The Face-Slap Theory

What Greenspan hath wrought
By PAUL KRUGMAN
New York Times

Friday’s employment report — which was so weak that it had many economists declaring that we’re already in a recession — was bad news. But it was actually less disturbing than what’s going on in the financial markets.

The scariest thing I’ve read recently is a speech given last week by Tim Geithner, the president of the Federal Reserve Bank of New York. Mr. Geithner came as close as a Fed official can to saying that we’re in the midst of a financial meltdown.

To understand the gravity of the situation, you have to know what the Fed did last summer, and again last fall.

As late as August the favorite buzzword of financial officials was “contained”: problems in subprime mortgages, we were assured, wouldn’t spread to other financial markets or to the economy as a whole.

Soon afterward, however, a full-fledged financial panic began. Investors pulled hundreds of billions of dollars out of asset-backed commercial paper, a little-known but important market that has taken over a lot of the work banks used to do. This de facto bank run sent shock waves through the financial system.

(Continued here.)