We have seen all of this unfold since last August. The stock market recovered its July high by mid-October. In fact, it was even a bit higher. The optimists thought the FED was on top of things when it announced the new, "temporary" Term Auction Facility. It also announced lower federal funds target rate. Happy days were here again. Then reality reasserted itself. Down, down, down the market fell. Take a look at the chart of the S&P 500.

The optimists grab at straws. FED programs are convenient straws.

A LOSS OF CONFIDENCE

We are seeing a broad-based loss of confidence in the American economy. This is affecting just about everything: housing prices ("the great American dream"), the stock market, the international currency market, the commodities market, the municipal bond market, and the banking system. Only the T-bill market seems immune. There has been a rush into T-bills, driving rates below 1.5%. This indicates looming panic in the other capital markets: a flight to safety. This loss of confidence is forcing huge changes in America's capital markets. We are seeing a move from confidence to doubt. Such a move always has a price: an increased risk premium on loans.

The Friday before the FED's announcement, a media story appeared on a looming default by the Carlyle Capital Corporation, the legally separate mortgage investment entity of the giant Carlyle Group, whose investors include George H. W. Bush and the Bin Laden family. Carlyle Capital Corp. could not meet margin calls. The margin call was $400 million.

Understand, this was not the total value of the fund. This was just the initial margin call.

On March 13, the bad news came true. The company could not meet these margin calls. The price of the shares fell by 95% in the Amsterdam market, where it is traded. It announced that it had defaulted on $16.6 billion.

When some poor guy in a Fannie Mae-funded home leaves because he cannot make the monthly payment, this is called walking away. When it is done by a corporation set up on the Channel island of Guernsey, it is not called walking away. It is called going bankrupt.

In July, the fund had tapped the public for $300 million in capital. In July, things were still rosy. The Dow was at 14,000. That was then. This is now.

It sure will!

There will be similar events. Count on it.

Now, we must get to the famous bottom line. Carlyle Capital Corp. was not acting alone. There were "counterparties."

In January, 2005, William Poole, the President of the Federal Reserve Bank of St. Louis, gave a speech on the GSE's: Fannie Mae and Freddie Mac. He sounded a warning.

He ended with a strongly worded warning that the managers of Carlyle Capital Corp. did not take seriously enough.

We are in the early stages of a write-down of assets not seen since the Great Depression. This is going to go into the history textbooks.

The man who predicted this most eloquently was Dr. Kurt Richebächer. He died on August 24, 2007, two weeks after the events he had long predicted began. He regarded the expansion of credit under Greenspan as laying the foundation of the worst post-World War II economic contraction. He seemed like John the Baptist, crying in the wilderness. He seems today more like Jeremiah, the author of Book of Lamentations.

These stories of busted investment companies will continue for the rest of 2008 and well into 2009. My fear is that the stories will get worse as time goes on. Because the financial industry is at the center of this recession, the economy is at great risk. It is one thing for manufacturing firms to go bust in a recession. There are fewer of them these days inside the United States.

We are now seeing huge banks in trouble. When they cease lending, the economy will topple. Declining capital due to credit market defaults will cause banks to reduce lending. They will not be operating on a 32-to-1 ratio.

Economic growth comes mainly from small companies that get big. So does employment. These are the companies that the capital markets generally ignore. Local banks are their source of loans. They will find that when local banks are in the middle of an international credit crisis, loans become very difficult to obtain. I saw this in Texas in the S&L crisis, 1984–87.

If this recession lasts only a year, I will be pleasantly surprised. The recovery will be weak. Why? Because this time confidence in the FED will be at rock bottom. Confidence of the Federal government is already low. Congress is impotent. There will be a new President. None of the candidates inspires confidence in people with money to invest.

CONCLUSION

We hear the phrase "systemic crisis" too often. Systemic crises are real, but they rarely manifest themselves until after time has run out. In the interim, nothing is done to correct them.

The FED is facing what appears to be the early phase of a systemic crisis. The stock market has not reflected this yet. It is slowly declining, with fits and starts. It is not collapsing.

My suggestion is that you do not pay much attention to upward moves in response to new programs offered by the Federal Reserve System. If it could do anything other than inflate the money supply, it would not be coming up with late-night emergency bailouts to be announced just before the opening bell of the New York Stock Exchange.