognizing that household mortgage debt expanded by almost 10% during 2001, there is little mystery as to the fuel behind the continued consumption boom. Overall domestic non-financial debt expanded by 6.0%, while financial sector borrowing grew by 10.8%. The point is that the economy is now getting very little bang for the Credit buck. The critical issues today are not the resiliency of demand or the shallowness of the "recession." Rather, one should part with the rose-colored glasses and ponder the reasons why GDP growth was so meager in the face of continued rampant Credit excess. Furthermore, there is the issue of the very poor performance of the corporate sector in the face of what has so far been the meekest of general economic slowdowns. To look at profits or corporate defaults, one would think we have been in the midst of a most severe downturn.

I posit to readers that what we are experiencing and witnessing is all very consistent with an historic Bubble economy. An out of control financial sector fuels self-reinforcing asset Bubbles (especially in the securities and real estate markets) that sustain consumption and spew purchasing power throughout the maladjusted "service-sector" U.S. economy. Myriad sectoral "sub-Bubbles" operate, with the bursting of the technology debt "sub-Bubble" having strangled that particular sector over the recent past. We will assume that the Fed believed that the technology sector was THE Bubble as the explanation for their major error in over-reacting. Their response to the bursting of a "sub-Bubble" was only to dramatically stoke the Great Credit Bubble. And with the two key and interrelated monetary transmission mechanisms - leveraged speculation in the Credit market and reckless lending throughout mortgage finance - operating on overdrive throughout the past year, there is no mystery whatsoever as to the monetary processes fueling this Bubble economy. But I think we have seen enough to confirm our supposition that this Bubble economy requires enormous amounts of new Credit to muster even marginal growth, while at the same time needing significant growth to mask the deep structural imbalances that have become endemic to the economy. The inherent characteristics of a dangerous Credit-induced Bubble economy then only incite further accommodation of increasingly dangerous Credit excess from our central bankers.

So we are left today rather sure of the dire consequences of any general slowdown in Credit growth. In this regard, we would expect any meaningful interruption in the liquidity generated in our two key transmission mechanisms (Credit market speculation and mortgage finance) to have major financial and economic ramifications. But at the same time, we must keep in mind that IF these processes continue to fuel enormous Credit excess, this Bubble economy will appear to many to be the miracle economy they want to see. If the markets hold, this rebound could surprise on the upside. This is a very fluid situation, and we can envisage several possible and very divergent near-term scenarios. With demand now recovering strongly (if very unevenly), the Credit Bubble has entered a very treacherous environment and we should expect circumstances could change rather quickly. We certainly see the possibility of a final wild speculative run in the Mortgage Finance Bubble as the system following the worst-case scenario.

I went through considerable economic detail in this Bulletin to support my view that the Fed is in serious trouble. I will highlight a few comments made this week from key Fed officials.

"You can analytically reach the conclusion that monetary policy is in a position now that is completely appropriate. At some point in the future, we're going to have to turn the dial a bit. It's just when this process begins and how rapidly it's likely to be that is the real question mark." Robert Parry, president of the San Francisco Federal Reserve Bank and non-voting member of the Federal Open Market Committee.

"We can be deliberative as we approach this issue of when policy has to change and how aggressive it has to be. I don't think inflation shows, or indicates, that there is any imminent problem… I don't feel, at this point, concern about inflation is very high on the list." Robert Parry

On the Fed raising rates: "Frankly I think we have to give the economy some time to evolve before we have to address that. It's too early to make a judgment, and I look with interest at the oncoming data. The data has been surprisingly strong and the recovery seems to be under way." On inflation: "I believe that inflation is at the moment well contained in the U.S. economy." Anthony Santomero , president Philadelphia Fed

"There are a lot of signs things are looking up. Sooner or later the economy gathers momentum and gets stronger, an adjustment will have to be made, but I'm in no hurry." Robert McTeer, president of the Dallas Fed

After all the system has gone through and they still want to believe that consumer price inflation is the key variable. Amazing. So we have the California real estate Bubble - a clear and present danger to the U.S. financial system - appearing to enter a wild state and Dr. Parry from the San Francisco Fed believes current policy is "appropriate" and doesn't see inflation as an issue. Are we to believe that 1.75% Fed funds is appropriate as inflated California home prices inflate at rates of about 20% per annum? Maybe I am asking too much, but I would expect by now that a central banker from San Francisco would be very cognizant of the risks of excessive Credit, speculation, and housing Bubbles. And the academic Dr. Santomero wants to give the economy time to "evolve." He should appreciate that waiting too long to reduce overly accommodative policy is the classic error in central banking. And then there's Mr. McTeer that is absolutely blind to the risk of Credit excess. We should expect much more from a central banker from Texas, especially one that so aggressively promoted the New Paradigm view during the peak of the technology Bubble. Seems to us the Fed has been much too conspicuous with silly dovish comments.

So what's the deal? Clearly, U.S. interest rates are ridiculously inappropriate and becoming more so by the week. Why not just raise them? Is this just continued gross incompetence or more likely obfuscation that comes with the knowledge that the Fed has nurtured momentous speculative leverage and acute systemic risk? Regardless, I remain in utter awe that the Teflon Fed continues to get away with what is becoming a long list of serious policy blunders. They got off Scot-free when the Fed, the GSEs, and Treasury bailed out the U.S. Credit System and Mexico back in 1994/95 that precipitated the fateful boom throughout SE Asia, Argentina, Russia and emerging markets generally. They similarly are beyond reproach when it comes to their and the GSEs' 1998 LTCM bailout and "reliquefication" that fueled the Internet/telecom debt/technology Bubble. The Fed erred once more in over-liquefying going into Y2K, throwing additional gas on the speculative fire that erupted during 2000's first-quarter. The bursting of the resulting technology Bubble only elicited unprecedented Fed accommodation that took the conspicuous Credit market and housing Bubbles to unimaginable dimensions.

We have the easy money-incited frauds and fiascos and Greenspan's policies are not even questioned. Indeed, the Fed continues to receive overwhelming support for keeping the Credit spigot wide open. Just wait until all the shenanigans in mortgage finance and Credit market speculations begin to surface. The Fed says it cut rates as an insurance policy, but then they don't take these cuts back when it becomes clear policy is much too accommodative. They dig deeper into policy abyss and take absolutely no responsibility for anything.

All one has to do is to look at the terrible tragedy unfolding in Argentina to appreciate the profound role that sound money and Credit play in an economy and society. The consequences of losing confidence in a nation's monetary system and institutions are extremely dire. Unlike SE Asia, Argentina does not have a strong export sector that, in conjunction with the U.S. Bubble, played a critical role in the relatively speedy recoveries throughout much of SE Asia after their brush with financial collapse. The Argentine peso has now lost about 70% of its value since the breakdown of its currency board, but this has garnered little trade advantage to its overall economy. They are in the midst of an absolute currency and debt collapse, and it will take many years to rebuild confidence. With this in mind, it is the Fed's total disregard for monetary stability and their accommodating unrelenting Credit and speculative excess that is absolutely inexcusable and infuriating. For Argentina, as long as foreign financial flows were forthcoming the peso looked solid and the currency regime bulletproof. Argentina had all appearances of enjoying a vibrant and healthy economy and financial stability. But it was an illusion of prosperity built on a foundation of Credit and unstable/unsustainable foreign financial flows. When confidence faltered, the game was over. U.S. prosperity has many of the same characteristics.

For too long the Fed has been too willing to bet the ranch that it would be able to maintain its own Confidence Game. Where they buried themselves was in not appreciating the degree of underlying structural distortions to the real economy and the consequences for all the Credit that it would take to sustain such a maladjusted Bubble - Credit for the real economy and financial Credit for the hopelessly leveraged financial sector. Greenspan always figured that he could recapitalize a financial system impaired by a bursting economic Bubble, perhaps not appreciating early on that these operations would incite unprecedented leveraged speculation throughout the U.S. Credit system. He thought the issue was keeping the financial sector liquid and capitalized. Rather, the critical issues were the amount of new Credit required to keep asset Bubbles levitated and a Bubble economy liquid and moving, as well as the acute instability of speculative leverage and foreign-sourced borrowings. What really hooked Alan Greenspan was the incredible power the Maestro could wield using the speculators as a policy tool. No more need to hassle with bank reserves, then wait and hope that the banks would lend and borrowers would borrow. It became, instead, a seductive game of providing speculators cheap finance and heady spreads and watching them aggressively go to work in the securities markets seconds later. It worked marvelously and it was exciting, with the costs hidden for later. For a central banker, playing into the hands of the speculators is selling one's soul to the devil.

One problem with Greenspan selling the soul of our financial system to the leveraged speculating community was that it was so darn easy and seductive. It allowed him and other members of the Fed to give nice speeches, enjoy public accolades, make no difficult decisions, and look the other way to rampant Credit and speculative excess. The Fed may even have begun believing all the praise that Wall Street lavished upon them. And as long as the Fed would provide pegged interest-rates, liquidity assurances, and the promise of no surprises - with GSE expansion all the while creating unending liquidity - the Street celebrated and all seemed to function smoothly. The Greenspan Fed, though, mistook speculator euphoria for a game rigged in their favor for a healthy market of investors approving of sound central bank policies. The Fed made it way too easy and things got completely out of hand. Unfortunately, there were no true statesmen that would rise above it all and explain that things were running amuck; too much money to be made to worry about the public interest.

Somewhere along the line - at least a few years back - the system basically crossed the point of no return, with the leveraged positions in U.S. securities markets becoming too significant to ever liquidate. The Fed's losing trade had become so large that they could only (Nick Leeson-style) keep "trading" and praying for a miracle. They began living a lie that they live to this day. Their losing trade ballooned. The sophisticated speculators well appreciated that the Fed was buried, and hot money rushed from all corners of the globe to profit from the Fed's desperate measures to try to gamble its way out of one hell of a mess.

We operate in a particularly parlous environment for pandering to leveraged speculators. As we've tried to explain, the U.S. financial sector provides an unfettered mechanism for creating financial Credit. The problem, then, of surreptitiously using the leveraged speculating community in accomplishing policy goals is the uncontrolled nature of speculative Credit and the potential for speculative Bubbles to run wild. Run wild they did. A desperate Greenspan made the rules of the game so favorable and, after a decade of conditioning, unprecedented numbers of players with unprecedented access to borrowings were all too anxious to play. But too much money playing the same game always changes the outcome and ends with disappointment. History tells us that crowds playing speculative Bubbles face eventual illiquidity and collapse.

These speculative flows, through the process of stoking asset markets and consumption, may have done wonders for containing the economic slowdown, but they have created an acutely fragile system. We've got a pair of wild speculative Bubbles that are going to be particularly difficult to manage and a terribly maladjusted economy extremely vulnerable to any reduction in speculative Credit. The real estate Bubble and U.S. Bubble economy will be demanding new Credit in such extreme quantities as to impart heightened stress on an increasingly nervous Credit market.

Significantly higher mortgage rates are now needed to cool overheated housing markets, but such rates would crush the speculative players and derivative dynamic hedgers and lead to liquidation and market dislocation. It would seem like the Fed could just call over to Fannie and Freddie managements and have them cut back on their aggressive Credit creation, but the dilemma is that this liquidity is desperately needed in the financial markets. And since mortgage and speculative finance have become the key monetary transmission mechanisms to the real economy, tinkering with the real estate and Credit market Bubbles is especially risky business. The Fed, not surprisingly, is desperate to keep rates low, the speculators in the game, and the housing Bubble expanding. But these artificially low rates stoke excessive demand for borrowing at the same time that the speculators are becoming increasingly nervous. When rates are low and declining, speculative Credit provides endless demand for securities. Rising rates lead to losses, liquidation, and faltering demand for securities. The fatal flaw in using the speculating players as policy pawns is that there always comes a day when the market environment changes and the speculators would prefer to cash in their chips.

The Fed, GSEs and the leveraged speculators have mastered the art of keeping the U.S. financial sector liquid, but it's not so easy to master that flood of liquidity as it acts on the maladjusted Bubble economy. It's been a particularly protracted Bubble and resulting dysfunctional monetary processes have imparted tremendous systemic damage. So it really has become a case where the longer all the hot money stays and plays, the greater the structural damage left to repair. And recognizing how much harm is done in final speculative blow-offs, we could be in the midst of disastrous excess in the terminal stage of the housing Bubble. It just makes it very clear that when the speculative financial flows eventually reverse (as they always do), the nature of the historic U.S. Bubble will be exposed and a rush to the exits will commence. It is also worth noting that now, for the first time in awhile, there are a few games working much better than playing the U.S. Credit market. Gold, a growing list of commodities, and Asian markets come immediately to mind. No longer do the U.S. financial sector and its dollar enjoy the great advantage of being the only game in town. There is absolutely no doubt about it: the environment is changing on several fronts and we see little working to the advantage of the perilous U.S. Credit Bubble.

We'll conclude with a quote underscoring the dimensions of the mortgage finance Bubble: "There is $6 trillion in mortgage debt outstanding. It is an incredible market. That's why when rates go down you have this tremendous boom in mortgage transactions -- last year over $2 trillion in mortgages being recorded because as rates came down the consumer refinanced at an historic rate. This $6 trillion dwarfs the $3 trillion the U.S. borrowed. So the largest debt in the world is the mortgage debt of the citizens of this country." Angelo Mozilo, Chairman Countrywide Credit Industries