The U.S. jobs market appears to be at a turning point.

After more than two years of staggering pain for workers, the latest employment data include signs that a historic wave of heavy job losses may be ending, although only modest gains are expected in the near future.

And even as the economy begins creating those new jobs, the unemployment rate could rise back above 10 percent, say some economists. In any case, it will likely be years before it falls again to “normal” levels or anywhere near the 5 percent where it stood before the recession began in December 2007.

Employers cut fewer jobs than expected in February, despite fears that a major storm would skew the numbers to the downside. The unemployment rate held steady at 9.7 percent as nonfarm payrolls shrank by a mere 36,000 jobs. There was more encouragement to be found in the revisions to the Labor Department’s original estimates for December and January, which 35,000 fewer net job losses than previously reported.

"If we did not have bad weather, then this number would have been solidly positive. It tells me the economy and the jobs market have evolved to the point where we are now ready to produce jobs," said Phil Orlando, chief equity market strategist at Federated Investors in New York.

That would be good news for President Barack Obama and fellow Democrats, who worry that voter anger could cost them in November if the economy doesn’t start putting Americans back to work.

"I'm not going to rest, and my administration is not going to rest, in our efforts to help people who are looking to find a job," Obama said Friday.

But the news about jobs may get worse before it gets better.

That’s because the widely followed unemployment rate may move higher again before it begins a longer-term decline. The reason is the mathematical flip side of the reason it has fallen from its peak of 10.1 percent over the past few months.

The "official" jobless rate represents the number of unemployed workers as a percentage of the work force, as measured by a survey of households. But to be counted in the work force, you have to be actively looking for a job. (Officially, “actively” means at some time in the past four weeks.)

As the job market went from bad to worse in the recession, the labor force shrank by roughly two million, in part because many people stopped looking for work.

“When there are no job opportunities, and there clearly have been no job opportunities over the last couple years, people say, ‘Why am I looking?,” said Mark Zandi, chief economist at Moody's Economy.com. “Some people get severance packages that are pretty good, and they’re saying, 'It doesn’t make sense for them to look. There are just no opportunities.'”

As the economy improves more unemployed workers could join the official work force simply by looking for jobs. That’s not unusual coming out of a recession, Zandi notes, which is why the unemployment rate tends to be one of the last economic indicators to show improvement when the economy begins growing again after a downturn.

With some other economic indicators already flashing green — notably big gains in gross domestic product for the past two quarters — most forecasters expect the recovery to pick up steam. Many believe the economy will soon begin showing a net gain in jobs.

“The February jobs report suggests that the economy is on the verge of creating jobs, and that it will break through to sustained job creation beginning in March,” Nigel Gault, chief U.S. economist at IHS Global Insight, wrote in a note to clients Friday.

That’s not surprising, given the massive government stimulus from hundreds of billions of dollars in emergency spending by the Treasury and the more than $1 trillion in fresh cash the Federal Reserve pumped into the economy. Voters will likely judge those policies by the number of jobs they create, not the impact on other economic data.

And some economists worry about the long-term impact of the stimulus programs.

“The government is going to be hiring workers and going to make (the jobs data) look good in March, April and May, and the government will claim credit for that,” said David Malpass, president of Encima Global, an economic research firm.

“But I don't think the actual programs that they're putting in place are helping at all," said Malpass, a former senior Treasury Department official in the Reagan administration. "If you're a small business, you're looking at a difficult financing environment with a very high tax rate." He said future high taxes will discourage small businesses from hiring.

While many economists believe the job market is getting better, no one is suggesting it’s in good shape. The searing pace of layoffs that sidelined more than eight million people in two years seems to be fading. But for most of those, employment prospects remain terrible.

Part of the reason is that the jobs that were lost may never come back, and the people who lost them may not have the right training for the jobs that are being created

"The trend is getting better for jobs, if you have the skills,” said John Silvia, chief economist for Wells Fargo.

Often overlooked in the discussion about monthly job numbers is that they represent a net figure after many jobs are created and others are eliminated. But the turnover in jobs created and lost remains stubbornly slow, said Malpass.

“There is a lot less dynamism in the economy,” he said. “Normally you have seven million people every quarter getting a job and almost seven million people losing a job. That's way down now in these current quarters.”

The unemployment rate is also expected to remain stubbornly high because this recession has created a pool of unemployed workers so large it could take years to rehire even in the strongest of recoveries.

Even if the economy soon begins creating 150,000 net new jobs a month — a “good” number by historical standards — that will just about keep up with the growth of the population. It will take a much higher level of job growth to have a significant impact on the unemployment rate.

“It’s really related to structural unemployment in terms of losses in housing and finance, Wall Street finance, automobiles and the associated small businesses that create those jobs,” said Bill Gross, head of money manager PIMCO. “It's not a normal business cycle that we're looking at."

The numbers do seem to indicate that the economy — and the job market — are turning a corner. But what’s around that corner?

The potential impact of the snowstorm may have been overstated, by us and other writers and analysts. We based those concerns on the historical pattern the last time there was a big snowstorm during the week the Department of Labor conducts its jobs survey, every month during the week that includes the 12th.

It turns out there were other factors that may have introduced “noise” to this month's number, including the hiring of a large pool of temporary Census workers.

But the revisions to prior months, which showed fewer jobs were lost that originally estimated, is clearly good news. The hope is that the worst of the mass layoffs of last year are behind us. Now the question is: What comes next?

“Better” — at this point — is a relative term. If you take an aspirin to get rid of a nasty headache, you would probably report that you’re feeling “better” if the pain starts to go away, but you still feel groggy.

That’s where we are right now. The searing pain of layoffs that sidelined more than 8 million people in two years seems to be fading. But we are still feel lousy. And it’s far from clear how long its going to take to shake off the illness that gave us the headache to begin with.

That may very well happen. Economist Mark Zandi at Moody’s Economy.com thinks the jobless rate will begin rising again — hitting 10.5 percent by Election Day.

It’s not unusual for the unemployment rate to rise at the end of a recession for the reason you cite. There are something like 2 million people who have left the official count of the workforce in the past two years because they gave up looking for work. As the job market gets better, they will likely re-enter the “official” workforce much faster than the economy creates new jobs.

That means the rate, or the percentage of the now-bigger workforce without jobs, goes up. It's a math thing.

This is the main reason we’re seeing big gains in “productivity” in the economic data. As companies large and small have slashed payrolls, they’ve been asking their remaining workers to pick up the slack left by their former colleagues in a quest to squeeze more profit from every hour worked.

The Labor Department reported Thursday that productivity jumped at an annual rate of 6.9 percent in the fourth quarter, even better than an initial estimate of 6.2 percent growth.

But it’s hard to see how this productive surge will last — there's a limit to how much more work the people who are still employed can do.

Government policies can’t cure a sick economy, but they can help it heal itself. But it’s not always easy to get the right policies in place.

For starters, the “experts” who dream up ideas about what government should do don’t agree. Some have complex mathematical models to prove their point.

Even if those folks could agree on the “right” thing to do, you then have to get these policies through the political process. That’s even tougher to get right.

But government policies play a very important role. Extending unemployment insurance, for example, isn't just the right thing to do — it helps support consumer spending when unemployment is high. That helps blunt the impact of consumers cutting back. Raising taxes in a recession, on the other hand, doesn't help small businesses create new jobs.

What's most troubling to me personally is that the political "debate" over what to do has overshadowed the question of what works and what doesn't. We're all seemingly more interested in assigning blame — based on preconceived ideological biases — than discussing the cause of the problem and working toward real solutions.

Some readers try to discern my own politics based on what I write. All I can say is that I have never registered with, or donated to, any political party. My politics are "fact-based."

I suppose there may be people who don’t want to work – who are happy to have the government pay their bills.

But I have yet to meet an unemployed reader who doesn’t want a job.

I may be naïve, I think it’s a pretty basic human need to have a purpose in life. The vast majority of people I hear from want desperately to go to work, feel like their part of a larger enterprise of some kind and go home at the end of their day feeling that, at the very least, they helped support their household.

The problem that I see is not that people don’t want to work — it’s that to many of them don’t have the skills required to fill the jobs that are out there. That may require a different kind of assistance, but it seems to me it would be an investment well spent. If we don’t invest in our workforce, other countries we compete with are very happy to do so. 

Glenda Green is working harder for less money.

When business fell off at Heinnies Backbarn Restaurant in Elkhart, Ind., after the recession hit, her employer had to cut her hours as a full-time bartender. For over a year, she’s been getting by on a few shifts a week, helping to boost profits by serving food at the bar.

“The owners are working more, the employees are working more ... just to try to even maintain what we were making before,” she said.

Green is one of millions of Americans pressured by a pair of forces that economists say are boosting productivity as companies large and small have slashed payrolls. At the same time, they’re asking their remaining workers to pick up the slack left by their former colleagues in a quest to squeeze more profit from every hour worked.

So far, it seems to be working for companies, at least. For workers and their families? Not so much.

The Labor Department reported Thursday that productivity jumped at an annual rate of 6.9 percent in the fourth quarter, even better than an initial estimate of 6.2 percent growth. The surge in productivity is much stronger than the 3.8 percent gain for all of 2009 and more than triple the 2 percent increase in 2008.

Few economists expect the surge in productivity to last — largely because there is a limit to how much more work the people who are still employed can do. For them, the hope is that as the economy continues on a path of slow recovery and their business begins picking up again, employers will have to hire back some of the more than 8 million people they’ve laid off since the recession began.

“My own hunch is we’re pretty close to the turning point in terms of the labor market,” said Josh Feinman, chief economist at DB Advisors, an asset management group. “And probably in the course of the next few months we’ll see some net hiring.”

But that rehiring has yet to show up in the official numbers. Economists expect Friday’s report on employment for February to show the economy continued to shed jobs last month.

In the meantime, big productivity gains have helped boost corporate profits. In the latest round of quarterly earnings reports, more than 70 percent of companies in the Standards and Poor’s 500 list beat Wall Street’s expectations for profit gains.

But while the corporate bottom line is recovering from the steepest slide since the Great Depression, Americans aren’t seeing it in their paychecks. The same report showed that “unit labor costs," which measures how much companies are paying for the same amount for work,  fell by 5.9 percent, more than the original 4.4 percent drop estimated for the quarter.

Lower labor costs are a reflection of several factors. Even as companies get more work out of their pared-down staffs, they have slowed wage increases for the employees who remain.

Many economists are encouraged by the continued strength in consumer spending, even as wages haven’t kept up. On Thursday, retailers posted their best monthly sales performance since just before the recession started in 2007, as leaner inventories in February brought in sales at full price.

The economic recovery can't survive a continued drop in labor costs forever. Consumer spending generates some two-thirds of U.S. economic activity. Without wage gains, it will be difficult to sustain the growth in consumer spending needed to take up the slack when the federal government stimulus spending wears off later this year.

Most forecasters expect the economy to post weak growth through the rest of the year and into 2011.

"While the economy seems to be picking up some momentum, massive excess capacity in factories and in the labor markets is still the order of the day," said Brian Bethune, chief U.S. financial economist at IHS Global Insight, in a recent note to clients.

Those "slow growth" forecasts make the assumption that companies will begin hiring again and expanding hours for people like Green.

Until then, American households will have to stretch a smaller paycheck even further. For Green, the bartender, the first things to go were the “extras," including dining out and Internet access on her cell phone. But that only goes so far. With savings dwindling, there's another fallback: more borrowing.

“I’ve been able to pay my bills, but I’m racking up credit card debt because my gas and my food, they’re going on my credit cards,” she said.

Lost paychecks for the more than 15 million workers who rank among the unemployed are also weighing on the housing market, which is considered another cornerstone for a solid economic recovery.

After perking up in response to government tax incentives for home buyers, the number of buyers who agreed to purchase a home fell sharply in January. Though sales in the Northeast may have been hurt by a series of winter storms, the weakness showed up throughout the country. It was the lowest reading since last April and a disappointment to economists, who had expected a gain for the month.

Friday’s employment is expected to show another 50,000 jobs lost in February, but economists are giving the report less weight than usual. Some analysts suggest the data may be skewed by a major snowstorm during the week the survey was conducted last month. Those losses could be offset by the ramp-up of temporary Census workers.

But there are early, tentative signs that the job market may soon show signs of improvement. The number of workers filing new applications for unemployment insurance fell last week. On Wednesday, a private trade group, the Institute for Supply Management, reported a modest gain in its hiring index for the services sector, which employs the lion's share of U.S. workers.

A survey released Thursday by a national staffing company, Robert Half International, found 10 percent of the 4,000 executives who responded expect to increase hiring in the second quarter, compared with 6 percent who anticipate cutting jobs. (The vast majority — 82 percent — plan no change in hiring.)

In Elkhart, Green said she just lost out as a finalist for a job as an administrator to a local chief executive. The company had been understaffed for months and the CEO told her he was worried about working the remaining staff too hard and losing good employees.

“They said, ‘We feel we’re wearing our staff thin,’” said Green, "'because if somebody is out on vacation or and somebody is sick, then people have to pick up double and triple duties. And we don’t want to do that to them anymore.’”

The three major snowstorms that have slammed the Northeast so far this winter have been more than just commuting and safety hassles — they may be creating yet another headwind for an already-wobbly economy.

While government data released Friday confirmed that the economy grew at a rapid pace in the fourth quarter of 2009, Old Man Winter is already blowing through results for the start of 2010.

“If we had a better economy, this would be nothing more than a blip on the radar screen,” said Diane Swonk, chief economist at Mesirow Financial. “This economy is on such thin ice that the weather actually matters.”

The economy surged at a 5.9 percent pace in the final quarter of last year, even better than the original 5.7 percent estimate, the government reported Friday.

The bump came from stronger spending by businesses and foreigners, but consumers are apparently losing steam. They increased spending by just 1.7 percent, weaker than first thought and down from a 2.8 percent growth rate in the third quarter.

With economic growth already on a slower-growth path, this winter’s worse-than-normal weather could make things worse. For starters, as “snow days” pile up, worker productivity takes a hit. Washington was shut down for days this month by historic snowfalls that left the region blanketed under record accumulations.

The latest storm dropped more than 20 inches of snow on New York City, Philadelphia and other Northeastern cities, closing schools and offices and clobbering foot traffic to stores that remained open.

Thousands of flights were canceled and heavy delays were reported for flights that made it through the storm. Winds gusted up to 50 mph in Philadelphia, which declared a snow emergency, its fourth of the winter. Amtrak canceled regional trains in upstate New York, and commuter bus service was suspended in northern New Jersey.

Heavy snow didn’t slow the pace of new applications for unemployment benefits, which surged unexpectedly last week, according to government data released Thursday. Even as two blizzards slammed the Mid-Atlantic region last week, dropping record snow and bringing the region to a standstill, claims jumped by 31,000 to a seasonally adjusted 473,000 in the week ended Feb. 13.

A Labor Department official said at least 95 percent of initial claims are now filed on line or by telephone.

One of the biggest impacts could show up in the closely watched monthly report on employment due March 5. That’s because the government’s February employment survey was conducted in the middle of one of the biggest storms of the winter. The last time that happened, in January 1996, the data for February showed a loss of 201,000 jobs after average gains of 143,000 in the previous six months, according to a recent research note from Barclays Capital.

“The 1996 example suggests that there could be severe effects on payroll growth in February from the snowstorms,” said Barclays.

Because so many people were unable to get to work in January 1996, the official size of the labor force also shrank, which left the unemployment rate unchanged. By March, however, the jobs data showed a gain of 705,000 jobs, suggesting that the weather-related impact was temporary.

That 1996 storm introduced noise in other economic data, Barclays noted, including reports on manufacturing production, which posted the sharpest decline in five years, and the Conference Board’s index on consumer confidence, which dropped nearly 11 points. Both rebounded sharply the following month.

With the current economy in much worse shape, weather-related blips in the data will make it even harder for forecasters to get an accurate read on whether the economy is still in gear or slipping back into neutral.

The bad weather also may be hurting the housing market, which is showing resumed signs of weakness, based on the latest data released this week. New homes sales fell last month to their lowest levels since the government began keeping records in 1963. Existing-home sales showed a bigger-than-expected drop.

Tighter credit standards, gloomy consumer sentiment and fears that home prices haven’t stopping falling have hurt housing markets — even those that didn’t see a flake of snow all winter.

But the serial snowstorms haven’t helped according to Milton Ezrati, senior economist at Lord, Abbett.

“The housing market, particularly this time of year, is very sensitive to seasonal (adjustments),” he said. “If not the whole decline, some of it is due to weather. It's overstating the weakness and understating the strength of that market.”

Record snowfalls are pushing some strained state and local government budgets to the breaking point. In Washington, back-to-back snowstorms this month have cost the city’s Metro transit agency an estimated $18 million in decreased ridership and increased snow removal expenses.

Other parts of the country have been hit too. President Barack Obama Thursday decalred a disaster in snow-slammed Nebraska and ordered federal aid to supplement state and local recovery efforts. Damage assessments put storm costs from Dec. 22 through Jan. 8 at more than $8 million, not including the full cost of snow removal.

The impact on businesses from such storms is mixed. Higher sales of snow shovels and windshield scrapers are offset by canceled trips out to dinner.

Airlines and retailers could be among the biggest losers. Retailers that are concentrated in the path of the storms, such as BJ's Wholesale and Dick's Sporting Goods, also are likely take a noticeable hit to first-quarter revenue, analysts say.

Major airlines say it’s too early to put a dollar figure on the storms' impact. But one analyst said February's foul weather would cost them heavily. Robert Herbst, an aviation consultant, said many customers will ask for credits toward future travel instead of refunds. That should work in the airlines' favor.

For shopping malls and department stores, the loss of revenue may be harder to get back.

Dan Hess, CEO of research firm Merchant Forecast, said storms of this winter’s magnitude can trim sales by 10 to 25 percent for the week. When it happens in the slow months of January and February, "you don't make that business back," Hess said.

But the snow isn't all bad news: Snowbound consumers typically turn to shopping online, giving those retailers the prospect of an electronic boost.

Ski resorts, liquor shops and hardware stores also are among the winners as out-of-school kids hit the slopes and grown-ups buy shovels and booze.

At Cairo Wine & Liquor in Washington, co-owner Mitch Aaronson said the storm that dumped two feet of snow on the nation’s capital earlier this month helped tripled sales.

"People (were) even asking us for things we don't sell, like milk," Aaronson said.

Ski resorts are having one of their best snow seasons in years, helping to boost traffic during the Presidents Day holiday week. In Utah, managers at Snowbird were expecting a weaker season because of the slow economy until the storms came.

"We got off to a slow start with low snowfall, but what we're seeing after Christmas is the numbers picking up, especially with destination skiers,” Snowbird Ski and Summer Resort spokesman Jared Ishkanian said this week. ”The word got out when we started to get substantial storms by mid-January — seven feet in seven days."

Closed school and government offices boosted traffic to east coast ski resorts within driving distance of big cities. Heavy snowfall also helped cut the cost of electricity used for man-made snow, said Don MacAskill, general manager of Pennsylvania's Whitetail ski area, located about 90 minutes from Washington.

At Frager's Hardware in Washington's Capitol Hill neighborhood, owner John Weintraub sold out of Duraflame logs and couldn’t restock because his supplier ran out. In Philadelphia, James Crouthamel, a manager at Fairmount Ace Hardware, said sales of rock salt and snow shovels were booming.

The storms have also brought extra work for plumbers and other handymen.

"The day of (a storm) is kind of interesting, with lots of emergency calls," said Sal Mangia at Citywide Sewer & Drain on New York's Long Island. "But after it melts, that's what gives us more work — flooded basements, clogged drains and cesspools backing up."

The economic impact may continue to be felt long after the last of the snow has melted.

Nearly a year after the stock market began one of the biggest rallies in history, investors have begun to worry that this bull may be getting wobbly. There’s no shortage of cause for concern.

When last year’s financial meltdown sent investors hiding for cover, the market’s collapse was swift and ugly. When it appeared that the worst was over, stocks roared back with a 68 percent gain from March lows. 

Now, with government stimulus fading, stubbornly high unemployment and the Federal Reserve signaling that interest rates may begin rising in a few months, investors seem to be having second thoughts.

Until a clearer outlook emerges, the market will likely remain stuck in neutral. Here are six market hazards to keep an eye on.

Corporate profits
The greatest single force driving the price of a company’s stock is its profitability. The news on that front has been outstanding. More than 70 percent of fourth-quarter earnings reports from Standard & Poor's 500 companies came in higher than expected, according to Thomson Reuters data. Overall, profits have returned to roughly where they were before the recession began.

But that's all history. On Wall Street, stocks trade on the prospects for future profits. And it's not at all clear whether the profits we saw in the fourth quarter are sustainable. The gains follow a historic round of layoffs and other cost-cutting combined with massive government stimulus spending and a flood of money from the Fed.

That means companies have been squeezing more profit out of each dollar of sales. Now, investors are looking for convincing signs of growth in those top line sales numbers. And many say they're just not seeing it.

"People, I think, are in a sour mood," said Bob Doll, chief investment strategist at Blackrock, an asset management firm. "They're looking at the glass as half-empty. I think we're going to have to show them some good news to get moods improving."

Recent data on consumer sentiment show just how bad the mood is. On Tuesday, The Conference Board reported that its consumer confidence index dropped sharply to a 10-month low in February after advancing for three months. Worries about the job market were a big reason for the drop, the group said.

The economy
The good news everyone is waiting for will have to come from economic data. For the time being, investors are still waiting.

On Thursday, the market sold off on news that new unemployment claims rose more than expected in the latest week and durable goods orders last month were disappointing. On Wednesday, the government reported that the annual pace of n ew home sales in January plunged to a record low of 309,000 units.

"The data we've seen over the last couple days certainly does not look good," said Warren Meyers, CEO of Wall Street trading firm Walter J. Dowd. "The jobs numbers today was very weak. The housing number yesterday was horrible."

That's a sharp reversal from a string of positive economic data in the second half of last year that fueled market euphoria as the government’s huge spending effort began to restart growth.

The housing market perked up after tax credits were handed out to home buyers; the Cash for Clunkers program helped spur car sales. The good news culminated in a preliminary report that the gross domestic product surged at an annual rate of 5.7 percent in the last three months of 2009.

But a closer look at the numbers has given some analysts pause. More than half the fourth-quarter GDP growth came from companies restocking inventories after slashing them to the bone last year. Overall demand for goods and services has yet to return to “normal” levels.

Wall Street's bulls argue that the economic momentum of the last six months — even it it was the result of a huge stimulus shot in the arm — is strong enough to get the rest of the economy moving ahead once that stimulus spending wears off.

"The vast majority of the information and data suggests we're well into a recovery here in the United States and globally," said James Paulsen, chief investment strategist at Wells Capital Management. "It's not likely to turn back."

No matter what the GDP data show, most investors will want to see solid evidence of a reversal of the massive job losses that have sidelined more than eight million workers since the recession began in December 2007. And that won’t come until government employment data begin showing net gains of 100,000 or so jobs a month.

"Either they're going to show up in the next couple of months or we're going to be talking about double-dip recession again," said Paulsen. "That's where the mentality is going to go."

Housing
Also unclear is whether the housing market has hit bottom and will get back on its feet this spring. Several factors could derail what appear to be early signs of a housing recovery.

One is the overhang of inventory from home foreclosures. Though inventory levels have begun to fall back to relatively healthy levels, some analysts warn of a large “shadow inventory” that isn’t showing up in the official statistics. With roughly one in three mortgage holders owing more than their house is worth, and unemployment near its highest level in a quarter-century,  default rates are expected to remain high into 2011. So far, efforts by the government and lending industry to head off foreclosures just haven’t worked.

The housing market has also gotten major support from the Fed’s huge buying spree of bonds’ backed by home mortgages. The central bank has said it will suspend those purchases when the $1.25 trillion program ends next month. That could send mortgage rates higher. No one knows how high.

Interest rates
The stock market’s record run has also gotten a big boost from the Fed’s “zero” interest rate policy. More than the government’s $700 billion TARP bailout, the policy of letting banks borrow at record low levels has helped the industry repair the giant hole left on its books from the collapse of the housing market. Until there are clear signs the economy is solidly back on its feet, many professional investors expect the Fed to keep rates low.

But Fed policymakers have been signaling that the policy won’t last forever. On Capitol Hill this week, Fed Chairman Ben Bernanke sought to calm concerns over a recent increase in the "discount" rate offered to banks in need of emergency loans.
Bernanke said rates would remain low for some time as a way to cushion the blow from high unemployment.

The Fed has also begun shutting down an alphabet soup of emergency lending programs set up at the depths of the financial crisis in 2009. 

Europe
With one eye on the U.S. central bank, investors have the other on the tough choices facing European bankers, amid rising concerns that Greece may default on its government debt. Larger European countries like France and Germany are reluctant to bail out the free-spending Greeks until they see evidence of tough austerity measures. But a series of strikes in response to calls for wage cuts and tax hikes have cast doubt on those measures.

Opinion is split on the outcome. Bailing out Greece could simply encourage overspending by other Eurozone governments. But if Greece is allowed to default, the worry is that other heavily indebted European countries may not be far behind.

Europe's monetary stalemate also highlights a wider problem weighing on the Eurozone's unified economy as it struggles through the worst downturn since the region consolidated around a single currency a decade ago.

"The problem with a lot of the European countries is they don't have an independent way to  stimulate their economies right now," said Jay Bryson, a global economist at Wells Fargo Securities. "Monetary policy is in the hands of the (European Central Bank). Most of their exports go to each other. They can't devaluate or depreciate their currencies. So you're looking at no way to stimulate the economy."

The dollar
As a result of Europe’s financial strains, global investors have been selling the euro and buying the dollar, boosting its value.

A stronger dollar helps ease upward pressure on interest rates because it helps support demand for dollar-denominated U.S. Treasuries. But if you own stock in a large multinational company that does a lot of business in Europe, the drop in the euro's value dilutes profits when they’re converted back into dollars.

A stronger dollar could also hurt U.S. exporters to European markets, who will lose the price advantage against competitors.

The Federal Reserve is sailing further into uncharted territory as it begins to unwind its trillion dollar-plus intervention in the financial markets and U.S. economy. As Fed Chairman Ben Bernanke and central bank policymakers are finding, this new territory is not unlike a place that early mapmakers would have illustrated with demons and dragons.

In his semiannual economic update to Congress Wednesday, Bernanke fielded questions covering a wide range of the perils the Fed faces as it tries to reverse its unprecedented easy credit policy.

“I’m not in any way minimizing how hard this is,” Bernanke told the panel.

In his remarks, Bernanke walked a fine line between highlighting the Fed's accomplishments and acknowledging the challenges that now confront the central bank.

On the one hand, the Fed is trying to prepare investors and businesses for the prospect of higher interest rates after an unprecedented policy of keeping short-term rates near zero. But with the U.S. economy still in the early stages of a wobbly recovery, the Fed has to tread lightly for fear of spooking investors who worry that higher rates could snuff out the rebound.

Bernanke's vow to keep rates low for some time helped boost stock prices Wednesday after a two-day slide.

Even as it seeks that balance, the Fed is trying to navigate a sea filled with perils over which it has little control. On top of the list is a massive federal deficit worsened by congressional efforts to bail out the banking system and stimulate the battered economy. The Obama administration this month proposed a federal budget that would mean a third straight year of $1 trillion-plus deficits.

Treasury Secretary Timothy Geithner addressed that issue in testimony Wednesday to the House Budget Committee when he said stimulus spending today would help control deficits tomorrow.

"If you care about future deficits — and you have to care about these future deficits — you need to care about economic growth today," Geithner said.

Congress is already at work on another round of spending, this time with the goal of taming a stubbornly high unemployment rate. On Wednesday, the Senate approved another $15 billion package of tax breaks and highway spending to create new jobs. The House has already approved a far bigger jobs package that would cost $155 billion.

Bernanke told the panel that "unemployment is the biggest problem we have" and that the government's stimulus spending so far has helped contain it.

"I think most economists would agree that the stimulus has created jobs relative to where the baseline would have been in the absence of the stimulus," he said.

So far, demand for fresh Treasury debt is holding up. But the worry is that too much borrowing here and around the world could spook investors, who would demand a higher return to lend money to the Treasury.

“It is possible that the bond market will become worried about sustainability (of the deficit) and we may find out self facing higher interest rates,” Bernanke told the House panel.

The Fed has even less control over other market forces that could push rates higher. The list includes the ongoing financial turmoil in Greece, where the government’s efforts to control spending and rein in debt has met strong local resistance. On Wednesday, a rally in Athens protesting spending cuts turned violent as police clashed with a crowd of some 50,000 demonstrators.

Bernanke told the House committee that the Fed has no plans to intervene in the debt crisis.

Greece and the European Union are playing what amounts to a game of chicken: Germany and France, which make up the economic flywheel of the single-currency euro zone, are loath to bail out what they see as the free-spending Greek government. European central bankers also fear that a bailout would only reward bad fiscal policies.

But if Greece defaults on its loans, it could push heavily indebted countries like Spain, Portugal and Ireland closer to the edge and imperil other European economies. It remains to be seen which side blinks first.

Meanwhile, the Fed faces looming perils closer to home, including the threat of increasing defaults on commercial real estate loans.

“It remains the biggest credit issue that we still have,” said Bernanke. 

Unlike a typical home mortgage, commercial property is backed by much shorter-term lending. That means investors and property owners who paid top dollar at the height of the real estate boom in the middle of the decade are now scrambling to refinance those loans as they come due over the next few years.

Commercial real estate values have fallen by as much as a third, leaving many properties under water. Widespread defaults on these loans could put severe pressure on the smaller banks that hold them, further tightening credit and pushing rates higher for home buyers and small businesses.

The Federal Deposit Insurance Corp. Tuesday reported that the number U.S. banks edging toward trouble rose 27 percent to more than 700 in the latest quarter and that troubled loans continued to increase.

The residential real estate market, one of the main engines of the U.S. economy, also faces a number of critical hurdles. One is the pressure from rising inventory of unsold homes, as the ongoing wave of foreclosures brings more houses to market at distressed prices. The government reported Wednesday that new home sales fell to record low levels in January, in part because of the overhang of that “shadow” inventory.

Since the financial crisis began in September 2008, the Fed has been propping up the housing market by pushing mortgage rates lower through a massive buying spree of mortgage-backed bonds. With the bulk of that $1.25 trillion war chest now spent, the Fed has announced it will stop buying mortgage bonds. The hope is that the housing finance market has recovered enough to sustain mortgage rates at current level. A rise in those rates could cut off access to mortgages for many buyers, throwing more cold water on the housing market.

Bernanke was also quizzed about the ongoing drop in lending, especially among smaller community banks that provide the bulk of credit for small businesses that have traditionally been the biggest source of new jobs. The Fed chairman blamed the drop on “both tightened lending standards and weak demand for credit amid uncertain economic prospects.”

The credit contraction presents the Fed with yet another tough call. As long as credit remains tight, the economic recovery will remain weak. But with the financial system still recovering from a lending spree that produced historic losses, bankers are leery of making more risky bets.

A stronger-than-expected uptick in housing starts confirms that the housing market has bottomed out after its steepest slide since the Great Depression. But it’s going to have to do better than that if the economy is to have a sustainable recovery.

Data reported Wednesday show the market is clearly moving in the right direction: Housing starts posted solid gains in January. And with prices down considerably since the market bubble burst in 2006, the "affordability" of homes has improved substantially.

But housing production, at under 600,000 units a year, is still far below the recent peak of more than 2 million at the height of the bubble just four years ago. Meanwhile, millions of homeowners face foreclosure, adding to the enormous supply of unsold homes on the market at distressed prices.

Other recent economic data also point to an economy bouncing along the bottom. A report Wednesday showed that industrial production, as measured by the Federal Reserve, continued to expand in January.
But as of December, the index had only recovered to levels last seen in 2002. That means industrial production now stands where it was eight years ago.

Digging out of that deep economic hole will take years, according to a forecast by Fed policymakers released Wednesday. The central bankers predicted it will take "some time" for the economy and the jobs market to get back to normal. In a previous report, Fed officials suggested it could take five or six years for economic conditions to return to full health. A "sizable minority," however, thinks it could take more than five or six years for a return to normal.

So far government and the lending industry efforts to stabilize head off foreclosures and the housing market have focused on trying to make existing mortgages more affordable by lowering payments and stretching out the payoff date. But the plan just isn’t working.

On Wednesday, the Treasury released the latest monthly figures for its Making Home Affordable program. As of last month, of the millions of homeowners who were supposed to get help, only 116,000 had gotten permanent relief. As more homeowners lose their jobs,  fewer qualify for a loan modification at any level. And so far few lenders have budged on cutting the amount of principal owed.

“The approach right now is we're kicking the can down the road,” said Daniel Mudd, former CEO of mortgage giant Fannie Mae, which was taken over by the government in 2008.

“We’re modifying, we're hoping the modifications work," he told CNBC. "But at some point we're going to have to face the music. And the music is that principal is going to have to be reduced. The mortgagers will have to be on a stable footing. Then we can start to move forward.”

It’s not clear whether foreclosures have yet peaked; some forecasters expect them to increase again this year. Some lenders fear that when a series of foreclosure “moratoriums” expire in the next few months, a backlog of foreclosures may hit the market at once, sending prices lower again, and putting more homeowners under water.

Housing analysts also point to a backlog of so-called “pay option” adjustable-rate mortgages that are due to reset later this year and next to higher payments.  Those resets will add further pressure to financially stressed homeowners trying to keep up.

At least some of the credit for the recent housing recovery goes to government initiatives to support the market, including a homebuyer tax credit and a Federal Reserve program to hold down mortgage rates lower though the purchase $1.25 trillion worth of mortgage-backed bonds.

After home sales perked up last fall as people went shopping in time to beat the first deadline for the tax, Congress extended it through this spring. But the credit may have just moved sales up that would have happened anyway.

“As we get past the expiration of the tax credit and start to look into the summer, things can change quite a bit if some of these government programs are pulled back,” said Paul Puryear, a housing analyst at Raymond James.

The housing industry also is bracing for a possible rise in interest rates after the Fed wraps up its final purchase of mortgage bonds in March. Megan Talbott McGrath at Barclays Capital estimates that every percentage point rise in mortgage rates cuts housing demand by about 8 percent. Once the Fed stops buying, she expects mortgage rates to rise by 1 to 1.2 percentage points by the end of the year

“We don't think it stops growth, but it could keep a little bit of a lid on it,” she said.

Some banks are trying to dampen another wave of foreclosures by moving more aggressively with so-called “short” sales, in which the home buyer sells the home for less than the mortgage amount and the lender forgives the unpaid principal.

“It’s a good idea, given that (lenders) get a higher price overall for housing,” said McGrath. “We think that's a positive and it will help to clear inventory a little bit quicker.”

With one in four homeowners saddled with a bigger mortgage than their home is worth, according to a recent report, short sales may head off even bigger problems for lenders. After years of slogging through a mortgage modification process clogged by multiple logjams, some homeowners are simply walking away from their mortgages. That’s creating even bigger headaches for lenders.

“It's not a pretty picture: Roofs don’t get maintained, appliances get taken out,” said Mudd. “That's the worst thing for everybody. But the short sale puts new buyers on a new footing — in at a value they can afford. That solves the problem.”

Those lower values may help new home buyers, but they continue to hammer the budgets of state and local governments as falling home prices cut deeply into property tax revenues.  Until the housing market recovers, state and local budgets will remain under pressure.

A full-fledged housing recovery will take more than a resolution of millions of underwater mortgages and the unsold inventory of foreclosed homes. Though the housing industry seems to have found a bottom, it has a long way to go before returning to “normal” levels.

No one is expecting a return those boom year levels anytime soon. But without a substantial rebound in home building, the rest of the economy will likely remain stuck in neutral.

The economic numbers are certainly moving in the right direction. Both housing starts and industrial production are up from last month. Other data show a slow but steady improvement from the depths of the recession.

But housing and production, for example, are still far below where they were when the recession began in December 2007. The Federal Reserve’s index for industrial production – tied to a benchmark set to the level of production in 2002 - didn’t hit 100 until December. Last month’s reading was 101.1. That means that industrial production is just now climbing back to where it was eight years ago.

So until these numbers get back to where we were before the recession began, growth won't feel like recovery. Especially to the 8 million people who lost their jobs to the recession.

No doubt a lot of people are hunkered down. And that will certainly help them "weather the storm." But the storm won't be over until the housing market begins a convincing, sustained recovery. Here's why:

There are a couple of reasons housing is so vital. In any down cycle, housing often leads the rest of the economy out of a recession. In a recession, home sales fall, but demand continues to grow with as the population expands. So when the recovery begins, that pent-up demand helps give the housing industry a nice boost, increasing sales of building supplies and putting construction workers back to work.

There’s a second boost that comes from sales of all the things that people need when they buy a new home: furniture, kitchen appliances, TVs, etc. Increased sales of those products puts people back to work (though many of those jobs are now overseas) and generates profits for the companies that sell and distribute those products locally. All of that increased activity has a cumulative effect: more sales generate more jobs, which give people money to buy more stuff, which gets the rest of the wheels turning. Consumer spending still makes up two-thirds of U.S. GDP.

Housing is certainly one of the big obstacles, for the reasons cited above. The government is already playing a big role - now that it has taken over the agencies that finance housing: Fannie Mae and Freddie Mac. The best thing the government could do now would be to clear the books of those two entities of bad loans - write them down and take the loss - to get housing finance started again.

Restarting the housing market is especially critical because this housing recession has cut much more deeply into the economy than any in memory. That’s because the value of homes has fallen so far since the peak. There are many reasons for this: housing appraisers cutting corners and inflating prices; mortgage brokers getting paid to write loans whether or not the money was paid back; Wall Street bankers selling bonds backed by those mortgages without taking on the risk they wouldn’t get paid back, etc.

Unfortunately, that seems to be where we're headed. Beginning last fall, many lenders instituted a hold on foreclosure while they tried to modify loans and keep people in their homes. As those "moratoriums" expire later this year, the risk is that a back load of foreclosed homes comes on the market. Some lenders I've spoken with call this "the 180-day bubble."

The approach taken by the government and the lending industry has been to try to modify loans – lowering payments and stretching out the payoff date – to try to make the mortgage affordable. It just isn’t working. We’re on the third program and all of the tweaking in the world won't fix it.

Of the millions of homeowners who were supposed to get help, maybe 100,000 have gotten permanent relief. The result is that we’re “kicking the can down the road” – just delaying the inevitable day when the house has to be sold at the market price and the lender, investor or homeowner – or all three – gets hit with another loss.

Pushing the problem into the future also just postpones the day when the housing market stages a convincing recovery. If millions of mortgages are unsustainable, and those homes have to be sold at distressed prices, the price of everyone else’s house will keep falling until the market is cleared of all that excess supply.

The tax credit certainly helped - home sales perked up last fall as people went shopping in time to get the credit. But the credit doesn't address the fundamental problems of the housing market. Until those are addressed, it's likely that we're just seeing sales moved up in time that would have happened anyway.

My personal view is that the experience of the last three years has provided a better antidote to "moral hazard" than any government program or new law. Anyone who has lived through a home foreclosure has gotten about the harshest lesson imaginable on the dangers of getting overextended.

I also happen to think that the primary cause of the collapse was not people deliberately loading up on debt with the idea that they would never pay it back. There is just too much evidence of predatory lending - and a complete dismissal of lending risk by mortgage brokers, lenders' investors, etc.

I would be more concerned with the issue of moral hazard as it relates to bankers. To prevent this from happening again, we need to make sure that the people who put up all the money to buy these overprice houses bear the consequences of ignoring risk.

But with the TARP bailout - and the Fed's unprecedented efforts to hold rates at zero (where banks can't lose money), the banking industry has no reason not to go on a rogue lending spree again.

The best case is that we keep gradually coming out of the worst housing recession in a lifetime. Prices have come down considerably and the "affordability" of homes has improved substantially. This case assumes that most of the fraudulent appraising and predatory lending has been washed out of the system. And that the Fed can keep mortgage rates low for the next several years.

The worst case is that foreclosures continue to rise this year, mortgage rates go up after the Fed stops its $1.25 trillion program of buying mortgage bonds in April, unemployment keeps people from qualifying for new mortgages to buy a home and the market gets hit with another wave of "pay option" adjustable mortgages that push more homeowners over the edge.

Those are the extremes. I don't have a crystal ball to tell you which one will happen.

The government’s report on the job market in January offered fresh hope that the economy is at last pulling out of its worst downturn since the Great Depression.

For the estimated 8.4 million people who lost their jobs to the recession, however, the data offered little cause for celebration.

Friday’s report left many economists, investors, employers and job seekers scratching their heads. The Bureau of Labor Statistics found in its survey of large employers that some 20,000 jobs were lost overall in January. But the separate survey of households showed a gain of more than a half-million jobs, which pushed the jobless rate down sharply to 9.7 percent from 10 percent.

The report also included a number of adjustments, including a revision of last year’s data that showed the economy shed 1.4 million more jobs last year than originally reported.

The speed with which companies shed jobs last year dramatically outpaced the last three recessions. Two years after the recession began in December 2007, U.S. payrolls shrank by 6 percent — double the contraction seen in the 1981-82 recession. Some forecasters think last year’s historic spree of layoffs means the economy is poised for a surge in job growth as the recovery takes hold this year.

“What we saw during the recession was that firms were much more aggressive, much quicker to shed workers, and that's why productivity was so good during the recession,” said former Federal Reserve Gov. Laurence Meyer. “In our view, that's going to reverse now, and firms are going to increase employment more than you would otherwise expect from the growth in output.”

There were some early signs of that in the January data, including a nice pick-up in temporary jobs and a drop in the number of people who told the BLS they were working part-time but wanted a full-time paycheck.

“I think if we just have a little patience here within the next three to six months we're going to be seeing substantial job gains," said Michael Darda, chief economist at MKM Partners.

But most of the 8.4 million workers sidelined by the recession will likely need to wait more than six months to get back to work. The economy needs to create 100,000 to 125,000 jobs a month just to keep up with the growth of the population.

“I don't think we're close yet to even a stable rate at this point,” said Mark Zandi, chief economist at Moody’s Economy.com. “We have yet to see any hiring. Until we get real, positive, substantive job growth, it's hard to conclude this is a self-sustaining economy."

Even if job growth returns to the pace of the boom years in the middle of the last decade, it would take years to create the millions of new jobs needed to bring employment back to pre-recession levels.

“Getting those jobs back is going to be very difficult,” said William Gross, a founder of investment manager PIMCO. He pointed out that a third of the jobs lost were in fields related to the housing boom, including construction workers and real estate agents. "Those jobs aren't coming back.”

It also remains to be seen whether the economy will continue moving forward even after massive government stimulus spending begins to fade later this year. The hope is that the surge in public spending will the keep the wheels of the economy turning, including business investment, consumer spending and export manufacturing.

So far, the plan seems to be working. The economy surged ahead at a strong annual rate of 5.7 percent in the fourth quarter of last year, as measured by gross domestic product. But the growth pop was largely based on the large checks written by the U.S. Treasury and other governments around the world, according to Gross.

“The minute that that check disappears, the private market is standing very lonesome and on its own legs,” he said. “The government is withdrawing because citizens and politicians are basically saying, enough is enough.”

Concerns about the swollen federal budget deficit and rising national debt may also curb enthusiasm on Capitol Hill for White House proposals to boost jobs. The latest package would include yet another extension of unemployment benefits to cope with the large pool of workers who have been out of a job for more than 27 weeks. That number rose to 6.3 million in January, up from 1.3 million when the recession began.

The impact of federal spending has been blunted by several factors weighing on economic growth. Though credit has begun to ease somewhat, lenders and investors are still extremely skittish about lending after losing hundreds of trillions of dollars in bad bets on faulty home mortgages, bad private equity deals and overpriced commercial real estate.

Business investment has begun to perk up, but companies are waiting for more convincing signs of recovery before they commit precious cash to buying new equipment and expanding operations. While federal spending has expanded dramatically, state and local governments are still cutting back as the recession, and falling home prices, have cut deeply into tax revenues.

Households are still working off high levels of debt; a third of homeowners with mortgages owe more than their home is worth. That drag on consumer spending has dampened the effects of government spending. And the high rate of foreclosures, expected to increase again this year, continues to put pressure on the housing market. Aside from the depressed levels of new home construction, the weak housing market dampens demand for all of the goods and services that comes with the purchase of a new house.

Once those forces are reversed, the economy will likely begin generating new jobs to meet renewed demand. But even after the monthly job numbers turn positive, it will likely feel like a recession until those 8.4 million workers are again collecting a paycheck.

“With the unemployment rate likely to be elevated for such a long time, the kind of angst out there and dissatisfaction and discomfort is going to last for a very long time,” said Meyer.

The U.S. economy turned in a surprisingly good performance in the fourth quarter, surging ahead by 5.7 percent on an annual basis, according to a government report released Friday.

Or did it?

President Obama was quick to highlight the economy’s progress and “the swift and aggressive actions that made it possible." At a manufacturing company in Baltimore, Md., Obama noted that last years’ massive economic stimulus program had also "stopped the flood of job losses."

He also repeated his administration’s commitment to spur job growth to re-hire the 8 million workers sidelined by the worst recession in 60 years.

Most economists wouldn’t argue with those statements. With more $1 trillion in additional government spending, bank bailout investment and loan guarantees, on top of another $1 trillion-plus in pump-priming from the Federal Reserve, it would be surprising if that money didn’t register a strong showing as it moves through the economy and financial markets.

Friday’s GDP numbers follow a positive showing in last year's third quarter, when GDP advanced 2.2 percent, along with other economic indicators showing signs of life in housing, industrial production and consumer spending, which is beginning to come back from the depths of the recession as confidence slowly recovers.

Corporate profits are also perking up. Of the 40 percent of companies in the Standard and Poor’s 500 that have reported earnings so far, roughly two-third have come in better than expected. Some small businesses are also reporting a pick up demand and have begun tentatively hiring back workers.

But when you look a little more closely at the numbers, it quickly becomes apparent that it’s hardly time to start breaking out the champagne. A big part of the latest GDP gain comes from a statistical adjustment for changes in inventory levels that don’t reflect real growth. Over the past year, businesses cut deeply into those inventories — not wanting to get stuck with unsold goods. Now that they’ve cut them to the bone, the rate of inventory-cutting has slowed. The way the GDP is calculated, that slowdown adds to “growth” — even though it doesn’t reflect increased production or sales. If you back out that inventory adjustment, GDP grew only 2.2 percent.

Friday’s report was the preliminary reading on GDP, which will be revised twice before it’s final. Last time around, the number for the third quarter of 2009 started out at 3.5 percent before pared back to 2.2 percent for the final report. That could well happen this time around.  Mike Englund at Action Economics thinks today’s number overestimated the drop in imports because the preliminary numbers may have overestimated the drop oil consumption. He says that accounted for a full percentage point of the 5.7 percent gain in the fourth quarter.

Even if the preliminary number holds through two rounds of revisions, few economists see that kind of growth as sustainable. A panel of economists surveyed by msnbc.com said they see U.S. GDP moving ahead at 2.7 percent this year.

Most of the credit for the boost in GDP has to go to the stimulus — along with the Fed’s historic moves to flood the system with cash and buy up mortgage bonds that no one else wants to touch. What’s far from clear is whether the rest of the economy’s gears will begin turning on their own — once the stimulus spending fades and the Fed turns off the money pump and begins soaking all that excess money.

Reversing course — from “easy” money to a “tighter” monetary policy — is going to be extremely difficult to pull off. If the Fed drains money too quickly, it risks stalling the recovery. If it drains too slowly, and keeps interest rates low for too long, it risks creating another bubble — or an outbreak of inflation.

The folks on the Fed are in a spirited debate about this quandary. This week’s decision by the Fed’s rate-setting committee included a dissenting view from Thomas Hoenig, president of the of the Kansas City Fed, who thinks it’s time to start thinking about raising rates to fight inflation. The rest of the Fed's Open Market Committee disagrees.

At the center of that debate is the question of just how much “slack” there is in the economy right now. The prevailing theory is that with so many people out of work, wages going nowhere and companies competing with each other for sales by keeping prices low, there’s just not much risk of an outbreak of inflation right now. If that theory is wrong — if companies already have taken the slack out of their businesses — the recovery could put more pressure on inflation than is widely expected.

There is also a risk that the “longer term” problem of large increases in the national debt is becoming a more immediate problem. If investors around the world begin worrying about the size of that debt, they may demand higher interest rates to lend Uncle Sam more money. Rising rates would also be bad news for the economy.

That’s why President Obama wants to freeze spending and set up a commission to look for ways to trim the debt. But cutting spending won’t be easy. Most of it goes to programs like Social Security, Medicare and defense that no one wants to see cut. Worse, the cost of Medicare is rising faster than the economy is growing, so it eats up a bigger piece of GDP every year. With all that spending “off the table,” there’s only 12 cents of every tax dollar left for education, roads, the courts — all the things we expect government to provide. That’s the part that will get cut.

There are also signs of life in the housing market, but it’s too soon to say the worst is over. After bouncing along at what looked like a bottom, homes sales recently headed lower again. As long as we continue to see more than 300,000 foreclosures a month — and those homes are dumped on a depressed market at discount prices — it’s hard to see how we get a sustainable recovery.

The outlook on that front isn’t promising. Much of the early wave of foreclosures came from adjustable mortgages that had a two- or three-year “teaser” rate. Another nastier product, called a “pay-option ARM” has a longer “fuse.” These are expected to begin resetting in large numbers this year and next. Unless something can be done to defuse those resets — or refinance those loans — there will be even more foreclosures. So far, the government’s effort to stop foreclosures has fallen woefully short of the mark. Most estimates suggest that foreclosure haven’t peaked and could rise to 4 million this year.

No matter what the latest GDP numbers show, most people judge their health of the economy based on their employment status. The cruel reality is that it takes the job market many months to recover - even after the economy begins a convincing upturn. That’s because employers do everything they can to meet increased demand before they hire permanent workers. They need to be fully convinced the recovery is real. Until then, they'll add overtime hours for current workers, or hire temps to pick up the pace of production.

So “growth” is really about getting the eight million people sidelined by the recession back to work. That math on that score is also troubling.

Even if we get back to the kind of “robust” growth that we saw in the mid-00s, the economy would only add about 300,000 jobs a month. You need about 125,000 new jobs just to keep up with the monthly growth in the workforce. So even if we got job growth back on track tomorrow — with, say, 175,000 net new jobs a month — it would still take nearly four years to get those eight million people back to work.

Even when hiring begins again, the other important trend to watch is the growth of wages. With so many unemployed people out there, employers don’t have to raise wages to attract workers. A separate report Friday showed that wages rose more slowly in 2009 that at any time on record.

The nationwide recession may have ended last summer, but most states and cities continue to struggle and have not yet begun to recover, according to the latest Adversity Index from Moody's Economy.com and msnbc.com.

A few more cities and states moved into recovery in November, according to the latest data, but most areas were still in a "moderating" recession, meaning the situation was still deteriorating, but more slowly, according to Andrew Gledhill, an economist with Moody's Economy.com.

“For a lot of these areas it hasn’t gotten measurably better, it just stopped getting worse," he said. "But there still hasn’t been the distinct uptick we’d like to see. This recession has been so deep, it’s going to take a long time to get back to where we were pre-recession.”

After the last recession in 2001, the swing to expansion was more rapid, according to the Adversity Index data, which goes back to 1994. In March 2002, most states were just coming out of recession; by September of that year expansion had taken hold widely.

This time, though the steepest part of the downturn ended in most states last June, most remained mired in a “moderating recession” as of November. Only scattered areas were in “recovery” and none yet show “expansion.”

Like all recoveries, this one has been felt unevenly across the country. One bright spot in the November index was Texas — which has moved into the recovery category. Rising energy prices have helped boost the number of drilling rigs in operation. Dallas and Houston were among 28 metropolitan areas that moved into the recovery category in the latest survey.

Heavy government spending on the economic stimulus program and a slowdown in the level of inventory drawdowns helped boost the nation's economic output in the second half of 2009.  But most economists expect growth to remain weak thorough this year.

“This recession was so consumer-driven, and that engine has really not yet picked up,” said Gledhill.

Weak job, housing markets
Until the housing and job markets turn around, it’s going to be tough to get consumers in a spending mood. Though job losses have been easing, payrolls continued to shrink in almost every state in November.

The only areas showing employment levels the same as a year earlier were North Dakota and Washington, D.C. In the hardest-hit states — Arizona, Michigan and Nevada — payrolls fell by more than 6 percent from November 2008 to November 2009.

After recovering from a steep slide, housing starts were still down by more than 20 percent during that period in Colorado, Illinois, Kansas, Nevada, Ohio and Wyoming. But housing starts were higher than a year ago in 17 states plus the District of Columbia. Those states are Arizona, Delaware, Hawaii, Iowa, Kentucky, Louisiana, Massachusetts, Maryland, Maine, Missouri, North Dakota, Oklahoma, Rhode Island, South Dakota, Texas, Utah and West Virginia.

Each month, the Adversity Index uses government data on employment, industrial production, housing starts and home prices to label each state and metro area as expanding, at risk of recession, in recession or recovering. The index was developed by msnbc.com and Moody's Economy.com, which sells in-depth economic forecasts on metro areas.

"Recovery" doesn't mean that an area's economy is above where it was at the beginning of the recession, just that the area has begun to dig its way out of the hole.

No metro area yet is showing "expansion," the most positive category; that label is triggered when a metro area's economy grows past its previous peak. Most of the recovering areas are far from that level.

Nearly one in three metro areas have started to recover, but most major cities are still in a moderating recession. (The full list is below.)

Of the nation's 384 metro areas 146, or 38 percent, were in recovery as of November, up from 31 percent in October, according to the Adversity Index.

A much larger group, 237 metro areas, were in a "moderating recession" in November, meaning their economies were still shrinking but not so severely as earlier this year.

That leaves just one metro area still spiraling downward in a full recession: Las Vegas.

‘Play’ the index
Here are several ways to explore this month's Adversity Index:

State by state
Looking at the state-level data, three more states moved into the recovery category in November: Arkansas, South Carolina and Texas. It joined Alabama, Alaska, Idaho, Indiana, Iowa, Louisiana, Mississippi, Missouri, Montana, Nebraska, North Dakota, South Dakota and Washington, D.C. Within those states some metro areas are still in "moderating" recession.

Nevada was the only state left classified as being in a full recession in November, according to the Adversity Index. All other states were in a moderating recession or recovery.

Metro areas in recovery
Here are the 146 metro areas where the Adversity Index shows a recovery under way in November. Several of the metro areas cross state lines and are listed more than once.

This is an especially cruel moment for the people of Haiti.

After decades of political corruption, civil unrest and massive unemployment, the tiny, impoverished country was just recently enjoying a small measure of stability. A series of public and private initiatives had spurred hope that economic development might finally end the misery of millions of people living on less than two dollars a day.

But the massive earthquake that flattened Haiti’s capital, left millions homeless and killed an estimated 50,000 also crushed hopes that the Western hemisphere’s poorest nation was beginning to dig itself out of abject poverty.

"Since about 2004 there had been a determination by the United Nations and by the international community in general that they were going to make a sustained effort at trying to develop Haiti as a functioning state and as a functioning economy,” said Peter DeShazo, director of the Americas Program at the Center for Strategic and International Studies. “This, of course, sets back the entire Haitian economy."

It may be some time before the longer-term impact on Haiti’s efforts to bootstrap its economy can be known. Officials are still struggling to develop estimates of loss of life and infrastructure damage. In the short term, the local economy likely will see a boost from a flood of international aid, including humanitarian relief and infrastructure reconstruction. But it is not at all clear that those efforts will translate into a lasting foundation for a economic development.

"There is going to be abundant capital to grow,” said Rafael Amiel, managing director for Latin America and the Caribbean at IHS Global Insight, a research firm. “How they handle that is the key question. This can jump-start a very good thing, because there’s going to be money. But usually small economies are very bad at spending money."

The job of developing Haiti’s economy — less than half as big as Vermont's — is daunting. Two-thirds of its 9 million people are unemployed. Public education is not widely available. Infrastructure, health and social services are often worse than in sub-Saharan Africa, according to the World Bank. Severe deforestation has crippled the agricultural economy and left the country's residents vulnerable to hurricanes, floods and landslides.

As it has struggled to pull itself out of poverty, Haiti has sustained numerous blows in recent years. In May 2004, three days of heavy rains and floods killed more than 2,600. Later that year, Tropical Storm Jeanne brought floods and landslides killing 1,900 and leaving 200,000 homeless. In 2008, three hurricanes and a tropical storm killed some 800, devastated crops and caused $1 billion in damage.

That has created a kind of crisis response to economic recovery that has hindered a longer-term approach to Haiti’s development, according to Riordan Roette, a member of the Council on Foreign Relations who specializes in Latin America.

“Sure, you can put things back together again — build rickety houses, get water flowing again, fix the presidential palace, but that doesn’t do anything,” he said. “The underlying issues have got to be addressed.”

Even before the quake, Haiti faced major challenges in its bid to join other Caribbean success stories and build an economy that could lift its people out of poverty. The physical infrastructure was only the beginning. Much of the Haiti’s skilled labor force has left the country for better job opportunities in the U.S., Canada and neighboring Dominican Republic, sending money home to support family and friends. Remittances from abroad generate roughly 20 percent of Haiti’s GDP.

For decades, economic development has also been thwarted by widespread corruption and political infighting among a handful of the ruling elite. After decades of civil strife, the 2006 election of President Rene Preval had restored some measure of political stability.

But Haiti’s political infrastructure sustained heavy damage in the quake. The National Palace —Haiti’s White House — was destroyed, along with buildings housing the Parliament and other government offices such as the tax office. The chaos also exposes long-standing fault lines in Haiti’s fractious political and business leadership, according to Roette.

“It’s going to take political leadership, and Preval can’t do it himself,” he said. “A benign hand from outside — not just the United States — might be just be the way to neutralize that competitiveness in Haitian society and allow them to draw up a long-term plan.”

Over the past few years, a number of public and private initiatives have been launched as part of a long-term effort to build a Haitian economy. The Inter-American Development Bank assembled $700 million in grants and loans, much of which has been invested in building roads and expanding access to water — infrastructure that was heavily damaged by the quake. The IADB also granted Haiti more than half a billion dollars in debt relief, freeing up more government funding for anti-poverty programs.

Former President Bill Clinton, named last year as a special envoy to Haiti by the U.N., also has been tapping public and private sector investment. In October, more than 500 private delegates and 150 public officials met in Port-au-Prince to develop plans to create more jobs.

One of those efforts included a $2 million fund to boost textile manufacturing, which generates some $130 million in exports. Last year, Congress extended duty-free access to Haitian garment makers in hopes of creating tens of thousands of new jobs.

But those garment exports make up just a few percentage points of GDP. To create a sustainable path out of poverty, Haiti will need to attract the private capital that has fueled the development of emerging economies in the Americas.

“For any of these countries what you need is a proper regulatory framework and the rule of law that allows foreign investors to come in and feel secure investing their money,” said Rafael de la Fuente, chief Latin American economist at BNP Paribas.

Rebuilding Haiti’s economy also will depend heavily on maintaining a level of security that had been restored after years of high crime rates and street violence inflicted by armed gangs. Calm has been restored largely through the efforts of a U.N. peacekeeping mission set up after the 2004 ouster of President Jean-Bertrand Aristide.

The quake has thrown that mission into disarray. The head of the mission, Hédi Annabi, and his deputy are among the missing along with 140 other U.N. workers. The main prison in the capital collapsed, and there were reports that inmates had escaped. On Thursday, police and U.N. peacekeepers reported looters roaming downtown shops.

For now, the focus remains on the overwhelming humanitarian effort to provide food, shelter and medical care to the quake’s survivors. The long-term outlook for Haiti’s economy won’t be known until the crisis subsides.

But to be successful, the effort to build a sustainable economy will require a commitment of a decade or more, according to Roette.

"This is an extraordinary opportunity — which we probably are going to waste — to start over and recreate a state in Haiti,” he said.

After paying for a $700 billion bailout, taxpayers say they're in no mood to see another round of six-, seven- or even eight-figure bonuses paid out to Wall Street rain makers. Sorry, readers: You'd better get used to them.

The windfalls are going to the folks who made such a mess of the financial markets that the resulting collapse threw some 8 million people out of their jobs and millions more out of their homes. So if you're not getting a Publishers Clearinghouse-sized check in the next few weeks for all the hard work you did in 2009, you have reason to be a little peeved.

The White House says these financial executives “just don’t get it.” But some Wall Street bankers report that the White House doesn’t get it, either.

These guys (and they're mostly guys; women get very few of the biggest bonuses) complain that restricting bonuses just isn't fair. They have bills to pay. There are mortgages on three or four houses, pricey tuition payments for exclusive prep schools and Ivy League colleges, alimony for multiple ex-wives.

Besides, taking huge risks with other people’s money is a very stressful job; if you lose that money, angry investors call you up all day long and complain. Further, these bankers are generating huge profits by taking a big pile of someone else’s money from over here, slicing off a nice chunk of it, and moving the rest over there. Why shouldn’t they be entitled to a nice slice of that profit?  

For a time, after the Treasury put up hundreds of billions of tax dollars to save Wall Street from its mistakes, government moved to restrict the big pots of gold paid by the banks that benefited from the bailout. But now that much of the bailout money’s been paid back, those restrictions have been lifted.

And, despite the pitchforks and torches being raised by angry mobs against big bonuses, it’s highly unlikely that any real caps will be put in place. Most readers don’t understand why that’s so.

1) The real problem with bonuses based on “performance” is that the benchmarks for that performance have nothing to do with whether anything of real value has been created. If you’re a Wall Street banker who arranges the leveraged buyout of a dying manufacturing company, for example, your “performance” isn’t based on whether the company gets back on its feet. You’re a candidate for a hero-sized bonus at the bank once you’ve scooped out your nine-figure fee. It matters little whether or not investors in your leveraged buyout make back their money or the company in question collapses under the weight of the debt you’ve loaded onto it.

2) Companies showering this year's bonuses on top "performers" may — or may not — be required to “name names.” Attorney General Andrew Cuomo on Monday asked the eight biggest banks — Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street and Wells Fargo — to reveal how much they plan to pay out in bonuses for 2009. (The nation's six biggest banks set aside $112 billion for compensation in the first nine months of 2009, according to the New York State Comptroller's Office.)

No question this is going to be a big bonus year. But we won’t necessarily find out who got what. Cuomo wants the information by Feb. 8. But he didn’t threaten legal action if he doesn’t get it. The reason is that there is no law that requires banks to comply with his request.

There is also no law limiting how much companies can pay executives, and it’s hard to see how there every will be. (Great Britain recently enacted a tax on large bonuses; it remains to be seen what kind of unintended consequences the new law produces. One might be to simply shift more trading and deal-making to this side of the pond.)

There have been proposals to limit bonuses since Wall Street paid itself billions for making a multi-trillion-dollar mess. But they never got very far. The reason is pretty simple. Over the past three decades, as the role of manufacturing has declined as a driver of economy growth, it has been replaced largely by the financial services industry. Members of Congress may enjoy pounding hearing room tables expressing outrage at “Wall Street greed. ” But they are very happy to collect their own piece of Wall Street largess when it comes time to run for re-election. You could say we have the best Congress money can buy.

So companies are free to decide for themselves who gets what. Most corporate “compensation committees” consist of a few of the CEO’s hand-picked golf buddies who rely on “compensation consultants” who report back on how much the bank across the street just raised bonuses for its executives. That arms race is part of Wall Street's justification for the upward bonus spiral. "If we don't hand out extravagant pay packages, our best people will leave!"

In theory, controls on executive pay should be in the hands of shareholders, not taxpayers. The money being doled out for one more house in the Hamptons or matching his and hers Lamborghini Murcielagos (MSRP: $382,400 each) is really shareholders’ money. If your mutual fund holds Goldman Sachs stock, for example, every dollar diverted to the bonus pool is a dollar that could have landed in your retirement account.

But the rules of corporate governance — by which the shareholder owners of a company are supposed to determine things like how much its executives get paid — are even more hopelessly dysfunctional than Congress.

Of course, Congress has had ample opportunity to reform corporate governance — which is ultimately regulated by the Securities and Exchange Commission. Those proposed reforms were just a warm up for the current debate over bonuses.

The latest chapter in this story hasn’t been written. Congress is currently hashing out a new package of “regulatory reforms” to try to prevent bonus-fueled risk-taking from once again pushing the global economy to the brink of collapse. It’s possible we’ll eventually see a return to the Depression-era approach imposing restrictions on risk-taking — and boundless bonuses — in return for government guarantees to protect savers and small investors.

But unless those restrictions have any real teeth, we’ll continue to have the worst of both worlds: a system that rewards reckless investing by bankers — who can remain confident the government won’t let them fail.

It’s possible we’ll get real reform. But don't hold your breath.

Now that the nation’s biggest banks have returned the money the government provided to keep them from collapsing, readers are wondering if those banks needed the money in the first place.

To be sure, the return of the money indicates that the bailout succeeded. Banks are healthy enough to give the money pack, and taxpayers didn’t have to foot the bill for their mistakes.

If only that were how the so-called TARP program really worked.

Wasn't the crux of the bailout money to provide the banks with money to lend out and move the economy?  If the "too big to fail" banks are paying that money back, did they use it for the intended purpose or are they just handing back the money to get out from the restrictions/oversight associated with it? 
- Lorri W., Alaska

The Troubled Asset Relief Program may have turned out to be a nightmare, but it wasn’t a hoax. Enacted in the depths of the worst financial panic since the 1930s, the law was supposed to fund government purchases of hundreds of billions of bonds backed by soured mortgages. Those failed investments swamped banks with losses and threatened to bring down the financial system we all rely on.

It’s next to impossible to know what would have happened if TARP money hadn’t been available because it’s not possible to predict the exact outcome of a global financial panic. It’s entirely possible the banking industry could have sustained major failures and kept lending. On the other hand, a widespread shutdown of credit — much worse than what we’ve seen in the past year — would have shut off the flow of capital that we all rely on in a modern economy. Once that flow shuts down, it can be extremely difficult to restart it.

In any case, the plan to buy up mortgage-backed bonds never happened. Treasury officials quickly realized the scheme was unworkable, largely because no one could figure out what these securities were worth. The government was the only buyer. If the Treasury set the prices too high, it would have lost tens or even hundreds of billions of taxpayer dollars. If it paid too little, the new “market” price could have forced banks to realize even bigger losses.

It’s also hard to predict what would have happened if a large commercial bank had been allowed to fail. When the financial system is functioning smoothly, the collapse of one large bank might be manageable. But in the fall of 2008 the system was in chaos. The potential for widespread damage was heightened by the collapse of Lehman Bros., the investment banking firm that was denied a government lifeline. The unexpected reverberations from the demise of that single, medium-sized Wall Street institution forced government officials to rethink their tough stance. 

Congress also tried to hang tough, voting down the TARP measure the first time – only to watch global financial markets plummet on the news. A week later, the Treasury got its bailout.

With a $700 billion slush fund just sitting there, the government soon figured out lots of other ways to spend it. Some money did eventually find its way to the banking industry, in the form of government investments in preferred stock. That cash helped banks offset their mortgage-related losses.

In the meantime, bankers were getting much potent relief from the Federal Reserve, which dropped the banking industry’s cost of short-term money to as low as zero percent. (If you can’t make money acquiring money for free and then charging borrowers as much as 30 percent on credit card debt, you should probably find another line of work.)  That interest rate windfall has been a much bigger tailwind for the banking industry that the TARP bailout. As they rebuild their cash base, bankers were only too eager to pay back TARP — and get the government out of their boardrooms.  Just in time to set year-end bonuses.

Some TARP recipients didn’t recover and probably never will. The biggest of those is AIG, which transformed itself from a profitable insurance company into a risk-riddled casino with a huge portfolio of credit defaults swaps. Those insurance contracts were written to protect other financial institutions against losses from bad debts; when the mortgage market cratered, and AIG couldn’t cover its bets, the government stepped in with TARP cash and made good on them. The Treasury now estimates it will lose at least $30 billion from its AIG rescue. We’ll never know whether the recipients of those billions could have sustained those losses.

The list of bailout recipients doesn't stop there. Some $50 billion went to try to save the auto industry through partial government takeovers of General Motors and Chrysler. In theory at least some of that money will come back to the Treasury as the companies are overhauled and continue restructuring. GM is expected to eventually sell stock to the public again, but that could be years away.

Another $75 billion was supposed to help stop the home foreclosures that are deflating the value of mortgage-backed bonds. That part of the plan has done little so far to stem the tide.

As of last month, two years after the government began trying to help homeowners, some 31,000 loans had been permanently modified. There were roughly 4 million foreclosures this year alone. Another 3.5 million homeowners are seriously in default. Without real relief, another 3 million are expected to default over the next two years. Until the lending industry gets serious about its foreclosure problem, it faces continued losses for years.

The story of the TARP fund, which was to have expired at the end of the year, isn’t over. Using a clause slipped into the law during the darkest hours of the panic, Treasury Secretary Tim Geithner has extended the program through October 2010.

Congress is already talking about using some of the money to extend unemployment benefits. The banking industry still faces the prospect of defaults on a huge pile of commercial real estate debt that needs to be refinanced in the next few years. Federal mortgage providers Fannie Mae and Freddie Mac are essentially broke.

So the government has the better part of another year to dream up more ways to spend hundreds of billions of dollars in a program that never spent a dime on the problem it was created to solve.

The housing market is in the midst of a rocky recovery, but it’s too soon to declare an end to the worst real estate slide since the Great Depression.

That became clear Wednesday, when the government reported that sales of new homes dropped a sharp 11.3 percent, surprising and disappointing forecasters who had expected an increase.

The report dashed cold water on recovery hopes that had been raised Tuesday by news that sales of existing homes picked up sharply last month. But sales of existing homes got a big boost from a tax credit program for first-time home buyers that was scheduled to expire Nov. 30, before it was extended and expanded by Congress.

For technical reasons, the tax break didn’t give new sales the same boost as existing homes in November. That’s because new sales are recorded when contracts are signed, while existing sales are logged when the sale closes. To get the original $8,000 tax credit, buyers had to close by Nov. 30, so new homes purchased in November likely wouldn't have closed in time to qualify.

Although the tax break was extended through April, it remains to be seen whether the housing momentum will carry over into the new year. The uncertainty surrounding the program in the fall could result in some distortion in the monthly numbers, analysts said.

“Existing-home sales are likely to plunge in December,” said Patrick Newport, U.S. economist at IHS Global Insight.

The outlook is further clouded by a big wave of foreclosures that’s expected to break in the next two years.

“We have a tsunami of foreclosures — 3.5 million people who are 60 days delinquent, seriously delinquent, and probably another 3 million after that who are going to reach that stage,” said Yale University economics professor John Geanakoplos. “All six million of those will probably be kicked out of their houses.”

Under the new housing tax credit program approved by Congress and signed into law by President Barack Obama, buyers who have lived in their current homes for at least five years can claim a credit of up to $6,500 on a new home if they sign a purchase agreement by April 30.

Unlike the first program, the new effort could boost the market's midrange and upper end. Because it targeted first-time buyers, the impact of the original tax credit was felt most heavily at the low end of the market. More than 70 percent of November sales involved houses priced under $250,000.

The hope is that by next spring, the housing market and economy will begin showing sustainable growth without the help of the government. The risk is that the tax credit simply moves up future sales without creating new demand.

Although new-home sales account for less than 10 percent of the overall market, they are important because they represent construction and new economic activity.

November's decline, reported by the Commerce Department, was the biggest monthly drop since January, to a 355,000 unit annual rate. Still, there were some bright spots. The median sale price for a new home rose 3.8 percent from October to $217,400, the highest level since May.

A sustained housing recovery will depend on several factors, including a recovery in the labor market. Most economists expect the unemployment rate, currently at 10 percent, to remain close to that level for through next year. Without a paycheck, those jobless workers can’t get a mortgage.

The housing market also faces a stiff headwind from the continuing high rate of foreclosures, which drives down prices and adds to the backlog of unsold homes as lenders put those properties back on the market. Foreclosure filings in the U.S. will hit another record this year, with an estimated 3.9 million notices sent to homeowners in default, according to RealtyTrac. A record 14 percent of homeowners with mortgages are either behind on payments or in foreclosure.

“It looks like builders are having a real problem trying to compete with the depressed prices in the existing-home market,” said Joel Naroff, president of Naroff Economic Advisors.

Despite three government relief programs since the housing market collapsed in 2007, millions of families are expected to lose their homes over the next two years. Under the latest program launched in March, some 760,000 eligible borrowers have been offered modified loans, but only 31,000 of those trial plans had been made permanent as of last month, according to a report this week from bank regulators.

Part of the reason for the poor showing is that mortgage servicers don't have adequate staff and systems to process the increasing number of trial plans, the report said.

Lenders have also been slow to take more aggressive steps, such as cutting mortgage balances to reflect lost home values. Mortgages that were pooled and sold to investors have also created financial incentives for mortgage companies to drag out the process, according to Geanakoplos.

“They are leaving (owners) in their homes longer and longer because (mortgage servicers) realize they can continue to keep their fees coming, even as the people sit there,” he said.

Effective foreclosure relief is only one piece of the housing outlook puzzle. A sustained recovery will also depend on the cost and availability of credit.

Mortgage rates remain below 5 percent, though they’ve been inching up in recent weeks. Those low rates have been engineered largely by the Federal Reserve through its program to buy $1.25 trillion in mortgage-backed securities. About two-thirds of that has already been spent. In its latest regular policy statement, the Fed included a reminder that the program is set to end next spring. It’s not clear whether rates will begin rising after the Fed stops buying mortgage-packed paper.

Low mortgage rates have helped millions of homeowners reduce payments on their existing homes; roughly three out of four mortgage applications in the first two weeks of December were for refinancing, according to the Mortgage Bankers Association. That will help household budgets and shore up consumer spending, but it hasn’t spurred home buying.

Consumer spending rose for a second straight month in November as incomes recorded their biggest gain in six months, the Commerce Department reported Wednesday.

Falling real estate prices also have helped boost demand for homes by making homes more affordable. The median price of existing homes sold in November was $172,600, down 4.3 percent from a year earlier.

The combination of cheap mortgage money and lower prices has pushed the so-called “affordability” index close to its highest level in nearly two decades, according to the National Association of Home Builders.

As prices stabilize, lenders may become more confident about writing new mortgages, helping sustain demand after government incentives expire, said Richard DeKaser, an economist at Woodley Park Research. “I think that we’ll have the baton passed from the public to the private sector as lenders start to loosen up the purse strings," he said.

A weak economy and a cloudy outlook in the financial markets have sent investors flocking to gold. Before you take the plunge with what’s left of your savings, take a closer look at what’s making the metal sparkle.

Investment managers shouldn't be scoffing at anyone these days. And you don't have to be a "weirdo gold bug" to benefit from buying precious metals.

Investors have been piling into gold for good reason, and there’s nothing wrong with the logic behind the case for buying. Gold has traditionally done very well in times of financial upheaval because of its perceived safety.

The price of gold typically rises when the value of paper money falls. As the Federal Reserve and U.S. government have flooded the world with paper money to try to revive the global economy, gold bulls argue that it’s only a matter of time before inflation returns. Surging prices for goods also push gold prices higher.

All of these conditions have helped spark big demand for gold, which creates additional upward pressure on prices. But keep in mind that gold prices can fall sharply with little notice. So while it may provide a useful hedge, it’s not a great place to stash your entire nest egg.

Investors who did so in the late 1970s learned the hard way why gold can be so risky. As inflation raged, gold prices doubled in the 10 months that ended in October 1979. Governments appeared powerless to stop the corrosive price spiral. Interest rates remained high because anyone lending paper money worried about its rapid loss of value. By January 1980, gold prices had doubled again to hit $850 an ounce.

But investors began fleeing gold two years before inflation was fully tamed and the economy had recovered. The collapse of gold prices left gold investors badly burned for a long time.

It would take nearly 20 years to reach the 1980 peak again. During that time, gold had lost 70 percent of its value from peak to trough.

Despite its reputation as a great hedge against inflation, gold hasn’t done a very good job there either. Let’s say you had waited for the crash after the 1980 bubble and bought at the low of $481.50 on March 18, 1980. Adjusted for inflation, that ounce of gold should be worth $1,265.43 in 2009 dollars.

But the price of gold has yet to hit that mark. (In just the last few weeks, the price of gold has fallen 8 percent from its peak of $1217.40)

The Fed's unprecedented moves to keep short-term interest rates at zero by flooding the system with cash is certainly cause for concern.

There’s little evidence of inflation in the economy today; the large excess capacity in housing, manufacturing capacity and labor markets are creating a big damper on prices. But if central bankers wait too long to mop up all that money, it could spark a fresh outbreak of inflation.

If you’re worried about inflation, there may be better ways to hedge. The price of metals like copper will likely rise if the global economy picks up and demand increases, especially in the developing world. (The same is true for oil.) For individual investors, there are a number of funds or ETFs that offer you a diversified basket of commodities.

If you’re worried about hedging against a more serious financial calamity, it’s far from clear that gold would be a safe place to protect wealth. Some readers have suggested that a rapid decline in the dollar, for example, could bring a return to the conditions a century ago when countries pegged the value of their currency to a fixed weight in gold.

That's highly unlikely. Countries dropped the gold standard because as global trade imbalances increased, floating rate currencies provided an important source of relief from the economic pressures that build sometimes between countries or regions. (Those cross-border pressures are now weighing on European central bankers, for example, as they try to coordinate policy among the many different economies that share the euro.)

All of the above applies to investing in gold. If you're worried about an end-of-the-world, global financial collapse creating a dystopia worthy of a Hollywood blockbuster, stashing gold in a 401(k) may not be your best strategy. For one thing, when you go to get your gold, you'll owe taxes and penalties, assuming there's still a government to collect them. If that's your main concern, you're better off burying some gold coins in the back yard. (We'd never call you a "weirdo" for doing so, but that's not exactly what we'd call investing in gold.)

It’s true that if we were to have another global financial panic, it’s likely that the price of gold would surge. If you’re worried that might happen, by all means park some of your savings in gold so you’ll sleep better at night. But before you do, take stock of the risk that you may lose money if the economy continues to improve and inflation remains tame.

No more stimulus, please, we're capitalists.

That’s the view, at least, of the majority of economists surveyed in msnbc.com’s year-end roundtable. Though unemployment will remain stubbornly high, and the economic recovery sluggish in 2010, the government doesn’t need to provide another round of stimulus spending to keep the economy afloat, they say.

The House last week narrowly approved a $155 billion “jobs” bill that includes nearly $50 billion in infrastructure spending and $79 billion for expanding benefits like unemployment insurance and Medicaid. But most of the forecasters in our panel are against the idea of another government stimulus package.

“The time to short-circuit the negative feedback from job losses is behind us,” said Ed Leamer is director of the UCLA Anderson Forecast. “Let the private sector heal the economy.”

Many feel the $787 billion package of tax cuts and new spending enacted in February spurred the rebound in the second half of this year. As the impact of that stimulus wears off, the expectation is that private spending by consumers and businesses will create enough demand to take up the slack.

“You have a floor (on growth) that comes from the fact that there’s an awful lot of latent demand out there that will slowly be tapped into,” said Joel Naroff at Naroff Economic Advisors.

The consensus of msnbc.com’s forecasters is that while growth will fade a bit next year, the economy will continue to expand at a slow but steady pace. After a 3.3 percent increase for the second half of 2009, gross domestic product growth is expected to slow to 2.6 percent for all of 2010, picking up a bit to 2.8 percent in 2011.

“Although the risk of a double-dip recession is still significant, it is not the most likely scenario,” said Diane Swonk, chief economist at Mesirow Financial. “Moreover, there are no silver bullets when it comes to fueling employment. I think our efforts would prove better if focused on improving the health of the credit market, most notably banks, as they are now the only game in town for many consumers and small businesses.”

Two members of the panel, Goldman Sachs chief economist Jan Hatzius and Ethan Harris, head of North American economics for Bank of America Merrill Lynch, support the idea of another round of government stimulus. Harris thinks the package should be “targeted to the housing or the job market.”

Given the dismal job market and high levels of unemployment, there’s widespread support in Congress for an extension of unemployment benefits through the first half of 2010. But there’s less agreement over proposals to give the economy another shot in the arm with a new spending package aimed at creating jobs.

The White House favors a targeted approach including a tax credit for small businesses that create new jobs. The House bill, which has not been taken up by the Senate, includes a grab bag of measures designed to keep the economy moving, including another $27.5 billion for highway construction projects and $8.4 billion for transit systems. Though much of the original $787 billion in stimulus remains to be spent, budget analysts estimate the positive economic impact of that measure will begin to fade by the second half of 2010.

The House bill would also help slow the pace of layoffs by cash-strapped state and local governments that are struggling to close budget gaps after a drop in property and income taxes. The bill would give s tates $23 billion to pay 250,000 teachers and repair school buildings, and $1.2 billion to pay for 5,500 police officers. They'd also get
$23.5 billion to help pay their share of the federal Medicaid healthcare program for the poor.

Small businesses have had a hard time borrowing the money they need to expand output and hire more workers. To keep credit flowing, the Federal Reserve is expected to keep interest rates low, although not as low as the 0 to 0.25 percent range consumers and businesses have enjoyed since last December.

Our forecasters see the Fed nudging them slightly higher, to 1 percent as measured by the federal funds rate, by the end of next year. None of them see inflation presenting a problem for Fed policymakers; the consensus inflation forecast, as measured by the core Consumer Price Index, is just 1.5 percent by the end of next year.

In their overall forecast, the msnbc.com panel sees slow but steady economic growth in 2010. But it won’t feel like a recovery for the millions of Americans who will remain unemployed, according to the roundtable.

The forecasters are not upbeat about the outlook for the job market next year. Though the latest employment data point to the end of a nasty cycle of job cuts, next year’s recovery is not expected to make much of a dent in the unemployment rate, which is hovering around 10 percent. The consensus is that the jobless rate drops by just two-tenths of a percent, to 9.8 percent, by the end of next year.

Recent economic data support the idea that the economy rebounded convincingly at the end of the year. Earlier this week, the Fed reported that industrial production rose by 0.8 percent in November. That’s a sign that businesses are beginning to rebuild their inventories after slashing them to the bone after the recession tightened its grip last year.

Exporters are also getting a continued lift form the weak dollar, which makes their products more competitive in overseas markets. Nariman Behravesh, chief economist at IHS Global Insight, expects industrial production to grow by a 3 to 5 percent annual rate next year.

The housing market also is showing signs of life after a historic collapse that dragged the broader economy down with it. Housing starts rose by 8.9 percent in November, and building permits, an indicator of future growth, rose by 6 percent.

The outlook is not as bright for the commercial real estate market, which is still on the way down. Construction is expected to continue falling next year, by 5.6 percent, before rebounding in 2011, according to Global Insight. A credit crunch also looms over owners of commercial property as they try to refinance trillions of dollars in loans extended during the mid-decade boom.

Continued recovery will depend on a number of forces — credit, consumer demand, job creation, business investment — all moving  in the same direction. For now, say economists, those gears appear to be turning again. But the recovery is fragile and is expected to remain weak through next year.

Unemployed workers and homebuyers caught a break thanks to a new law signed by President Barack Obama on Friday. The law offers tax credits for homebuyers, extending and expanding a popular program, and extends jobless benefits up to 20 weeks for unemployed workers who can’t find a job. Here’s how the plans will work.

The legislation signed by Obama on Friday will extend unemployment benefits for the roughly 50,000 people a week whose claims were expiring — along with some 3.4 million more who are still collecting on their insurance.

The plan adds 14 weeks of benefits; workers living in states where the unemployment rate is above 8.5 percent get an additional six weeks of benefits for a total of 20 extra weeks of benefits. (The most recent figures put New York's jobless rate at 8.7 percent, putting the state into the 20-week category.)

Before the recession began in December 2007, benefits typically ran out after 26 weeks. But because so many workers have been unable to find new jobs, Congress has extended eligibility four times, giving some people up to 79 weeks of benefits. The length varies from state to state, because some states have passed their own additional extensions.

The surge in claims has severely stretched state trust funds that cover these benefits. So far roughly half the states have had to borrow from the federal government to keep writing checks. To pay back the money, they’ll either have to raise taxes on businesses or trim benefits. Neither option will do much to get the economy back on track.

To qualify, workers have to meet minimum requirements, set by each state, for wages earned or time worked during what’s called the "base period." In most states, that’s the first four out of the last five calendar quarters before your claim is filed. You also have to have lost your job through no fault of your own. (If that’s in dispute, the unemployment office reviews the circumstances and decides whether you qualify.)

It’s important to check the rules carefully for each state. Though programs are similar — the states have to follow federal guidelines — there can be big differences in the level of benefits and eligibility rules. (You can check here for information on your state.)

In New York state, for example, the maximum unemployment benefit is $430 a week, compared with $564 in Pennsylvania and $609 in New Jersey. One big reason is that New York requires employers to pay into the unemployment insurance trust fund for just the first $8,500 for an employee’s annual wages. The national average is $11,800, and it's more than $14,000 in neighboring Connecticut, Massachusetts and New Jersey.

For more information on filing a claim, check the Department of Labor’s Web site.

You never know with the IRS, but as far as we’re concerned a year that starts on July 1 ends on June 30. So you should be good to go.

The homebuyer tax credit the Senate tacked on to the extension of jobless benefits (which was one reason it took so long to extend benefits) expands the first-time homebuyer credit that has helped perk up the housing market.

You claim it when you file your taxes by deducting from the tax you owe. If the credit is bigger than your tax bill, you get a check back for the difference. And if you want an immediate refund, you can amend your 2008 tax return.

The credit is good for 10 percent of the purchase price of  a primary residence, up to $8,000 for “first-time” homebuyers — which are defined as people who haven’t owned a home in the past three years. “Repeat” buyers — who have owned their current home at least five years —can get up to $6,500.

To qualify, you have to sign a purchase agreement by April 30, 2010, and closed by June 30. (The deadline is extended by a year for members of the military who have served outside the U.S. for at least 90 days from Jan. 1, 2009, to May 1, 2010.)

There are some other limits on who is eligible. You can't claim the credit on a house that costs more than $800,000. If you earn more than $125,000 a year — or $225,000 for joint filers — you get a reduced credit that fully phases out when incomes hit $145,000 for individuals and $245,000 for joint filers.

The economy is still shedding jobs, but at a much slower pace than at the height of the financial crisis this year, according to government figures released Friday. That bolsters the view that the economy is making a slow but steady recovery from the worst downturn in decades.

But for the nearly 16 million people out of a job, it hardly feels like a recovery.

Over the past three months, the economy has shed a net 188,000 jobs a month, down from a pace of 700,000 monthly early this year. As jobs continued to disappear the unemployment rate rose to 10.2 percent in October, up from 9.8 percent in September. It was the first time since 1983 the jobless rate topped 10 percent.

Job losses swept through most industries again last month, from manufacturing and construction to retail and financial. A broader measure of labor force strength that includes people who have settled for part-time jobs or stopped looking for work showed an unemployment rate of 17.5 percent, up from 8.4 percent before the recession began two years ago.

As bad as the report was, it shows continued improvement in the economy, analysts say. A separate report this week showed that new claims for unemployment benefits continue to trend lower, although they are still at extremely high levels historically.

“It is true that it's slow progress, but it's unambiguous progress,” said Robert Barbera, chief economist at ITG.

That is small comfort to the millions of worker who don’t have a paycheck. That loss of income  weighs on consumer spending, which accounts for roughly two-thirds of U.S. economic activity. Investors reacted cautiously, and stocks were little changed in midday trading.

President Barack Obama called the new jobs report another illustration of why much more work is needed to spur business creation and consumer spending. Noting legislation he's signing to provide additional unemployment benefits for laid-off workers, Obama said, "I will not rest until all Americans who want work can find work."

The rising level of unemployment also has a spillover effect on the families and friends of those out of work, undermining consumer confidence. If anxious consumers continue to hold back spending, the fragile economic recovery could be in jeopardy.

“Whether Main Street can get over this 10.2 percent rate in terms of psychological impact for the holiday season remains to be seen,” said Tony Crescenzi, a bond portfolio manager at Pimco. “It’s really critical how the shopping season fares because it will affect the production cycle.”

One sign of how hard it still is to find a job: Those out of work for six months or longer rose to 5.6 million, a record. That’s more than a third of the unemployed population.  

Hundreds of thousands of those who have lost jobs have exhausted their unemployment benefits, although Obama Friday signed into law a measure extending benefits for almost 2 million people. The bill adds 14 to 20 extra weeks of aid for recipients, marking the fourth time Congress has extended benefits since the recession began.

With six unemployed workers for every posted job opening, those who have jobs are working harder for less money.

And companies are squeezing more work from their existing employees. Productivity, the amount of output per hour worked, jumped 9.5 percent in the third quarter, the Labor Department said Thursday.

That's the sharpest increase in six years and followed a 6.9 percent rise in the second quarter. The increases enable companies to produce more without hiring extra people.

While that may be bad news for workers, it’s been great news for companies trying to rebuild their profits. Those rising corporate profits have helped propel the stock market higher this year.

High unemployment and rising productivity come as good news for the Federal Reserve, which is keeping interest rates at historically low levels to help the banking and financial system repair the damage from the industry's crisis. As long as the labor market is weak, and productivity continues to rise, the Fed stands a better chance of avoiding another outbreak of inflation.

Fed policymakers left rates unchanged after a two-day meeting this week, predicting that "inflation will remain subdued for some time," according to a statement they issued.

But big gains in productivity also hint that labor market conditions are worse than the data suggest, said Mark Zandi, chief economist at Moody’s Economy.com

“Productivity is a great thing, but it depends on what it does,” he said. “If businesses respond to the better productivity and profits by hiring then that’s great, we’re off and running. But if they don't, demand is going to weaken and we’re going to be right back in the soup.”

The number of people who lost their jobs in October may be even higher than the “official” report, which relies on the government survey of business payrolls. A separate Labor Department survey of households found that 589,000 jobs were lost last month.

One reason for the discrepancy is that the payroll survey covers government and larger businesses, said economist David Malpass, president of Encima Global.

“They are doing well because all the credit is going in that direction,” he said. “The bottom line is the (payroll) survey has been overestimating the health of the labor environment.”  

Small businesses that have typically been the biggest producer of new jobs face tight credit and don't have the cash to expand their business and hire more workers.

Out of work, out of savings and out of things to sell, Carolyn Johansen is running out of options to keep her home even as her unemployment benefits run out.

"By February I will be in a tent," said Johansen, from Fredericksburg, Va. “My big concerns are finding homes for my German shepherd Anna and my cat Tigra and a free place to store a thousand hardback and paperback books.”

For millions of out-of-work job seekers like Johansen, unemployment insurance is providing an increasingly tenuous financial lifeline.

With jobless benefits expiring for a record number of workers, some 7,000 a day, Congress is sending the president legislation to expand a popular homebuyers tax credit and extend unemployment benefits.  The $24 billion economic package seeks both to propel a sluggish economic recovery and help out the millions who have lost jobs and have been unable to rejoin the workforce.  

Under the measure, the $8,000 tax credit for first-time homebuyers would be extended for seven months and expanded with a $6,500 credit for some prospective homebuyers who already own homes.  The nearly 2 million people who have lost or are in danger of exhausting unemployment benefits before the end of the year would receive up to 20 weeks in additional benefits.

The measure comes as state unemployment insurance funds are running low, and tight budgets are fraying the safety net that jobless workers without benefits rely on.

After losing her job last October, Johansen figures she’s applied for over 300 jobs, but can’t find anything, not even seasonal work for the holidays. A single mom with a master’s degree and a career as a librarian, she applied for work at Blockbuster this week but couldn’t get an interview.

Johansen said she’s burned through her IRA and 401(k) savings and sold everything she could sell, including her jewelry. She applied for food stamps, but her $297 weekly jobless benefit, which expires Dec. 31, is $12 too high to let her qualify. She sent her teenage daughter to live with her older sister in Nevada; a disabled son who lives with her is scheduled to enter a residential treatment center in March.

Nearly two months after it was introduced in the House, the benefits extension has been delayed by debate over its cost and how to pay for it. Passage also has been complicated by added provisions that would extend tax credits for businesses and first-time home buyers.

As Congress has debated, weekly checks have run out for nearly 400,000 people. Friday’s looming employment report, expected to show another roughly 200,000 workers lost their jobs in October, has increased the political pressure on both parties to pass the measure. 

“I just sent in my form requesting my last unemployment check,” Jim Schmitt, 58, of Apple Valley, Calif., said in an e-mail. “I have always voted Republican, and now I'm reading the Republicans are holding up the vote to extend the benefits. I might not be voting Republican again, even though the Democrats are no better.”

Under the Senate bill, jobless benefits would be extended by 14 weeks for workers who have exhausted their benefits. Those in states with jobless rates of 8.5 percent or more would get another six weeks of benefits, for a total of 20 weeks extra.

The extension would help head off financial suffering for the hundreds of thousands who face the loss of benefits by year's end. It also would help shore up a frail economy in the very early stages of a recovery from the worst contraction since the Great Depression.

For millions of households, the outlook remains bleak. Roughly 6,600 new foreclosures are filed every day, or about one every 13 seconds.  As of the end of September, some 2.6 million mortgages were in some stage of foreclosure and another 1.6 million loans were 90 days late and headed there. Another 6 million families could lose their homes over the next three years, according to the Treasury Department.

The rise in homelessness is straining state and local budgets, already reeling from lower tax receipts, as they try to cope with the increased need for social services. In Fredericksburg, Va., said Johansen, local nonprofits have take up some of the slack, but they’re still stretched.

“There are 80 beds in the homeless shelter, and every night they turn people away,” she said.

Though massive government spending has given the economy a lift, any recovery will be short-lived unless it’s followed by a sustainable recovery of consumer spending, which accounts for two-thirds of economic activity.

“It’s about supporting demand,” said Mark Zandi, chief economist at Moody’s Economy.com. “If unemployed workers have no social safety net, they have to significantly ramp back their spending. And in many cases they force everyone around them to ramp down, too. They’re borrowing money from their family and friends and putting financial pressure on everyone.”

Aside from easing financial suffering, extending unemployment benefits is one of the most efficient ways to stimulate the economy, say some economists. Zandi estimates that, with the exception food stamps, money spent to extend unemployment insurance gets the biggest bang for the buck, roughly $1.61 in added economic activity for every dollar spent. That’s because the payments are typically spent right away unlike, say, tax cuts which may be diverted into savings.

“They’ve gone through their savings,” said James Parrott, chief economist of the Fiscal Policy Institute, a New York state think tank. “You can pretty much expect that they will take every dollar they get in extended unemployment benefits and spend that money to cover basic essentials for living.”

An extension of benefits will help some but not all unemployed workers. For one thing, even an extra 13 weeks won't be enough for some job seekers.

As of September a record 5.4 million workers had been out of a job for 27 weeks or more, more than double year-ago levels and the highest since the government began tracking the data in 1948.

Those numbers don’t include 2.2 million people who are considered “marginally attached to the labor force” — up from 615,000 a year earlier. These people don’t show up in the official unemployment numbers because they didn't look for work in the 4 weeks preceding the survey.

Having that many people without a financial safety net can put a serious damper on overall consumer confidence, said Zandi.

“Nothing is more debilitating than having no financial resources,” he said. “But it’s also very psychologically scarring on everyone around that unemployed person. It’s scary to see that happen. And confidence in a recession is so important — it’s the key to spending and investment and everything else that drives the economy forward.”

After his unemployment benefits ran out last week, Bruce Cordray, of Ypsilanti, Mich., said the state of Michigan was able to extend them for another 16 weeks. Though his wife is still working, their household income is about a third of what it was when he was working.

With a business degree and a 36-year career in industrial engineering and purchasing management, Cordray lost his job with an auto parts manufacturer in March. Since then, he’s been trolling job listings and consulting for several manufacturers for free in hopes their businesses grow enough that they can afford to hire him.

To make ends meet, he and his wife have “gotten creative.”

“I have a big home garden and we have taken on 25 chickens,” he said. “I’ve never had any type of livestock before. But we do sell the eggs.”

Extending unemployment benefits would help bring stability to the housing market, without which the current weak recovery could be snuffed out.

Early in the downturn, the majority of foreclosures resulted from bad mortgages. Today, the rise in unemployment is the biggest cause of foreclosure, according to Neighborworks, a nonprofit housing agency that works with families to save their homes. Homeowners facing foreclosure can use jobless benefits as qualifying income under the government’s mortgage modification program. 

For those without a financial lifeline, the choices can become stark. Deb Saunders and her husband are getting back on their feet since relocating to Texas after she lost her job at Wells Fargo and he lost his in construction. After selling everything they had, they bought a 25-year-old RV.

“We were almost homeless,” she said. “We thought, ‘We‘re going to get through this. At least they can’t take the RV away from us. Worst-case scenario we can park it in Wal-Mart because Wal-Mart lets you do that. We’ll just have to drive it around.”

Her husband is working again, and they’re renting a house. But two months after filing for jobless benefits, she’s still waiting for the paperwork to be processed.

“They’re saying (the delay) is  because of all the new claims that are being filed,” she said. 

Extending jobless benefits for 13 weeks may help postpone painful choices, but the dismal job market is taking an emotional toll on the nearly 15 million Americans who are out of work or have been forced to take a job well below their earning potential.

Some economists warn that these levels of long-term unemployment and underemployment could have a lasting impact on the economy.

“If it continues for very long, it really degrades the quality of the labor force,” said Parrott. “The quality of skills erodes from being unemployed or underemployed. And that represents a reduction in the economic potential of the economy.”

Last week's news that the economy is growing again produced a number of reports that "the Great Recession is over." Even if that were true, what follows may be more painful that any economic recovery in living memory.

If the recession is over, then why does consumer confidence continue to fall, home sales are going south again and unemployment continue to inch up and up?  
— Greg, Smyrna, Ga.

There are two possible explanations. One is that the recession isn’t over.

Despite the high-fiving among economic forecasters over last week’s report that the economy began expanding again in the third quarter, one quarter of growth is not enough to mark the end of a recession. And when you take a look inside the report, the 3.5 percent advance in the gross domestic product doesn’t exactly point to an economy on the mend. (Keep in mind this the government’s first attempt at estimating the latest quarter of GDP. This number will be revised twice before it’s considered “final.”)

The biggest gain, roughly 1 percentage point, came from vehicle sales, which surged during the wildly popular, now-ended Cash for Clunkers program. The rebound in the housing market, thanks to the first-time homebuyer tax credit that expires in November, added another 0.5 percentage point. Direct government spending added another 0.5 percent.

Third-quarter GDP also got a big boost — 0.9 percent — from a change in the level of inventories. To avoid getting stuck with piles of unsold goods, businesses continued cutting inventories in the third quarter. But because they've already cut to the bone, they did so at a slower pace in the third quarter. According to GDP math, that's a good thing.

So if you take out the growth that was directly or indirectly paid for by the government, along with the way GDP accounts for changes in inventories, the economy grew by just 0.4 percent. That’s roughly the size of a typical revision by the time the final data is released.

All of which means that most of the “recovery” in the third quarter was essentially a sugar high from one of the most aggressive government interventions in history. If the jolt from the stimulus simply moved up sales of cars and houses that would have happened later this year and next, all we will have done is created a hole in future GDP numbers.

It also turns out that the stimulus — as big as it was — may not have been big enough. About one-third of the $787 billion total went to tax cuts, much of which has only helped offset lost wages. Much of the rest is essentially going to fill a giant, $360 billion hole in state budgets this year and next. That leaves about $140 billion in incremental government spending, or 1 percent of GDP.

When the impact of that government spending begins to wane next year, the hope is that other sectors of the economy such as consumer spending and business investment will kick in. But consumers don’t yet seem ready or able to do a lot of spending. Two separate measures last week showed consumer confidence fell in October. Businesses continue to try to squeeze more profits from the same dollar of sales by cutting costs, which means they're spending less, not more.

Even if they get in a spending mood, consumers don’t have a lot of extra income to go shopping.

The latest data show that overall income was flat in September, despite the tax refund portion of the government’s stimulus program. Without those transfers, wages and salaries fell 0.2 percent.

After the last recession in 2001, some consumers made up for falling wages by borrowing against the equity in their houses or running up credit card debt. That boost to consumer spending is now working in reverse: Credit has tightened considerably and consumers are putting more money toward saving or paying down their credit cards to make up for the fallen value of their homes.

Of course, there's another possible explanation for the mismatch between the economic data and public perception: The recession is over, but the economy is growing weakly and unemployment will keep rising into next year. That’s not uncommon: The end of a recession just means the economy has hit its lowest point. When you’re at the bottom of a trough, looking up at the peak you just slid down from, it usually doesn’t feel much like things are picking up.

It’s encouraging to see reports of an increase in housing construction or industrial production or car sales. But those gains are coming from extremely low levels.  Sales of new single-family homes, for example, have been rising. But they’re still at levels last seen in 1995. Worse, though job losses appear to be slowing, the total level of employment is lower than it was before the economy entered the last recession 2001. In other words, all of the job growth for nearly an entire decade has been wiped out.

When recessions end, it takes time for companies to start hiring again. Most want to see a convincing pickup for at least several months before they begin taking on new workers or opening new businesses.

If we are indeed at the bottom of the trough, the question now is, how long will it take to make up for the damage done by the deepest contraction since the 1930s? Here's some quick math: 

When the last, relatively mild recession ended in November 2001, the economy continued to shed jobs for nearly two years. It wasn't until February 2005 that the growing economy had replaced the 2.7 million jobs lost to the 2001 recession.

This time around, the job losses have been much more severe — some 8 million and counting. Once those job losses stop, it takes about 100,000 new jobs just to keep up with the growth of the workforce. During the last expansion, the economy created roughly 160,000 jobs a month. During the previous 1990s expansion, the longest in history, the economy created roughly 200,000 a month. At that rate, it would take six and a half years to create enough jobs to keep up with the growth of the workforce and replace the jobs lost to the recession.

Even if this is “the bottom,” it will be years before the economy creates enough paychecks for consumers to once again add convincingly to GDP. Until that happens, it will still feel like a recession — even if the data shows the economy is growing again.

Even though the nation's economy showed growth in the third quarter for the first time in more than a year, don't assume that the Great Recession of 2008-09 is over.

For a reality check, try asking Larry Van Sant, who owns a plumbing and heating business in Mount Airy, Md.

“I don’t think this recession is over by any means,” said Van Sant. He said business is so slow he has had to lay off 68 of his 168 employees. “We normally can look and tell it’s over before anyone announced it’s over.”

Van Sant is one of hundreds of msnbc.com readers who sent e-mails disputing the view of many mainstream economists who say the recession, which began in December 2007, might well have ended over the summer. And with unemployment at a 26-year high of 9.8 percent, the skepticism is understandable — despite figures released Thursday showing the nation's gross domestic product grew at a 3.5 percent pace in the latest quarter, the best showing in two years.

“I get upset every time I hear or read in the news that the recession is over and the economy is recovery,” said Janice Benson, owner of a small real estate office in Bend, Ore., where she lives with her husband and son. “The president’s stimulus package only helped the banks and a few special groups. It did not help mainstream America.”

President Barack Obama took an optimistic, but cautious, tone about the GDP data. In remarks Thursday to a small business group, he said the economy "has come a long way" since early this year, but added "we have a long way to go to fully restore our economy."

“In my view, the economy has not picked up,” said Zoltan Rab, a research analyst in Greensboro, N.C., who lost his job in May 2008 and was out of work until December. "The weak state of the economy is quite visible. I think it is simply irresponsible to make average citizens believe otherwise.”

Part of the disconnect between upbeat forecasts and the skepticism expressed by many readers  starts with the definition of a recession.

Contrary to popular misconception, a recession is not necessarily over even if the economy shows two consecutive quarters of positive growth as measured by gross domestic product. The start and end dates of U.S. recessions are established by the National Bureau of Economic Research, a research organization whose conclusions on business cycles are widely accepted. The NBER's Business Cycle Dating Committee looks at a variety of statistics — including GDP, employment, and industrial production — before determining the beginning or end of a recession.

Jeffrey Frankel, an economist at the Massachusetts Institute of Technology and a member of the committee, said he and other analysts want to see signs of a convincing and lasting recovery before declaring the recession is over. Although he thinks the recession ended in July, he also believes there is a one in three chance the recovery may stall out next year.

“If a new downturn made us reconsider, we’d call that part of the same recession,” he said. “So we wait.”

For many Americans, their view of the economy depends on where they live. Just as some parts of the country have been harder hit than others by the downturn, the recovery will be stronger in some regions and lag in others.

The latest Adversity Index from Moody's Economy.com and msnbc.com shows that only one in five of the 384 metro areas in the United States has moved from recession into the "recovery" category, based on August data on jobs, manufacturing and housing. The recession is "moderating" in another 270 areas, meaning the contraction in those economies is slowing; some 35 metro areas are still in full-blown recession.

The recovery also will be uneven from one industry to the next. In the industrial Midwest, many of the manufacturing jobs lost to the recession may never come back. That’s forced millions of workers to try to retrain themselves for a new career.

Alan Dustan, 54, works as a career guidance specialist for Maricopa County in Phoenix, Ariz.  While his office has been a sharp pickup in jobless workers, he also sees many of them turning to new careers in industries that are hiring.

“With so many retirees coming out here, health care has taken on a major role," in the economy, he said. “I see a lot of people that have been in, say, the mortgage business for 20 years and now they’re going to back for 42 weeks to get their (nursing) license."

Much of the optimism about economic recovery centers on upbeat news from the housing industry over the past few months. Sales have picked up and prices seem to have stabilized and begun rising again in some parts of the country.

But at least some of that improvement stems from the $8,000 tax credit extended to first-time home buyers. And many sales are going to investors snapping up foreclosed homes at distressed prices. With the tax credit set to expire next month, and the foreclosure rate showing no signs of easing up, Goldman Sachs economist Alec Phillips cautions that the recent upturn could be temporary.

“The risk of renewed home price declines remains significant,” he wrote in a research note last week. "And our working assumption is a further 5-10 percent decline by mid-2010.”

Though residential housing may be nearing a bottom, commercial real estate is in a steep slide. The pace of layoffs has slowed, but the labor market remains "weak across all Districts," according to the latest economic report card from the Federal Reserve’s “beige book” survey. 

As long as those layoffs continue, it’s hard to see how an economy based largely on consumer spending can stage a strong recovery. Though the “official” jobless rate is at 9.8 percent, the government’s broader measure — which includes categories like “discouraged” workers who’ve given up looking for work — stands at 17 percent.

While stock prices have surged on Wall Street since the spring, consumers remain pessimistic about the economy and their own finances. The latest NBC/Wall Street Journal survey, released this week, found 49 percent of Americans "very dissatisfied" with the state of the economy, up from 41 percent last month.

Consumer confidence fell in October as job prospects remained bleak, the Conference Board reported this week. That added to worries that an already gloomy holiday shopping forecast could worsen. With the exception of the “Cash for Clunkers” program subsidizing car sales, spending remains flat in most categories.

The mismatch between economic data and public perception may also indicate sharp differences in attitudes based on where people are on the economic ladder, said Frankel.

“There is an income distribution issue,” he said. “If the overall economy is growing but the benefits are accruing to a minority of wealthy, then you can easily explain why the majority view is that things are not getting better.”

An uptick in the GDP data used to measure economic growth can also been seen as a sign that the recession has stopped getting worse. Once the economy begins growing again, it won’t feel like prosperity has returned until the nearly 8 million people sidelined by the recession have found jobs again. That process could take years: Even the most optimistic forecasts look for weak growth through 2010.

That big whoosh you're hearing is the air rushing out of a commercial real estate bubble.

More than two years into the worst housing crisis in decades, commercial real estate is shaping up as the second half of what some are calling a “double bubble.” Owners of shopping malls, hotels, office space and apartment buildings — and the bankers who financed them — face a major crunch over the next two years as the mortgages on those properties start coming due.

Much like homeowners who now owe more on their mortgage than their house is worth, many commercial property owners have seen the value of their properties plummet, increasing the risk of default on hundreds of billions in commercial real estate loans.

That is expected to put more stress on thousands of banks that have already been deemed “not too big to fail.”

“I have never seen anything this bad,” said Dan Tishman, CEO of Tishman Construction, one of the nation's leading construction and management firms, comparing the current slide to major commercial real estate busts in the 1980s and '90s.

Even as economists and federal officials point to recent signs that the recession may be ending, there’s widespread concern that commercial real estate could pose a threat to the recovery. Federal Reserve Chairman Ben Bernanke told members of the House Financial Services Committee this month that "commercial real estate remains a very serious problem."

Though the market is only about a third the size of the $22 trillion residential market, in some ways the problem for commercial real estate is more severe. Unlike home mortgages that run for 15 or 30 years, much of the roughly $1.6 trillion in commercial real estate loans outstanding involves much shorter terms of three to seven years. Many of the loans were written at the height of the boom.

“There was this unbelievable bout of lending that occurred all on a very short term,” said Tishman. “With short maturities you’ve squeezed the accordion as close as you can get and caused a lot more refinancing in a short period of time.”

Commercial real estate became hugely popular with bankers during the boom. In 2006, commercial real estate made up 56 percent of U.S. banks’ loan portfolios up from 40 percent a decade earlier, according to FDIC data. For smaller banks with assets under $1 billion the concentration is even higher. Some 74 percent of all loans held by smaller banks are secured by commercial real estate. These roughly 6,500 banks represent some 90 percent of all U.S. banks.

The risk for consumers is that heavy losses on commercial real estate could force banks to tighten
lending for home mortgages, car loans and credit cards even further. It also could force bankers to try to offset commercial loan losses by accelerating sales of foreclosed homes, which could put further pressure on home prices.

For commercial real estate owners, the problem starts with the impact of the recession on their properties. Massive layoffs have left office buildings with unrented space. The slowdown in consumer spending is hitting owners of malls and retail space where foot traffic has dried up. Hotel owners have been hurt by the slowdown in travel and tourism.

On top of lost rent, commercial real estate owners who bought properties at the height of the boom have suffered the same fate as homeowners and suffered plunging values. From the peak in mid-2007, commercial property values are down by some 35 percent, according to Moody’s.

As commercial real estate loans come due, property owners face the same dilemma as many homeowners. If they sell the property, they’ll take a big loss. But to refinance, they’ll have to come up with a lot of cash to make up for the value lost since they took out the loan.

Most lenders are not especially interested in foreclosing because they’ll lose money selling into a distressed commercial real estate market. That’s prompted lenders to undertake a strategy of what industry insiders are calling “pretend and extend."

As long as the commercial property owner is making payments, bankers are willing to delay refinancing for a few years in hopes that the economy and real estate market improve. But it remains to be seen whether that strategy will work.

‘I don’t think the banks can hold out that long,” said Lesley Deutch, who follows the commercial real estate market for John Burns Real Estate Consulting. “There was a lot underwritten during (the boom); there’s just too much to refinance, and the values have gone down too significantly."

A lot depends on how well the economy recovers in the next several years. If companies begin hiring again, empty space in office buildings will begin to fill up, shuttered stores in malls will reopen and hotel owners will see occupancy rates rise. But even if that happens, it’s not clear how long it will be before these properties regain their lost value.

“So many of those assets were acquired at top dollar,” said Susan Smith, director of the real estate group at Pricewaterhouse Coopers. “When you add on top of that the significant amount of debt that was used to acquire many of these real estate properties, I think you are looking at a much more troublesome problem down the road with commercial defaults than residential if something doesn’t happen to facilitate refinancing.”

Some commercial property owners won’t have a patient banker to talk to when it comes time to try to postpone their refinancing. That’s because about a third of commercial loans are held by investors who bought commercial mortgage-backed securities, or bonds backed by the interest payments on those loans.

Because each loan is held by dozens of investors, there is no mechanism for negotiating an extension, even if there were new investors to buy fresh mortgage bonds. Tishman estimates that some $200 billion of these bonds will need to be refinanced in the next year, or about four times the annual volume during the lending boom.

“The reason that everyone is projecting the pain yet to come in commercial real estate is because the bulk of this debt that was done at high valuation, and high leverage has yet to mature,” said Michael Pollock, general counsel of The Ashforth Co., which owns, develops and invests in commercial real estate. “We’re really just seeing the tip of the iceberg."

Though there’s widespread agreement that a financial crunch is looming, some think the commercial real estate market may escape the kind of collapse in residential housing that brought down the U.S. economy. For one thing, the market is smaller.

Bankers also have time to prepare for the crunch over the next few years. Tishman says he hopes federal regulators and legislators will be more proactive this time in heading off the problem.

“Washington is no longer in the position to just float every industry there is,” he said. “But when they see an industry that’s in need, they are going to do something about it before they will let it take the general economy down like the housing market and Lehman did.”

ST. LOUIS - Following the lead of Fed Chairman Ben Bernanke and the stock market, the nation’s top business economists, gathering here for their annual meeting, have declared “the Great Recession of 2008-09 is over.” But the forecasters aren’t exactly popping champagne corks about what they see coming next.

After the deepest slide since the Great Depression, the economy looks like it has finally hit bottom, according to a survey of the National Association of Business Economists. The group sees the gross domestic product posting a solid 2.9 percent gain in the second half of this year.

That’s the good news. The group is less confident about the strength of the recovery, saying it is “likely to be more moderate than those typically experienced following steep declines.”

And they see a long list of problems that could weaken that recovery.

The biggest worry: a prolonged period of high unemployment following the destruction of eight million jobs since the recession began in December 2007. The economists don’t see the jobless rate falling below 9.5 percent by the end of next year. They expect only weak job growth in 2010; an average of some 107,000 net new jobs created each month in 2010. That’s barely enough to keep up with the annual growth of the workforce.

"You can have 2 or 3 percent GDP growth and not have job growth, and that in turn doesn’t help sustain economic growth,” said Stuart Hoffman, chief economist at PNC Financial Services. “Economies are like gears — they all have to engage. And you can get one wheel spinning, but if it doesn’t engage, it eventually loses momentum.”

With one in 10 workers without a paycheck, the level of consumer spending is also expected to be weak — inching up next year by just 1.6 percent. High levels of debt and trillions of dollars of lost home equity will continue to put a big crimp on spending.

Consumers may catch a break if the NABE is right about its inflation forecast, which calls for prices to rise by just 1.4 percent next year. The low inflation forecast is largely based on the conventional wisdom that the amount of slack demand and excess capacity in the economy — the so-called “output gap” — will keep pressure off price hikes for raw materials and force companies to keep their prices down.

But James Bullard, president of the Federal Reserve Bank of St. Louis, warned that given the Fed’s massive expansion of the monetary base to combat the financial meltdown, the economists may be too quick to dismiss the risk of higher inflation.

“I am concerned about a popular narrative in use today — the narrative being that the output gap must be large since the recession is so severe,” Bullard told the economists at a luncheon speech. “And so, any medium-term inflation threat is negligible, even in the face of extraordinarily accommodative monetary policy. I think this narrative overplays the output gap story.”  

With weak consumer spending expected to add little to growth, the hope is that businesses will begin to invest in rebuilding inventories that have been slashed during the recession and to buy equipment they’ve deferred replacing during the downturn. But those businesses may have trouble getting credit; just as employers are skittish about hiring, bankers say they’re having trouble finding enough solid businesses to lend to, according to Bullard.

“They want to make loans because that’s how they make money,” he told reporters. “But they don’t want to make a bad loan because that’s how that’s how they got into trouble.”

With bankers pulling back, credit has also tightened in the so-called “shadow banking” market, in which loans are packaged into securities and sold to investors. Once a ready source of capital for mortgages, student loans and credit card debts, that market has largely shut down.

“If you can’t get this market back, you’re not going to be able to finance most consumer loans,” said Gary Gorton, an economist at the Yale School of Management.

Not everyone here agrees with the consensus forecast, given the long list of underlying problems that are weighing on economic growth.

“Residential foreclosures are high, commercial foreclosures are still climbing and have not peaked, bank charges off are still climbing and they have not peaked,” said Dan Hamilton, an economist and forecaster at California Lutheran University. “If the government stops pumping a ton into fiscal spending, after that we see weakness — it could even be negative (GDP).”

Some economists here see a permanent cutback by consumers following a decade-long, debt-fueled spending spree on bigger homes, giant backyard gas grills and elaborate vacations and parties. Cornell economist Robert Frank said much of that spending was fueled by the desire to try to keep up with rapidly rising incomes at the top of the economic ladder, even as wages at the bottom were falling behind. Now, with hard times hitting all income groups, Frank thinks lower consumption levels may become part of a new attitude toward spending.

“Were not going to be unhappy because consumption is a little lower,” said Frank. “We’ll adjust.”

But workers without a job, or whose hours have been cut sharply, will have a much harder time adjusting. For those workers who do have jobs, few should expect much in the way of a raise. Economists here expect the growth in workers’ compensation to grow just 1 percent this year and 2.2 percent next year, the lowest two-year showing on record. But get ready to work harder next year: despite that meager wage growth, worker productivity is expected to rise another 2.5 percent.

The economists are also pinning their hopes on other the housing market to pull help the economy out of recession. After the steepest decline in decades, the housing industry is due for a bounce, according to the group’s forecast, with investment in residential real estate picking up by eight percent next year. That translates to a pickup in housing starts to some 800,000 next year, but below the 910,000 recorded for 2008.

That forecast comes with a caveat that the rebound could be derailed by the high levels of unemployment and the tightening of credit that has made it tough for some home buyers to get a mortgage.

Any housing rebound will also be dampened by the continuing high rate of foreclosures, now running roughly 300,000 a month, which adds further downward pressure to housing prices just as they seem to be bottoming out. Housing market skeptics also note that signs of a recovery could bring a glut of new listings from homeowners who have been sitting out the downturn, further adding to the amount of unsold homes on the market.

There’s less optimism among the economists here about the rebirth of the auto industry, despite a strong pickup in car sales thanks to the government’s Cash for Clunkers program. After hitting a 40-year low in 2009 of 10.3 million light trucks and cars, vehicle sales are expected to see a bump to 12 million next year, yet still well below the 13.2 million sales recorded in 2008.

Economists are also looking for an 11 percent pickup in corporate profits next year, which will come as good news to investors if it happens. High hopes for the economic recovery have pushed stock prices in the S&P 500 index to 140 times earnings, or three times the levels seen at the height of the Internet bubble.

Forecasters’ optimism about the economy and the stock market is tempered by some serious concerns about potential threats to this upbeat scenario. Chief among them is the swollen federal budget deficit, which is expected to hit $1.5 trillion this year.

It’s also not clear how the historic moves by the Federal Reserve will play out over the long run. To support the housing market and keep interest rates low, the Fed has been buying hundreds of billions of mortgage backed securities.

Though the Fed has targeted $1.75 trillion for this asset purchase program, it hasn’t said how it might adjust the program based on economic conditions. Bullard said his colleagues on the central bank need to do a better job of signaling its plans to the markets.

“There has been little indication of how or whether these (asset purchase) amounts might be adjusted given incoming information on economic performance,” he said. This lack of clarity has created uncertainty in financial markets.”

NEW YORK - There were some hopeful signs among the blizzard of economic data released this week. But the recovery from the worst downturn in decades remains hostage to one of the ugliest numbers on the list: the unemployment rate.

"The hole that has been blown in the labor market is absolutely enormous,” said Heidi Shierholz, an economist with the Economic Policy Institute.

That hole continues to widen. On Thursday, the Labor Department said initial claims for unemployment insurance rose to a seasonally adjusted 551,000 — up from 534,000 in the previous week and more than Wall Street economists expected.

The data followed a report Wednesday from payroll manager ADP showing that U.S. companies cut 254,000 jobs in September, also more than forecast. Government figures for September, including the official unemployment rate, will be released Friday morning.

The bad news on the job front has been partially offset by other signs that the economy may be on the mend. A private trade group said Thursday that manufacturing expanded for the second straight month in September, but at a slightly slower pace than in August and not as robustly as economists predicted. Construction spending also rose a bit in August.

And consumer spending, which accounts for 70 percent of total economic activity, jumped in August by the largest amount in nearly eight years, even though personal incomes continued to lag. Housing sales have also perked up this summer; pending sales of existing homes rose 6.4 percent in August.

But consumer spending and home buying have gotten a big boost from government programs like the hugely popular Cash for Clunkers car buying subsidies, which has expired, and the $8,000 first-time home buyer tax credit, which expires at the end of next month.

Indeed, auto sales at Ford and Chrysler dropped in September, showing that automakers were likely to have a tough time luring buyers into showrooms now that the clunkers program has ended.   

Consumers may not be able to continue to boost spending without government subsidies — especially the nearly 7 million workers who have lost their jobs since the worst economic downturn since the Great Depression began in December 2007.

Even if the economy were to rebound sharply, the job market would have to create 400,000 jobs a month, every month, for two years to put those people back to work. Economists and government officials, including Federal Reserve Chairman Ben Bernanke, warn that the recovery will likely be very weak.

"Even though from a technical perspective the recession is very likely over at this point,” he said last month, “it's still going to feel like a very weak economy for some time as many people will still find that their job security and their employment status is not what they wish it was.”

That view was echoed Wednesday by the chairman of Wal-Mart Stores Inc., who warned that the global economic recovery likely will be lethargic. The world's biggest retailer is betting on stronger growth potential in China and India.

"The world recovery is going to be led by Asia, although it's going to be very challenging. I think this recovery is going to be a slow one," Robson Walton told a global CEO business conference in Kuala Lampur, Malaysia. Walton, the eldest son of Wal-Mart founder Sam Walton, said "sales have been tough," even though the retailer was benefiting from the economic downturn as more people shop at discounters for bargains.

Walton’s comments echoed remarks Tuesday in Singapore by General Electric chief executive Jeffrey Immelt, who warned that high unemployment and slower lending will drag on U.S. economic growth, likely resulting in the weakest recovery in decades. (Msnbc.com is a joint venture of Microsoft and GE’s NBC Universal unit.)

The recovery is also being dampened by an ongoing downturn in the commercial real estate market.

“Commercial real estate remains a very serious problem,” Bernanke told Congress Thursday. “We are concerned both because the fundamentals are weakening and because the financing situation is bad. That could provide a source of a lot of stress, particularly for small and regional banks that have a very heavy concentration in commercial real estate.”

The expected pickup in growth in the second half of the year is the result, in part, of companies rebuilding inventories that were cut sharply during the deepest trough of the recession. But overall demand may not rise soon to pre-recession levels.

So far, employers aren’t seeing much of a pop in demand, according to employment consultant Challenger, Challenger, Gray & Christmas, which surveys companies on layoffs plans.

“Declining demand is still the dominant reason (for layoffs),” said Rick Cobb, the company’s executive vice president. “It’s far and away above any of the other reasons given.”

High unemployment has placed a major drag on consumer spending; so has the beating households have taken on their savings and the drop in the value of their homes. Despite recent gains in the stock market, U.S. households have lost roughly $12 trillion in net worth since the recession began, according to the Federal Reserve’s flow of funds data.

“So cash that people do have — they're putting toward rebuilding their savings rather than spending,” said Shierholz. “It is going to be a long haul until we get consumer spending back up.”

With consumers tapped out, Uncle Sam has become the spender of last resort. As the $787 billion worth of tax cuts and spending projects works through the system, that money has helped move some of the key economic data into positive territory. But that impact will fade as government spending dries up.

That budget squeeze is already playing out at all but a handful of state and local governments. As state and local budgets are cut, spending falls, creating more layoffs. Unlike Congress, states and local governments can't borrow money to close budget gaps.

After continuing to create new jobs well into the recession, overall government payrolls began shrinking in April and have been declining since then.

Confusion about the outlook for the economy abounds, and consumers, who are responsible for the bulk of economic activity, may be the most puzzled about it.

Despite all the talk of "green shoots" on Wall Street, consumers have good reason to be skeptical. With much of the economy still badly battered by the worst downturn since the Great Depression, it remains to be seen how strongly the economy will emerge from that slump.

On Tuesday the Conference Board, an industry group, reported that its index of consumer attitudes fell to 53.1 in September from a revised 54.5 in August. The news surprised Wall Street, which had been expecting the index to rise to 57.0.

Part of the surprise came from conflicting signals from last week's widely watched University of Michigan survey, which found consumer confidence rising in August.

Consumers who see the glass as half-full seem to be responding to recent positive reports about the recession coming to an end. The University of Michigan survey tracks changes in whether consumers are hearing “good news” or “bad news" about the economic outlook. In August, that index took a big jump.

No wonder. There's been plenty of good news lately about the economy, and some data due out later this week are expected to add to the evidence that the longest, deepest postwar recession is coming to an end.

"From a technical perspective, the recession is very likely over at this point," Federal Reserve chairman Ben Bernanke said earlier this month. "It's still going to feel like a very weak economy for some time because many people will still find that their job security and their employment status is not what they wish it was."

Many private economists expect that the official barometer of economic growth, the gross domestic product, will post gains in the second half of the year — thanks to a multitrillion-dollar pump-priming by the federal government over the past year. But there are widespread doubts about whether the engine will keep turning strongly enough to produce jobs after the government's stimulus spending is over.

Those fears showed up in the latest Conference Board survey: The index of people who described jobs as "hard to get" rose to 47.0 from 44.3. And the gauge of "jobs plentiful" fell to 3.4 from 4.3, the lowest since February 1983.

Even those who see the recession ending concede that it will be years before the job market brings employment levels back to anything close to a "normal" economy. That’s because each of the four major sectors that produce economic growth still face major headwinds.

Here’s a look at each sector:

Consumer spending
Because consumers account for about 70 cents of every dollar’s worth of U.S. economic growth, it’s hard to have a recovery unless households are spending. Some economists believe that, as the recession ends, consumers are getting more confident and will soon return to their traditional role as the main engine of economic growth.

The latest data on the housing market and retail sales seem to back that up. Existing home sales have risen in four of the past in six months, and new home sales have risen for four straight months. Retail sales bumped up 2.7 percent in August, the biggest gain in three years. Recent gains in the stock market have helped households rebuild battered investment savings, easing some of the financial gloom that cut into consumer spending.

But those gains are from basement-bottom levels; home sales are still off more than 25 percent from their 2005 peak. Car sales, which also picked up in August, are still well below levels seen for most of the decade.

September auto sales will be reported Thursday and are expected to show a 20 percent drop from levels in August, which were boosted by the federal "Cash for Clunkers" program. Housing sales also could drop after Nov. 30, when an $8,000 federal tax credit for new home buyers, is set to expire.

With or without government incentives, consumers can’t spend money they don’t have. Some 14 million workers are without a paycheck; many of those who relied on credit card debt or home equity loans during the past decade can no longer tap that spending power. And while job losses appear to be easing, most economists expect the unemployment rate to remain stubbornly high, and possibly climb more.

“We are digging out of a very deep hole,” said Julia Coronado, a senior economist at BNP Paribas. “Until we see (job gains) of 125,000 or 150,000 (a month), the unemployment rate is going to be drifting higher.”

After cutting payrolls to the bone, employers won’t be in a hiring mood until they’re convinced the recovery is solid and sustainable. That’s going to take more than a few quarters of positive GDP growth. 

“(Employers) have pared down, they’ve cut back and they’re pretty lean right now and you’re going to see pretty big jumps in productivity,” said John Engler, president of the National Association of Manufacturers. “I think it’s going to be a very slow recovery, but as it comes back I think you’re going to see a lot of increased production without a lot of hires.“

A weak housing market could also slow the recovery in new hires as job seekers who want to relocate run into roadblocks trying to sell their homes.

“In the U.S. traditionally there’s a lot of labor mobility,” said David Blitzer, an economist with Standard & Poor's. “And as you begin to see a little improvement in the economy it’s not clear that the new jobs will be where the old jobs were. But it will be very difficult for people to move to take the new job because they’ll be stuck with the house where the old job was.”

Business investment
Notice how many items are back-ordered these days? As the recession deepened, businesses cut back inventories to the bone, afraid to get stuck with unsold goods if consumers stopped buying. Now that the economy seems to be finding a bottom, production is expected to ramp up smartly to restock those depleted inventories.

It may already be happening. Industrial production is up 1.8 percent in the past two months. Economists looking for a boost in business investment also note that companies deferred purchases of new computers and other equipment, so they eventually have to buy new ones. After peaking at 17 percent of GDP in 2006, business investment fell to just 11 percent in the first half of this year.

But strong business investment won’t be sustained until it’s clear there is strong consumer demand for more goods and services, according to David Roche, global strategist at Independent Strategy Limited.

And even if demand does come back, businesses still have lots of excess capacity to meet it after deep cuts in jobs and production during the recession. As of August, U.S. factories were running at just 67 percent of capacity, down from average levels of 80 percent for the past three decades.

“With all the excess capacity out there, I think it would be very difficult to see a big capital spending boom,” said Gary Shilling, a private economist and consultant.

Federal spending
As consumers closed their wallets, Uncle Sam opened his with one of the biggest spending programs in history, roughly $1.5 trillion in less than a year. Some $700 billion went to shore up shaky banks; another $787 billion paid for tax cuts and a surge in spending on new roads, green technology and a host of other projects designed to pump dollars into a shrinking economy.

A separate alphabet soup of money transfers from the Federal Reserve added another $1 trillion, much of it to guarantee loans and buy up bad investments from banks that couldn’t sell them, freeing up cash for them to lend.

The strategy seems to have worked, and much of the planned direct government spending is still in the pipeline. The hope is all that federal spending gets the gears of the economy turning again with enough momentum that as the federal spending spigot starts to slow down, other sectors of the economy will take up the slack.

But that plan comes with potential pitfalls. At some point, the Federal Reserve will have to unwind its trillion-dollar infusion of cash or risk igniting another asset bubble or nasty round of inflation. If it unwinds too quickly, it risks setting off another panic in the financial markets. If it leaves its policy in place too long, bankers will assume they can keep making risky loans and sell them to the Fed if they go bad.

“I believe they will continue to wind those (Fed backstops) down gradually,” said William Isaac, a former head of the FDIC. “We need to take sort of baby steps: take them down a little bit, see what happens, and take them down some more. Because we need to wean the markets off of these things. We can't keep them there forever.”

The government’s direct spending is being funded entirely with borrowed money, which is fine as long as investors keep buying U.S. Treasury debt. If they begin to lose their appetite, that could force interest rates higher, creating a big problem for businesses and consumers who need to borrow money.

Much of the hundreds of billions in federal spending has also been siphoned into a hole that diluted its impact: the growing chasm in state and local government budgets.

State and local spending
About half of government spending comes from state and local governments, which can’t borrow money when they get in a bind. And today, state and local governments are in an historic bind.

All but two states face budget shortfalls; in all, the deficits amount to about $168 billion, or about 25 percent of total state budgets. That number is expected to rise to $350 billion by 2011, according to the Center on Budget and Policy Priorities. If the Obama administration’s health care plan relies on Medicaid to cover more uninsured households, states could face a bill for tens of billions more.

As a result, the impact of the federal stimulus spending has been blunted by the sharp drop in state spending.

“The falloff in local and state revenues for roads and bridges was so precipitous that the federal money really kind of got us back to about level,” said Engler of the manufacturers' group. “There was really no net significant gain there.”

Local governments, which rely heavily on property taxes, also face budget shortfalls over the next several years as falling home prices force them to lower property assessments.

That means cutting spending and laying off workers, a process that is already under way.

Net exports
The last component of GDP — net exports — has actually been a drain on growth because the U.S. imports more than it exports. But the gap has been narrowing, and a continued pickup in exports would ultimately add to the economy’s overall growth.

Much of the gains for U.S. exporters have come from the declining value of the dollar, which makes U.S. goods and services more competitive in overseas markets. U.S. exports jumped to roughly $1.8 trillion from $1 trillion in 2001, when the last recession ended.

But U.S. exporters may not be able to rely much longer on a weak dollar to expand their business.

The common refrain you hear is, ‘Well, if we cheapen up the dollar, it will make it better for the trade deficit,” said Stephen Stanley, chief economist at RBS Greenwich Capital. “That’s a mantra that I'm not sure is really borne out over time.”

A continued slide in the dollar could bring some nasty side effects. The most worrisome is a rise in interest rates as overseas investors demand a higher return on U.S. Treasury bonds to make up for the eroding value of any investment denominated in dollars.

“The U.S dollar is on the weak side, and that’s great for our exports for now,” said Todd Buchholz, former director of White House economic policy from 1989 to 1992. “But there’s a narrow gap between helping the economy and being so weak that it becomes a crisis.”

NEW YORK - A year after the panic that brought the world’s financial system to the brink of collapse, the Group of 20 nations will now assume the role of a permanent council on global economic cooperation. But there is still no global regulatory framework to prevent another major market meltdown.

About the biggest news coming out of this week's gathering in Pittsburgh is that the invitiation list to future meetings on global economic policy will be expanded. The Group of 20 will now take over the job that had been done for more than three decades by a smaller group of the wealthiest countries known as the Group of 7. That body became the Group of 8 when Russia was invited to in 1997.

But adding more seats at the table doesn't seem to have produced any meaningful headway on thorny issues like the need for new global financial regulations.

“There are always fine statements,” said Dan Price, a lawyer with Sidley Austin who specializes in global financial regulation. “Unfortunately, they’re followed by backsliding as leaders go home and feel domestic political pressure."

German Chancellor Angela Merkel had warned Wednesday that officials gathering for the G-20 meeting should focus on the imperative of revamping the world's financial regulatory system and not get distracted by a U.S.-led drive to reduce global trade imbalances.

The United States has been pushing for nations such as China to reduce their dependence on exports and boost domestic spending. In return, the U.S. would increase savings and reduce its debt burden.  

So far, individual G-20 countries have made little progress in getting their own financial houses in order.

In the United States, Congress is mired in health care reform and facing a divisive battle over carbon cap-and-trade legislation, making financial regulatory reform look less likely this year.

“Any global process is bound to be slowed down because the U.S. legislative agenda is so backed up now,” said Geoffrey Garrett from the University of Sydney's U.S. Studies Centre. “So we’re now talking about mid-2010 or later for any resolution on the U.S. side about what their reform is going to look like after the crisis.”

Meanwhile the global banking industry is still struggling to rebuild the capital that was destroyed by a lending spree that relied on huge leverage, producing huge gains on the way up and historic pain on the way down. Curbing the systemic risk that blew a trillion-dollar hole in the world financial system is a major goal of the G-20 financial leaders. But it’s not clear who will take the lead.

“Among the regulators it really has to be the U.S. and U.K. regulators who have a 30-year history of always leading from the front,” said Michael Foot, chairman of consulting firm Promontory Financial Group. “But one of the tragedies is that in both the States and the U.K. there are turf wars and uncertainties for what regulation will look like in two years' time.”

“We are absolutely at the levels of risk from 2004 or 2005,” said Simon Johnson, an MIT economist and former chief economist for the International Monetary Fund. “So it’s not imminent crisis, but the danger signals are there already in the amount of risk that the big banks are taking, and their attitudes towards risk and the controls they have over their derivatives (trading.)"

One likely scenario would require banks to keep more capital on hand and limit the amount of lending backed by that capital. But stiffening the rules now risks tightening credit just as the global economy is struggling to get back on its feet. That’s one reason regulators are in no hurry to force banks to keep more cash in the vault.

The discussion over requiring banks to hold more capital has also opened a major fault line among the biggest banking powers. Without a uniform set of regulations, countries that adopt easier capital requirements will hand their domestic banks a strong advantage over global competitors.

“The Americans don’t want to do enough on capital requirements, in my opinion,” said Johnson. “But the Europeans don’t even want to do that because their banks are so thinly capitalized."

In any case, bankers are in no hurry to play by a new set of rules on capital standards. Forcing them to lend fewer dollars for every dollar they hold in reserve means they’ll have less money to lend, and less profit to show for it.

“I think there’s no choice but that banks will have to expect much lower average returns on equity and returns on assets,” said Foot.

The discussion of restricting banks from relying on razor-thin capital reserves has also been overshadowed by a loud debate about capping lavish banker bonuses. Some critics have argued that excessive compensation contributed to the excessive risk-taking that produced the global lending bubble.

European leaders, lead by French President Nicolas Sarkozy, are calling for strict limits on bankers’ pay and bonuses. U.S. and British leaders, facing strong resistance from the global banking centers of Wall Street and the City of London, are pushing for more flexible oversight.

“We’re beginning to see some emerging consensus around a set of principles that ties compensation to performance, that discourages excessive risk-taking and that provides for claw-back in the event a firm’s performance suffers,” said Price. “What we’re moving away from — helpfully and sensibly — is talk of actual caps or ratios.”

The discussion over tighter bank regulation is being squeezed into a packed two-day agenda in Pittsburgh along with a long list of other pressing issues. Climate change, a perennial topic, has new urgency now that Congress is debating various proposals to cap carbon emissions.

The global recession has also increased pressure to protect domestic industries. Trade skirmishes between the U.S. and China over tires and chickens have brought those protectionist frictions to the front burner.

President Barack Obama's decision this month to slap tariffs on Chinese-made tires has been among the most visible signs of this growing friction. The rising risk is that as countries try to jump-start their economies, they will move to protect domestic industries. Any new barriers to international trade will only slow the weak recovery in the global economy.

“We have a series of skirmishes now, which we hope doesn’t escalate into a war,” said Mark Michelson, a Hong Kong-based consultant based with APCO Worldwide. “There’s going to be some of this tit-for-tat for a while. Some (are) not as obvious — in terms of regulations and barriers to trade that are not clearly stated.”

Global leaders also face the daunting task of winding down big budget deficits left behind as the industrialized world cranked up government spending to try to reverse the global downturn.

While it’s too soon to know just how effective those programs have been, the long-term impact of continued deficit spending is clear. Heavy government borrowing can squeeze credit in the private sector, eventually slowing growth and weakening the recovery.

“Obviously this isn't the time to start cutting those budget deficits,” said Martin Feldstein, a Harvard economist and chief economic adviser in the Reagan administration. “But it is the time to explain the plan and to make concrete promises about what's going to happen as the economy recovers.”

Friday's monthly jobs report — showing a slower pace of layoffs in July — adds to growing optimism about signs of life in the economy. But this recovery, when it comes, won’t feel like any in memory.

The reason is that consumers — the mainspring of the economy — remain hunkered down. Growth is still coming from cost-cutting and federal spending, not from a pickup in real demand. And with 7 million workers sidelined by this recession — bringing the total number of jobless to nearly 15 million — that headwind likely will be blowing for several years.

“We're not going to go back to where we've come from," said Mohamed El-Erian, CEO of PIMCO, a global investment management firm. "There's still an assumption out there in the marketplace that somehow this was a very nasty cyclical fall, and we're going to go back to where we've come from. That's not what’s going to happen.”

The government's report on employment — that employers cut 247,000 jobs in July, the fewest in a year — was better than expected and provided strong evidence that the wave of job cuts from the current recession may be winding down. The unemployment rate dipped to 9.4 percent, the first drop in 15 months.

The report follows other positive clues that the worst economic downturn since the Great Depression is easing. Last week, a series of reports offered hopeful signs that the housing market may be nearing the end of its economy-stopping collapse. A report by the Federal Reserve found that most of its 12 regional banks concluded that either the recession was easing or that economic activity had "begun to stabilize, albeit at a low level."

On Friday, the government's initial report on second-quarter gross domestic product showed the economy contracted by just 1 percent, a better-than-expected reading, after plunging by 6.4 percent in the first quarter.

All of which seems to have convinced stock market investors that happy days, if not here again already, are at least not too far down the road. Since its March low, the S&P 500 index — the broadest measure of stocks — is up nearly 50 percent.

Brown shoots
Those signs of economic stability follow an unprecedented government mobilization to head off a wider collapse: from the Fed’s trillion-dollar intervention in the financial markets to the Treasury’s massive bank bailout and the Obama administration’s $787 billion stimulus package. Other than massive government spending by the U.S. and other countries, though, the level of demand for goods and services needed to lead the economy out of recession hasn’t kicked in.

“There still is generally a picture of very weak final demand, especially in North America, Europe and Japan which are the primary industrialized countries still in recession,” said Brian Bethune, an economist at IHS Global Insight.

A major reason for that slack demand is that consumers, whose spending still accounts for two-thirds of GDP, remain hunkered down and show little sign of opening their wallets any time soon. Consumer confidence fell in July, and retailers Thursday reported another month of lousy sales results.

Consumer spending rose slightly in June for the second straight month, but incomes — the fuel for future spending — dropped by 1.3 percent. The savings rate dipped to 4.6 percent in June, but remained well above last year's 1 percent rate.

Falling home prices continue to erode consumers' wealth and sap their spending power. By 2011, roughly half of all American homeowners will be "underwater" - owing more on their mortgage than their home is worth, according to a report by analysts at Deutsche Bank.

Until real demand picks up, the large pool of workers sidelined by the recession will continue to have a hard time finding a job.

“Unless an individual company is in the position where they're really seeing their business pick up, they're very cautious about adding back,” said Tig Gilliam, CEO of staffing company Adecco North America. "And there are large companies out there who are going to come with big announcements still. We're not past the large announced layoff process yet, even in this cycle."

In the meantime, hundreds of thousands of unemployed workers face the loss of unemployment benefits as the recession drags on. The National Employment Law Project estimates that some 540,000 Americans will exhaust benefits by the end of September, and a 1.5 million will run out of coverage by the end of the year.

As of July, 4.4 million Americans had been out of work for more than six months, up from 2.6 million in February. Some 29 percent of jobless workers have been out of work for six months, a record since data were first reported in 1948, according to the NELP.

With unemployment stuck at high levels, jobless benefits running out and those consumers who have disposable income devoting more of it to savings, demand will likely remain sluggish.

Once companies do begin hiring again, it may be several years before overall employment reaches pre-recession levels. Roughly 125,000 new jobs are needed each month just to keep up with the growth of the work force.

So even if the economy quickly returned to the peak job creation performance of 2007, when the economy was adding roughly 400,000 new jobs a month, it would take more than two years to rehire the 7 million workers who lost their jobs to the recession.

Few economists expect a return to those 2007 growth levels any time soon. As demand picks up, companies will likely increase hours for part-time staff or bring back furloughed workers before creating new full-time jobs.

“We’re a long way from a recovery in new hiring,” said Bethune. “That's going to be a damper for the overall situation in the labor market.”

Analysts say some companies are also postponing hiring decisions until they get a better handle on the impact of new federal policies like healthcare reform.

So as the steep economic contraction that began 20 months ago begins to ease, analysts surveying the damage say the period following this recession may be like no other in recent memory: persistent high unemployment coupled with very weak growth. Though a return to growth is likely to mean the official end of the worst recession since the 1930s, it won’t feel like a recovery for millions of Americans.

“We can have muted growth,” said El-Erian. “We can have a nominal GDP in the 3 percent range. But that's not enough to stabilize the system. We have a system that has grown accustomed to 5, 6 percent nominal GDP. So we will have growth, but it will be timid. It will be what we call the ‘new normal.’"

ELKHART, Ind. - When President Barack Obama last visited Elkhart, Ind., in February, he was trying to generate popular support for a massive economic stimulus package, then facing growing opposition in Congress. It was his third visit to the economically hard-hit area in less than a year, and he used his visit to tout the benefits of his program to Elkhart and the nation.

“I promised you (during the election campaign) that, if elected I’d do everything I could to help this community recover," he told a cheering crowd. "That’s why I came back today, because I intend to keep my promise.”

At the time, Obama listed a number of promises he has made. Some of them involved specific measures in the stimulus package. Others were broader pledges to put the economy in Elkhart —and the nation — back on track.

As Obama prepares to return to Elkhart County Wednesday, here is an assessment of the progress he has made in fulfilling some of his promises.

Tax relief
In his February speech, he touted the stimulus plan for providing "tax relief for 95 percent of American workers."

"So that you who are being pinched, even if you still have a job, with rising costs, while your wages and incomes are flatlined, you'll actually have a little bit of extra money at the end of the month to buy the necessities for you and your children," he said.

The $787 billion stimulus package ultimately passed included $287 billion — about a third of the total — for temporary tax breaks. This included a broad range of targeted cuts and credit, the biggest of which, the “Making Work Pay” tax credit of up to 6.2 percent of earnings, provided up to $500 per worker. The bill cut the amount of money withheld for taxes from weekly paychecks, releasing the money immediately to individuals and families and encouraging them to spend it.

The rest of the tax relief was highly targeted, including earned-income tax credits for lower-income families, incentives for energy-related home improvements and a break for first-time homebuyers.

“If you add in the checks that old people got out of the stimulus and the fact that the stimulus bill reduced the taxation of unemployment benefits, Obama has cut taxes for a large fraction of the population — pretty close to 95 percent,” said Gerald Prante, senior economist at the Tax Foundation. “And I would say that he's basically held true to that campaign promise.”

One caveat: The promise applies only to 95 percent of “American workers.” That doesn’t include the more than six million people who have lost their jobs (and therefore don’t pay wage taxes) since the recession began.

Obama’s critics note that this is one of the hardest promises to assess because there is no way to measure how many jobs are “saved.” To do so, you’d have to poll employers and ask them how many people they decided not to fire because the stimulus package came along.

On the “creating” side of the employment ledger, the Obama administration still has a huge job ahead of it. Jobs are still being lost at a pace of roughly half a million a month. Assuming that pace tapers off by year-end, as some economists are predicting, as many as 7.5 million jobs will have been lost to this recession. Unless and until the majority of those people can be put back to work — with wages to fuel the consumer spending that makes up two-thirds of the U.S. economy, future “growth” won’t feel like good times to millions of sidelined workers.

Job losses in states like Indiana — where roughly a quarter of the work force is employed in construction and manufacturing — have continued since February, as the auto and commercial real estate industries continue to contract.

Since Obama's speech in February, at least 66,438 Hoosiers have lost their jobs, based on June figures, the latest available. Elkhart has fared a bit better: Employment is up by 762 jobs.

The stimulus package did help extend unemployment benefits, but the payments and length of extension vary by state. The stimulus package provided money to states that choose to keep paying after 26 weeks.

But some 18 states have exhausted their unemployment war chests, which are funded by payroll taxes, and are now borrowing from the federal government to keep the checks flowing to laid-off workers. Congress recently moved to set aside another $7.5 billion to keep these funds from running out of money.

To pay that money back and keep up with the rise in jobless claims, states have begun to raise the premiums they charge employers. That could make it harder for companies to add new workers to the payroll.

The oversight board is up and running, including 10 inspectors general from the federal departments through which the stimulus money will be flowing. Each inspector general’s office is staffed with an army of auditors who are well-versed in tracking the spending of taxpayer dollars.

But much of the money has been turned over to the states, which have broad discretion on how to spend it. More work needs to be done at the state level, according to a July report by the General Accountability Office.

“Current guidance does not achieve the level of accountability needed to effective respond to the Recovery Act risks,” said the GAO.

Recovery.gov is a wealth of information about the many moving parts of the stimulus package. The site includes a state-by-state, city-by-city tally of funds that have been approved and spent so far, along with a breakdown of which federal departments and agencies are spending your money.

The site also demonstrates the difficulties the Obama administration faces getting the stimulus money flowing. On the one hand, strict oversight of spending is helping cut down on waste and abuse. On the other hand, while billions of dollars in spending have been approved, the actual flow of money has been relatively slow. As msnbc.com reported, that has blunted the impact of the stimulus on boosting the economy.

Roads
"It's not just the jobs that will benefit Indiana and the rest of America, it's the work people will be doing: rebuilding our roads, our bridges, our dams, our levees, roads like U.S. 31 here in Indiana that Hoosiers can count on, that connect small towns and rural communities to opportunities for economic growth."

Obama put his finger on a major pain point when he cited U.S. 31, according to Elkhart County highway department manager Jeff Taylor. It’s the major corridor for the flow of goods and services between the smaller counties in the northern part of the state and Indianapolis, the main commercial hub. And it needs work.

“U.S. 31 is nothing but traffic signals,” said Taylor. “That corridor is under design and under construction. But it just at the very beginning (of being upgraded.)”

Though stimulus money may help move the project along, it's a long way from improving the  movement of Elkhart's goods and services downstate. According to the state Department of Transportation, the northern portion of the project that would speed traffic to Elkhart is scheduled for completion in 2013.

Sometimes the "shovel-ready" roads from the government's economic stimulus program lead straight to a pile of paperwork but not to the jobs they were supposed to create.

To find out how well increased federal spending is flowing through the economy, take a drive down Country Road 17 in Elkhart, Ind.

Traffic along this major thoroughfare heads south from the Interstate, bypasses downtown and then stops dead just outside of Goshen, the next town over. The plan to extend the road is approved and ready to go to bid within 60 days, according to county highway manager Jeff Taylor.

But instead of digging new bridge foundations, Taylor said his department is digging through a deluge of government forms.

“I’ve got an engineer full time and that’s just about all he’s doing is red tape every day — filling out forms, filling out forms,” he said. “You will not see stimulus used until next year because this year is going to be all red tape."

An approval process that usually takes his department five steps has now stretched to 50, Taylor said. Rights of way that have already been acquired, for example, have to be reviewed and re-approved.

“They’ve made it so rigorous that when you say ‘shovel ready,’ the lay person sitting at the bar having his beer wishing he could get back to work is thinking ‘Why don’t we get busy?,’” Taylor said. “And I’m telling you we’re not going to get busy any time soon because it takes a long, long time to get through the paperwork.”

Taylor is among thousands of front-line managers overseeing the planning and design of billions of dollars worth of projects that were supposed to get a jump-start from the $787 billion stimulus package enacted in February. The boost in spending was, in turn, supposed to help reverse the collapse in the economy and create new jobs.

So far, it doesn't seem to be working out that way. Though the rise in unemployment has slowed somewhat since the stimulus was enacted, the Obama administration concedes that job losses may not ease for some time, even with massive government spending designed to create new ones.

"How employment numbers are going to respond is not yet clear," President Barack Obama said earlier this week before heading to Michigan, where the unemployment rate is among the highest in the country. "My expectation is that we will probably continue to see unemployment tick up for several months."

Defenders of the stimulus package note that without the huge government response, the unemployment rate would be even higher. They also note that the loss of trillions of dollars in household wealth and the huge pile of bad debts choking the banking system have created an economic mess unlike any other economic downturn in memory. 

“We are in a balance sheet recession,” said Laura Tyson, a former head of the Council of Economic Advisers during the Clinton Administration who is now one of President Obama's economic advisors. “We haven't gone through this kind of recession in most of the lifetimes of the forecasters. By the way, the models that forecasters use are the same models that missed the fact that we were going to have this recession. So let's admit a lot of uncertainty here.”

When Congress and the White House put together a plan to spend $787 billion to try to rescue the U.S. economy, they agreed to spread the flow of money over several years. According to the Congressional Budget Office, some $185 billion is targeted to be spent this year, roughly $400 billion next year, $135 billion in 2011 and the remainder in the following years.

Critics of the package say that it’s not surprising that the huge war chest seems to be having a limited impact.

“I think it's doing exactly what everyone predicted it would do,” said Lawrence Lindsey, a private economist and senior economic advisor in the Bush administration. “Every major budget analyst in both parties, and the Congressional Budget Office, said that this stimulus, the way it was constructed, wasn't timely, wasn't targeted on jobs and, therefore, wasn't going to stimulate the economy. And lo and behold, it didn't.”

So far, the bulk of the funds have been spent to fill the huge — and widening — holes in state budgets. The two biggest spending categories are for Medicaid and education. But that money is largely offsetting the collapse of revenues as falling house prices have eroded property taxes and rising unemployment have cut into income taxes.

Almost all 50 states are facing budget gaps for the upcoming fiscal year to the tune of about $166 billion, or 24 percent of all state spending, according to the Center on Budget and Policy Priorities. The group projects that by 2011 state budget shortfalls will top $350 billion — nearly half the entire stimulus package. Filling those state budget shortfalls with federal stimulus funds will help blunt deeper cuts in state jobs and services, but that money won’t help create new jobs.

“The stimulus wasn't going to turn this around overnight, but it's hard to argue that it's really in the pipeline and making a big difference right now,” said John Engler, the former governor of Michigan who is president of the National Association of Manufacturing.

When the stimulus plan was enacted the Obama administration predicted it would “save or create” 3.5 million jobs before 2011. Supporters of the plan argue that without it, the recession would have been deeper and job losses even greater. But the impact of the spending package is difficult to assess when the economy is still shedding jobs and the unemployment rate is rising.

“I don’t know how you measure job preservation,” said GOP Strategist Terry Holt. “The American people are going to judge this president and this economy based on whether or not they can create jobs. As long as this economy isn't creating jobs, the political weight will get heavier on this administration with every passing month.”

Since the recession began in December 2007, the economy has shed more than 6 million jobs, including 467,000 in June. During the peak jobs market of this decade, in 2005, the economy was creating about 200,000 jobs a month; about 125,000 new jobs are needed every month just to keep up with the growth of the work force.

So even once the economy begins creating new jobs again, it could be several years before the millions of workers laid off during the recession re-enter the job market and the unemployment rate begins falling to more normal levels. 

Continued job losses also are weighing more heavily on the economy as lost wages cut deeper into consumer spending, which accounts for roughly two-thirds of the U.S. economy. If federal spending doesn’t flow quickly enough to offset the drop in personal income, sluggish consumer spending will remain a drag on growth for some time.

Consumer spending has also been depressed by the collapse of the housing market and huge losses in savings.  That’s forced many households to tighten their belts; massive federal spending by itself will do little to get them back in a spending mood.

“Baby boomers feel like they lost 35 percent of their net worth in one year, and they don't feel like they’ve got as much time as they head into their retirement years,” said Fred Crawford, CEO of the business consulting firm Alix Partners. “So they are doubling down on savings. We are expecting the savings rate — which was just a year ago around zero percent and has now jumped to around seven percent — will probably approach 10 percent in the next couple of quarters. That’s is a big swing in spending.”

It would be a fitting use for this quasi-cash to send it right back to the government. But for most state workers, it likely won’t get that far.

For starters, the law bars paying state workers with anything other than real money. But plenty of other people owed money will have to figure out how to get by for a bit without it.

To save cash, California will print up $3.6 billion in funny money this month to pay some of its other bills — mostly to vendors who sell goods and services to the state. These include both major corporations and mom-and-pop operations that can ill-afford the disruption in their cash flow. Some of these businesses may have to fold, generating more layoffs in a state where the official unemployment rate already stood at 11.5 percent in May.

In the short run, businesses or individuals could send the bogus bucks right back to Sacramento to pay taxes. But these IOUs will likely mature in 90 days, which means the state will convert them back into cash — with interest — before most people have to pay their taxes in April. In the meantime, the IRS will continue to require that employers withhold taxes from most workers’ paychecks. So the IOUs can’t be used to offset that federal tax liability.

It’s also not clear whether banks will accept this funny money once it’s issued. Most did so the last time this happened in 1992, but the financial problems of both the state and the banks are much worse than they were 17 years ago. If banks do accept IOUs, they’ll probably pocket the interest paid when the IOUs convert back to cash. Or they may charge a fee to cover the risk that these faux dollars turn out to be worthless.

Given the sorry state of the state’s financial and political affairs, that’s not an unreasonable fear. State officials in Sacramento have been flailing for years as this budget nightmare has escalated. But they didn’t create this mess by themselves. The people of California, having led the nation in a “property tax revolt,” have now shot themselves in the foot with a government that spends $26.3 billion more on services than it takes in on taxes.

This is roughly equivalent to cash-strapped family members who can’t agree on where to stop spending — so they just keep running up their credit cards and then ignore the bill. It worked for a few years. Now, after raiding the piggy bank and selling everything they can think of on eBay, there’s no more cash. Friends and family have cut them off. But instead of cutting spending or looking for a second job, these folks go right on spending.

State officials insist they won’t default on their bonds, a prospect that could have a catastrophic impact on the financial markets. Issuing IOUs may yet bring a round of defaults by local governments and state agencies that rely on the Sacramento to honor its financial commitments with real cash. By using IOUs, state officials are passing along the financial mess they created to local officials. If those local governments run out of cash, they may have to default payments to investors who bought their municipal bonds.

California may have started this trend of living beyond its means, but other states have picked up the same bad habit of winning favor with voters by offering popular services — without having the courage to explain to those voters how much it all costs. Now, with the collapse in property values and the slowdown in retail sales, tax revenues have plunged and budget gaps have widened. But in most statehouses, elected officials are still stuck at the finger-pointing stage.

Despite all the political theatrics, the solution is pretty simple. Taxpayers have to pay more to cover the cost of the services they don’t want to give up. Or they have to expect a lot less from state government — including big cuts in basic services like education and road repair.

Just like the family that spent more than it could afford during the bubble, the party is over for state governments. We may be only beginning to feel the hangover.

I disagree with your perception that my colleagues at MSNBC are broadly uncritical of the Obama administration. In general, I think some readers are quick to see bias where none exists. (I will say that I think all cable television news channels have strayed too far in offering up political opinion as “news.”)

To your broader question, I tend to agree that many financial writers are more skeptical about the economic outlook and forecasts offered up by Congress and the White House. This is not a partisan issue; politicians of all stripes are notorious for glossing over economic problems. (See: State budgets, California). Politicians can generally say whatever they want — as long as they can keep a straight face.

The financial markets, however, are a lot less forgiving. It’s been my experience that people tend to stick closer to the facts when they decide where to save or invest than they do when formulating a political opinion. So the economy and financial markets represent a kind of popular referendum on government policies, one that’s often a lot easier to read than opinion polls and usually much more reliable.

The markets also provide an important reality check. There’s nothing particularly wrong with Obama’s ambitious agenda: save the world from global economic collapse, defuse the ticking bomb of runaway medical spending, salvage what’s left of the U.S. auto industry, etc. Other than a few misguided, hyperpartisan malcontents, I don’t know why anyone would want to see any president fail.

But if, for example, Congress and the White House can’t control federal spending and shrink the deficit, anxious Treasury bond buyers will demand a higher return, and interest rates will go up. You could argue that the market is wrong to demand those higher rates. Or you could disagree over which policy, exactly, was responsible for those deficits. But you can’t argue about whether rates have gone up or down — or what the impact will be.

Lastly, we get a lot of mail from readers asking why we’re so gloomy all the time. These readers seem to think that a frank discussion of economic risks and underlying problems hurts consumer confidence and, in turn, does further damage to the economy. We think they’re wrong on several counts.

First, it’s not our job to cheerlead the economy: There are more than enough politicians already doing so. Second, it serves no purpose to report only “good” economic news and ignore the warning signs. But most importantly, people are smart enough to make their own minds about how well or poorly the economy is doing. There’s little we could write that would change that.

No. I think you’ve pretty much got it covered.

The worst of the job market collapse appears to be over. But with businesses still shedding hundreds of thousands of jobs each month, it will take well into next year or longer before the economy creates enough new jobs to begin bringing the the unemployment rate back to pre-recession levels.

Even though the jobless rate jumped in May to a 26-year high of 9.4 percent, Friday's monthly report was much better than expected. The economy's net loss of 345,000 jobs, below the 500,000-plus forecast and the lowest monthly total since September of last year.

That suggests the worst of the carnage that began with the financial crisis last year has ended, an impression that was confirmed by this week's report that the number of people receiving unemployment benefits fell for the first time in more than four months. These indicators are consistent with evidence that the economy is working its way to recovery after the worst recession since World War II.

But the damage inflicted on the job market has been heavy, and is far from over.

Already some 6 million jobs have been lost since the economy peaked in December 2007, and with employers still shedding jobs the total may reach 9 million before the job market turns around, according to John Silvia, chief economist for Wachovia. That would represent about 6 percent of the work force. The number of long-term unemployed — those out of work for 27 weeks or more — stands at a record 3.9 million, triple the number at the start of the recession.

With employers continuing to shed jobs, the jobless rate is likely to top 10 percent and could remain stubbornly high for some time to come. In recent recoveries, employers have been slow to higher, meaning that the jobless rate can continue to rise even as the economy begins to expand.

“The economy had two horrific quarters in (in late 2008 and early 2009), really the worst back-to-back quarters in 50 years,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank. “Things are stabilizing, no question. But the fact is you still have job losses. We're still many months away from positive increases.”

The improvement in the job market offers evidence that that the government’s multitrillion- dollar effort to cut taxes, increase public spending and keep interest rates low is helping to stabilize the economy.

"This is exactly what the stimulus is supposed to do," said Mark Zandi, chief economist at Moody's Economy.com. "But here’s the thing: The stimulus starts to fade next year, and the economy may slow. And we may need another round."

That could put government policymakers in a bind. Interest rates already have begun to creep higher due to the sheer volume of government debt and concerns about inflation down the road. But efforts to cut back on federal spending or raise taxes too soon could choke off the economic recovery before it takes hold.

“I suspect that we will continue to need a trillion dollars' worth of deficit financing, fiscal stimulation, for several years at least," said Bill Gross, managing director of Pimco, which runs the world's largest bond fund. "This economy is still de-levering. It is still at the whim, so to speak, of savings vs. consumption. It is deglobalizing. It is reregulating. These are forces that slow growth."

The contraction in employment has cut a wide swath, sparing few sectors or industries, unlike  past downturns. In the private sector, only education and health care have managed to hold the line on employment, adding another 44,000 jobs last month. But Diane Swonk, chief economist at Mesirow Financial, expects those gains to remain weak.

“We have heard of a lot of pink slips going out for teachers and health care starting to get hit by the number of people underinsured and cutting costs at hospitals,” she said

Until recently, government payrolls have also held up relatively well, but that appears to be changing. With state and local budgets squeezed, job cuts have picked up. Falling home prices have cut into local property tax rolls, local sales taxes are drying up and job losses have taken a bite out of state income tax receipts.

The government sector shed 7,000 jobs in May, according to Friday's report.

State and local governments "have to balance their budgets,” said John Challenger, CEO of the outplacement firm Challenger, Gray & Christmas. "They're under tremendous pressure. We're likely to see more during the summer."

And while the pace of job cuts across the economy seems to be easing, the pink slips remain widely spread across most sectors and industries, according to the latest report from ADP, a payroll management company.

"There were significant losses  across all the (sectors we track) — in the goods producing  sector, in the service producing sector, in large-, small- and medium-sized businesses," said  Joel Prakken, chairman of Macroeconomic Advisers, which compiles the estimate of monthly employment. "So the bleeding is coming from all the different veins."

The manufacturing sector remains the hardest hit, with another 156,000 jobs lost last month. While the pace of job cuts may be easing in other industries, analysts say the ongoing downsizing of the auto industry means that sector will face continued heavy job cuts through the summer as more plants are closed and parts suppliers shut down.  

Retailers have also been hammered by a sharp cutback in spending, cutting another 17,500 jobs last month. Consumers are also cutting back as they see more job losses coming across all sectors; spending will likely remain subdued as long as the unemployment rate continues to rise.

With fewer goods being made and sold, shipping companies have also been cutting back workers and idling capacity. Some 25 miles of rail freight cars are reportedly sitting idle on the tracks, according to Brian Bethune, HIS Global Insight's senior economist.

Though banks still face big losses from bad loans, there are signs the worst of the credit crunch is easing. An uptick in home sales and rising stock prices have also prompted many forecasters to firm up predictions that the economy will begin recovering by the second half of the year.

Those gains could be short-lived, however, if interest rates extend their recent rise, eliminating the cheap mortgages that have helped expand the pool of home shoppers who can afford to buy. Last week, mortgage rates jumped back above 5 percent and the yields on Treasury debt moved higher. Some economists fear that the trillions of dollars of government debt being floated around the world to combat the financial crisis may force the cost of borrowing higher in coming months.

Continued job losses are also expected to force millions more homeowners into foreclosure, postponing the housing recovery that is typically one of main engines of growth coming out of a recession. The other — a rebound in auto sales — is also likely to be subdued until potential car buyers see a significant improvement in their job prospects.

“I don't see where the second half recovery is coming from,” said David Rosenberg, chief economist at Gluskin Sheff, a Toronto–based investment firm. “Until employment stops falling, this recession is still intact."

As the U.S. Treasury continues to churn out hundreds of billions of dollars of fresh debt, officials are confronting one of the thorniest problems since the financial crisis began.

Who’s going to buy all this paper? And if demand dries up, how much higher will interest rates have to go to attract new buyers?

The question is not just academic. When the crisis first hit last fall, investors worldwide sought shelter in U.S. Treasuries, and interest rates plunged. That helped to shore up battered banks and restart the housing industry with low mortgage rates

But now, as the financial crisis seems to have waned and the global economy shows signs of recovering, interest rates have begun rising, or "backing up." Any further rise in rates could throw cold water on the economy, boost the cost of mortgages and other loans and push back the recovery that many forecasters are looking for before the year is over.

“Along with declining home prices, those (lower) interest rates were key to reviving housing demand," said Thomas Higgins, chief economist with the Los Angeles investment management firm Payden & Rygel. “That's a key risk for the latter part of the year. We know where the crisis began, and it began in housing. And we need housing to recover.”

Though home sales have perked up this spring as mortgage rates fell below 5 percent, the 30-year fixed rate recently reversed course, rising to 5.29 percent this week — up nearly four-tenths of a percentage point from a week ago, according to Freddie Mac.

Fed officials say they are committed to keeping rates low, but it remains to be seen how far it can defend its target in the global money market. The central bank typically manages only short-term lending rates used by banks for overnight loans. Since the financial crisis hit last fall, the Fed has embarked on a bold experiment to push down longer-term rates by wading into the multitrillion-dollar global market for Treasuries.

The Fed’s task is made more complicated by the hundreds of billions in fresh debt paper the Treasury is churning out to finance the economic stimulus package, plug the growing hole in the federal budget and roll over the huge pile of past government borrowing that comes due every quarter. To attract investors to buy those bonds, the Treasury pays interest rates based on the lowest bids at auction. If investors demand higher rates, the cost of all long-term borrowing goes up.

“The government is keeping these rates lower and there are no legitimate, long-term real buyers of size to handle these auctions and the mortgage product that's being produced to try to stimulate the economy,” said Rich Berg, CEO of Performance Trust Capital Partners. "So (rates are headed higher) unless Uncle Sam is going to finance the whole thing for the next 20 years, which is not going to happen."

That’s one reason Treasury Secretary Timothy Geithner went to China this week: to drum up continued demand for U.S. debt. The worry is that if China loses its appetite for Treasuries, rates could move even higher.

“We actually have some experience of what happens when China stops buying because China stopped buying agency bonds and Freddie and Fannie bonds last fall, and for a brief period (rates) on agencies went up significantly,” said Brad Setser, a fellow at the Council on Foreign Relations and recent author of a paper, "If the Dollar Plummets." “And those rates only came down when the Fed started buying. So if you lose a big buyer, it does have an impact on the market.

As suggested by Setser's paper, foreign investors and governments are also worried about the impact of the surge in U.S. borrowing on the value of the dollar.  A falling dollar can hurt the value of existing Treasury holdings.

In his trip to China, Geither also sought to reassured Chinese leaders that the U.S. is serious about paying down this new borrowing quickly and that the Chinese government’s $760 billion investment in dollar-denominated debt is safe.

But concerns about the dollar have been growing in Beijing for some time. Earlier this year, Chinese leaders wondered out loud about long-term damage on the dollar from the borrowing binge and suggested the world needs a new “reserve” currency for global trade. (That view was echoed Tuesday by Russian Prime minister Dmitry Medvedev in an interview with CNBC.)

In the short run, China faces a difficult choice, say analysts. If it holds back on buying Treasuries, it risks accelerating the decline in the dollar's value. That would both reduce the value of existing dollar holdings and force the value of its own currency, the yuan, to rise. A stronger local currency would make China’s exports more expensive abroad, stifling growth of the country’s manufacturing-based economy.

But over the longer run, said Setser, the huge flow of dollars between the two countries may not be sustainable.

“China no longer seems confortable subsidizing American (borrowing and) consumption — and in the process subsidizing Chinese exports,” he said. “From the American point of view, the binge of borrowing that the U.S. went on from 2002 to 2008 — borrowing that China in no small part financed — didn’t end out too well. So both parties, I think, are recalibrating their interests. But in the short run, they’re still stuck in the marriage because the cost of getting out is quite high.”

The recent signs of global economic recovery also have revived fears that inflation may return as demand increases for raw materials like oil and other commodities. Oil prices have nearly doubled from their lows in just the past three months. Gold prices are approaching record highs.

Inflation worries also push the dollar lower and interest rates higher.

“As the economy has started to look like it's at least no longer in free fall, people are looking forward to what happens when we emerge from the recession,” said Michelle Girard of RBS Greenwich Capital. “You see more people focus on the inflationary consequences of all the liquidity that the Fed has put into the system.”

The Fed also risks falling into a vicious cycle as it serves as the buyer of last resort for U.S. Treasury debt. As rate pressure rises, the Fed has to buy more Treasuries to prop up prices and keep a lid on long-term interest rates. To pay for those Treasuries, the central bank issues more Federal Reserve notes, aka cash. That extra cash increases the risk of inflation, and the cycle continues.

Most economists expect that the economic recovery, when it comes, will be weak until the housing market works through a glut of unsold homes and employers create enough new jobs to make a dent in the nearly 6 million positions lost since the recession began.

“We lost $20 trillion of net worth just over the past year and a half,” said David Rosenberg, chief economist at Gluskin Sheff & Associates. “So we have this severe trauma in the household balance sheet. There is definitely going to be lingering impact from that, whether we're in a technical recession or not, for the next several years.”

Those households will have an even tougher time getting back on their feet if rising interest rates boost the cost of borrowing to buying a new house or car.

There are signs that the housing market may finally be hitting bottom, including this week's report that sales of existing homes rose in April from March levels. But there are also signs that the recovery may take a lot longer than usual.

CNBC cited a “refi boom” as perhaps signaling that the worst is over for housing. It seems to me that exchanging debt for debt, even reduced slightly over time, does not do much to put more money into the economy. The only case I could make is that there is again money to borrow, but again, how does that help the economy in general?
— Brian P., Seattle, Wash.

The increased borrowing is a good sign, but it’s not the only one. The biggest benefit to the economy from refinancing is the household spending money that’s freed up from paying higher mortgage-interest payments. Consumers can now use that extra money to save or spend. (In the short run, spending is the better for economic growth.)

Banks are beneficiaries, too, which helps rebuild the financial system and promote more lending. It’s true that a bank holding a mortgage getting refinanced loses out on future interest when the loan is paid off early. But most newly refinanced mortgages carry hefty upfront fees, which go straight to the bottom line of the bank writing the new mortgage. That infusion of cash is helping to fill in the multitrillion-dollar hole in the banking system that needs to be replenished before lending can get back up to speed.

None of this, however, does much for the housing industry. For that you need to see a pickup in new and existing home sales. About the best you can say on that front is that it looks like the pace of sales may have stopped falling. In April, homes were sold at an annual rate of 4.7 million — a bit better than March's level but down from 6.5 million in 2006, according to the National Association of Realtors. The median price of $170,200 was 15 percent below year-ago levels, as nearly half the sales were for "distressed properties" that typically sell at a deep discount.

Home sales add a big boost to the economy beyond the fees earned by real estate agents and mortgage brokers. Home buyers typically also spend money on new appliances, furnishings, repairs and improvements. Buyers of new homes create even more economic activity as the sale price covers wages for all of the contractors and laborers who built the house and as well as materials and supplies.

In April
new home construction fell to a record low annual rate of just 458,000 units — down from a rate of more than 1.4 million as recently as 2007.

Even if low mortgage rates spur demand for new homes, builders face a huge overhang of existing homes on the market. In the first quarter, there was nearly 10 months' supply of unsold homes listed. That’s up from an average 6.5 months in 2006 and 4.5 months in 2005. As the housing market shows signs of improving, there may be more listings coming from homeowners who have been hoping to sell but waiting for the market to improve.

In past recessions, the pickup in home sales has been an important foundation for the economic recovery that follows. This time around, the recovery may lag somewhat — largely because home prices are still falling. As of March (latest data available), the
S&P Case Shiller home price index was down 32 percent from its peak in June 2006 and still falling.

The loss of trillions of dollars in home equity — the bulk of most Americans' savings before the housing market collapsed — is going to put a damper on consumer spending even after the housing market gets on its feet again. That’s why many forecasters are expecting only a weak recovery later this year and into 2010.

I have read that all this new money that the government will be pumping into the economy will increase the money supply and cause inflation. But I was wondering how much, if at all, that will be countered by the presumed reduction in money supply caused by the large drop in the stock market and real estate market.
— Bob B., Barre, Vt.

That’s exactly what the folks at the Federal Reserve are hoping. So far, there’s evidence that they’re right. Despite the trillions of new money pumped into the economy and banking system — from Fed loans, the Treasury bank bailout and the economic stimulus package — there’s been barely a whiff of inflation. Prices, in fact, have been falling at the fastest pace since the 1950s.

Falling stock and home prices are part of the story. Another is the sharp drop in energy prices after the oil market collapsed last year. A deep global recession has also taken the pressure off prices of raw materials and basic equipment. As demand has dried up, the cost of a ton of steel or a new drilling rig has fallen sharply.

Readers are quick to point out that not all prices are falling. Food costs are up more than 3 percent from a year ago. So are medical costs. And we can confidently report that college tuition payments continue to rise — as they have every year we’ve been paying them.

For now, the inflation risk from all those trillions of new dollars sloshing around the global finance system seems to be fairly low. That risk will rise when the banking system and economy get back on their feet. A return to global economic growth will once again put pressure on prices of energy and raw materials. The huge pile of cash that banks and consumers are now hoarding will again be chasing a limited supply of goods and services. If the Fed hasn’t pulled enough money back out of the system by then, we could be in for another round of inflation — or another asset bubble — or both.

Based on the minutes of recent Fed policy meetings — and comments from Fed Chairman Ben Bernanke — the central bankers are well aware of this risk, even if they don’t see it as an imminent threat. Though he told Congress in February he didn’t see signs of inflation coming back, he did say that “once the economy begins to recover — as usual, the Fed would have to begin to tighten policy. It is very important for us to begin then to unwind our monetary expansion."

The hope is that, with a gradual recovery, the Fed can gradually drain money out of the system and head off a surge in prices. But the timing will be tricky. In some ways, flooding the system with cash to head off the catastrophic collapse of the global banking system was the easy part. Now the Fed has to time its exit just right.

Treasury officials face a similar issue with the hundreds of billions of dollars used to shore up the balance sheets of big banks. While some banks are expected to pay the money back fairly quickly, others may require government funding for some time. Treasury Secretary Tim Geithner assured Congress on May 20 that for the bank bailout to work, it was important to “unwind it as quickly as conditions permit.” That is central to the effectiveness of the strategy.

But, Geithner told lawmakers, “I'm not prepared to talk to that today. It is not quite time yet. We're not quite there yet."

There are a lot of differing opinions and advice from financial 'experts' about where stocks and the economy are headed. How do you tell who's right?

Though no one knows what tomorrow will bring, I am perplexed by the vast difference of opinions from well-known and experienced professionals concerning the timeframe for the economic recovery. ... I guess my question is the same as everyone’s because I want to get back into my mutual funds. But I am suspicious of the guests on the stock market shows. It seems to me they have a hidden agenda to be so optimistic. Is it even possible for you to comment on the wide difference of opinions from professionals?
-- Keith W., Address withheld

I watch the same TV guests you do, and I have the same questions about their agendas. I guess I would say that if you look closely enough, those agendas aren't all that hidden.

The financial services industry — which includes real estate agents, mortgage brokers, lenders, stock and mutual fund salesmen (aka "financial advisors") — has an enormous vested interest in restoring the confidence of people like you and me in the products they sell and the advice they provide. No matter how personable, intelligent, honest or trustworthy they may be, they are making a living selling a product.

As millions of consumers have learned the hard way, many of these products and much of the advice turned out to be seriously flawed. After losing trillions of dollars in housing wealth and retirement savings, consumers are rightly leery of stepping in to "buy on the dips" — whether it's a home selling for 30 percent less than its peak price or a stock that is touted as the “bargain of a lifetime.”

The first question to ask yourself when you listen to one of these supremely confident forecasts is how does the forecaster get paid? Some conflicts of interest are pretty clear. A car salesman is not likely to volunteer all the recalls and known defects for the model you're asking about. But you know that when you step into the showroom, and you take appropriate steps to balance the pleasant patter with your own research from independent sources.

For some reason, consumers who will dicker for the last $50 off the price of a new car don’t think twice about following the advice of a stranger on TV — or worse, turning over their life savings to a “financial adviser” based on nothing more than a magazine ad or referral from a friend. Investors turned their hard-earned retirement savings over to money managers who, on average, don’t even keep up with the return of stock market indices. Home buyers signed dozens of pages of imponderable mortgage documents based on little more than a real estate agent or mortgage broker’s soothing reassurance that home prices “never go down.”

There may be a couple of reasons for this. First, financial services professionals have done everything they can to obfuscate the process of borrowing and investing by creating a jargon-filled lexicon that puffs up their supposed expertise, overstates the complexity of what they're selling and puts their clients on the defensive. All that risk management modeling, interest-only negative amortization, asset allocation rebalancing and second derivative negative correlation analysis turned out to about as valuable as a share of bank stock.

Further, it’s still very difficult to identify the conflicts of interest that sank borrowers and investors of all shapes and sizes in the latest market collapse. When you hear a TV “expert” talking up the idea of buying stocks, for example, you’re likely hearing optimism about a decision they’ve just made about buying for their own portfolio. A money manager who has just “sold short” (betting stocks will go down) is more likely to express a bearish view. Disclosing these facts doesn’t cure the conflict of interest.

There are other sources of advice and analysis where the conflict isn't as visible. Financial economists may be honest, but their forecasts inevitably will be colored by the interests of the large banks and brokerages that issue their paychecks. An economics professor confidently calling an economic top or bottom, or the imminent demise of capitalism, may be hoping his latest book has a shot at the best-seller list.

So, whom to trust?

The urge to follow someone else’s advice remains strong, especially when the outlook is so murky. After all, if the “expert” advice turns out to be wrong, you won’t have to blame yourself.

But in the end, you have only your own judgment to rely on. When it comes to borrowing and investing, if you’re not willing to step up and act on that judgment, maybe you should hold off until you are.

Gee, I thought I did say what I think. To be clear, what I think is that there are several possible outcomes and — as I wrote — a lot depends on how we all respond from this point forward.

I think what you’re asking is: Which one of these outcomes do I believe is going to happen. The only honest answer (which I also wrote) is: “No one knows.” Since I have a very dim view of economic forecasting, it’s hard to see how I could offer up a forecast of my own.

To do so, I would have to know how all of the global constituents — governments, consumers, voters, bankers, investors, trade unions, CEOs, etc. — will respond to the ongoing recession. That’s beyond my capabilities. And I have yet to meet anyone who has has this gift. (Making a prediction or two that later comes true doesn't count: A broken clock is right twice a day.)

The forecast for persistently high levels of unemployment is a little easier to make. For one thing, it's happened after most modern recessions. This time, the math is pretty simple: There have been some 6 million jobs (net) destroyed by the downturn, and another million or so needed every year just to keep up with the growth of the population.

During the peak job growth of the last expansion — in 2005 and 2006, when GDP was growing about 3 percent — the economy created a little over 4 million new jobs a year. So even if this economy comes roaring back next year (which few forecasters are expecting), millions of workers will remain on the sidelines for some time.

I agree with you that technology — and human resourcefulness — have produced solutions that have surprised past generations confronted with serious economic problems. On the other hand, history shows that bad things sometimes befall societies that ignore serious imbalances for too long.

So to answer your question: What do I really think is going to happen?

I have absolutely no idea.

With the economy showing early signs of stabilizing, it's time to start wondering: What is the 'new normal' economy going to look like?

A lot people are wondering what the “new” normal will look like once the worst of the financial crisis and recession have passed. Even the most optimistic scenarios see only very gradual improvement in economic growth, with unemployment remaining high for the next several years. The only honest answer is that no one really knows.

Even beyond the specific forecasts for growth, it’s pretty clear that the economic collapse of the last year will bring profound changes in the global economy and financial system. We’re still in early innings, though, so much depends on how we respond from this point forward.

If you see the glass as half full, the "new normal" could bring long-overdue positive changes. When lenders make bad loans, they lose money. This time they lost big piles of it, which means they’re going to be a lot more careful in the future. That's a good thing, unless they're too careful and make it too hard to get a loan.

Other changes are long overdue. For government, cutting taxes without cutting spending turned out to be a multitrillion-dollar mistake. Consumers who thought that a credit card was a savings account and a home was a piggy bank have learned the hard way that neither of those things are true.

Those lessons are pretty hard to unlearn. (Though you could argue that, three generations after the Great Depression, that’s exactly what we did.)

The "new normal" could also bring some unpleasant changes. To stop the downward spiral, the government has flooded the economy and financial system with more than $1 trillion in loans from the Federal Reserve and roughly the same in new spending from Congress. That may put the fire out, but there’s going to be a major mess to clean up.

Adding $1 trillion to the money supply in a matter of months, for example, creates a major risk of inflation down the road. Successfully sopping up that much money from the economy without tipping it back into recession is a feat the Fed has never tried before.

If Congress and the White House try to balance the budget too quickly with spending cuts, tax increases or both, that could also send the economy back into a downward slide. But over the longer term, if they can't figure out how to whittle away at the massive pile of government debt, investors could lose faith in the dollar. That would drive up interest rates and put a major lid on economic growth. 

In any case, the events of the past few years will have a lasting psychological impact. No matter how well they’re still paying themselves, most financial industry professionals have been humbled by the disastrous effects of the financial alchemy they unleashed on the rest of us. If nothing else, it’s in their own self-interest to avoid another rogue wave of risk-taking.

The financial meltdown has also created a broad consensus that the system of regulating the financial markets is badly broken. The debate over how to fix that system will have a major impact on what the “new normal” looks like.

Finally, the impact on consumers, investors, savers, workers and homeowners can’t be understated. For the past 30 years, we have lived with the mistaken belief that we can buy stocks and houses without any real risk of losing money over the long run. Lesson learned.

It’s also becoming clear that we can either expect less services and benefits from our government or pay more in taxes. Borrowing the difference isn’t a sustainable plan.

Borrowers who owe more on their mortgage than their house is worth may not be “doomed,” but they present the toughest challenge for government officials, housing advocates and other groups who are working to stop foreclosures.

No one has figured out the answer to the thorniest question in the whole housing mess. Who is going to bear the loss from the housing collapse: The lender who wrote a mortgage on a house that has dropped in value or the homeowner who signed the loan and agreed to the risk?

The question isn't going away. More than 15 million people, or about one in five homeowners, are “under water,” according to Moody’s. That number will continue to grow as long as home prices keep falling.

The government’s Hope for Homeowners program is a good start in breaking the logjam of negotiations between lenders and borrowers, but it won’t help if you've lost your job and can't afford even a lower monthly payment.

Under the plan, lenders agree to cut the interest rate on the loan and take a loss on payments lowered to 38 percent of a borrower's income. The government subsidizes a further reduction to 31 percent of income. If necessary, the loan can be extended to 40 years to bring it under the cap.

A final step, forgiving some of the principal, may help some borrowers. But the decision to do so is entirely up to the lender. For the past year, Congress has been debating a plan to let bankruptcy judges order lenders to take less than the full amount — the so-called “cram down” provision. But the latest effort to change the law failed this month.

That leaves few options for homeowners who can’t get a lower payment from their lender. This week, the government expanded the Hope for Homeowners program to formalize and streamline a process that millions of families are going through as they lose their homes.

One option is to sell your house with the lender's permission for less than the value of your loan in what’s called a “short sale.” Though you lose your home, you can move on without owing anything to the bank. (Another option lets you sign over the property title to the lender and walk away in what’s called a “deed in lieu of foreclosure.”)

The program is only two months old. This week, the Treasury said it has helped some 55,000 homeowners. But the government has a long way to go to stop the wave of millions more foreclosures.

Call it one of the recession's silver linings — with each passing day, the purchasing power of each consumer dollar is getting stronger.

But if it keeps up, and prices continue to fall, that boost in buying power comes with some nasty side effects, say economists.

The government reported Friday that consumer prices fell over the past 12 months at the fastest rate since Dwight D. Eisenhower was president.

Prices were flat in April after dropping 0.1 percent in March, leaving the Consumer Price Index 0.7 percent lower than it was a year ago, according to the Labor Department. That's the biggest 12-month decline since June 1955.

General deflation of any kind has not been seen in the United States since the 1950s, and benefits cash-strapped consumers looking for bargains and retirees trying to live on a fixed income.

Falling prices also help savers. If consumer prices are falling 1 percent a year, the real (price-adjusted) return on a bank CD paying 2 percent magically becomes 3 percent.

And falling prices are a terrific antidote to the stagnant wage growth that has weighed on many U.S. households since the last recession ended in 2001. Even if your boss freezes your wages, when prices are falling 2 percent a year, your real wage is rising 2 percent.

The flip side is that borrowers and consumers carrying heavy debt loads see their burden increase. As prices fall, the purchasing power of your dollars goes up, so your future monthly payments will take a bigger bite out of your spending power. That means if you’re paying 8 percent on a mortgage, and prices are falling 2 percent a year, your borrowing cost in real, price-adjusted terms is 10 percent.

Household borrowers are not the only ones who need to worry about falling prices. The threat of continued deflation is a thorny problem for businesses, and government policymakers including Federal Reserve Chairman Ben Bernanke. The risk is that the drop in prices begins to feed on itself. Lower prices take a big bite out of employers’ profits, which forces wage cuts or layoffs. That cuts consumer spending and demand, which brings more price cuts to spur sales.

“Once you get more downward pressure on wage and prices and it’s hard to get yourself out of that cycle,” said Brian Bethune, chief U.S. economist at IHS Global Insight.

Take the falling price of airline tickets, which have dropped for eight straight months — down another 1.5 percent in April, according to government data.

As the recession grinds on, consumers continue to postpone discretionary travel, further weakening demand. Business travel is also off sharply according to Mark Masuda, who manages airline partnerships with Travel Leaders, a Minneapolis-based travel company.  

“They’re putting the screws to their budgets and holding their travel and entertainment expenses down,” he said. “Once they get comfortable that consumers are coming back, they’re going to have to get out and see customers and find new customers and you’re going to see that travel increase as well."

Until then, the only way for airlines to fill planes is to cut fares.  If that keeps up, airlines can afford to lose only so much money before they make steeper cuts in their schedules, which means lower wages for their workers. As those workers spend less on other products and services, the lower demand forces wider cuts in prices.

Since the recession began over a year ago, changes in consumer prices have been uneven. While some categories have fallen, others continue to post gains, especially for goods and services where prices are regulated or changes take time to work their way through the system. Medicare reimbursements don’t fall if fewer patients show up for a given procedure. When bus ridership goes down, fares rarely follow. (Fares may even have to go up to make up for the revenue shortfall.) If an office building has lots of vacant space, most business tenants won’t get a break on their rent until their lease it up.

But there’s evidence that consumer prices are falling faster than the so-called “headline” consumer price index.

Take housing prices, for example. As of February, home prices nationwide had fallen by more than 18 percent in the prior 12 months, according to the S&P/Case Schiller Home Price Index. The National Association of Realtors, which uses a separate formula, figures home prices in the first quarter of this year were nearly 14 percent lower than a year earlier.

But the housing component of the government’s price formula — which makes up about a third of the Consumer Price Index — shows housing costs have risen about 1.5 percent in the 12 months ending in March.  One big reason is that since 1983 the government has measured homeowners’ housing costs with “rental equivalence” — what they would pay to rent their own home. (The Labor Department says it made the change to strip out the investment gains homeowners enjoy when home prices are rising.)

Critics of the inflation formula say it tends to understate the inflationary effects of housing prices on the way up and is now underestimating the drop in consumer prices as housing prices have fallen.

“The reality is that deflation will become more apparent in the CPI numbers as we look forward over the next few months,” said Bethune.

Economists are divided on how long prices will keep falling. A lot depends on how long it takes for the economy to start growing again. With consumer spending making up 70 percent of the gross domestic product, that won’t happen until consumers get back in a spending mood.

The economy has been shedding more than half a million jobs a month, so most households have sharply boosted savings for a rainy day. Until the job market stabilizes, consumers will likely remain skittish.

Consumers' discretionary spending in April dropped 90 percent compared to a year ago, according to Britt Beemer, Chairman of America's Research Group, a market research firm.

“The only thing they bought this year compared to last year was major appliances because they had to buy them because the one they had in their home was broken," said Beemer. "That tells you their mindset.” 

Falling prices may throw even more cold water on spending. Why buy a new car if you expect prices to fall further in the next six months?

Consumers aren’t the only ones motivated to hoard cash when prices fall. Banks lending money become leery about accepting collateral that is losing value: If the borrower doesn’t pay back the loan, the bank is at greater risk for losing money.

American households have also cut spending and boosted savings to try to fill the huge hole created by the twin collapse of the stock and housing markets, which destroyed trillions of dollars of wealth they were counting on for retirement. With 401(k) accounts in tatters, millions of older Americas are putting off retirement and regrouping.   

“If a lot of consumers think they're going to have to work three (or) five years longer, they're not going to change their spending habits for a long time,” said Beemer. “I feel we're going to be in this retail deep freeze until Labor Day 2010. There's just too many issues out there consumers have got to get beyond before they’re going to have any money to spend.”

A true downward deflationary spiral hasn’t been seen in this country since the Great Depression. Now, the threat of deflation has spurred the Federal Reserve to undertake an unprecedented program of “reflating” the economy with a $1 trillion expansion in lending to pump more money into the financial system.

The hope is that all that money will offset the collapse in wealth from the housing and financial markets and prevent deflation from taking hold.

In the short run, the plan seems to be working. The drop in housing prices is slowing; so is the rise in job losses. The historic government response has been generally well-received by the public. But it remains to be seen what the longer-term impact of these policies will be.

“The electorate doesn't have a high degree of tolerance for a lot of pain,” said Michael Darda,   Chief Economist at MKM Partners. “People don't like rising unemployment and falling incomes. So they want government action.”

But the long term impact of these policies is still an open question, said Darda. The huge expansion of government debt could bring a crushing tax burden that hurts the economy. The Fed’s lending spree could bring major distortoins in the money supply and spark a longer-term bout of inflation.  

“(The government response) does certainly increase the potential for probably a more rapid rebound — and then a possibly a  hangover effect,” said Darda.

It may be a false dawn, but recent data are providing mounting evidence that the U.S. economy is edging toward the long road back to recovery.

The freshest evidence came with the government’s monthly report on the jobs market for April, when some 539,000 jobs were lost. Though hardly good news by itself, that pace is slower than the steep slide that has thrown roughly 5.7 million people out of work since the recession began 15 months ago.

With similar “green shoots” sprouting up in other measures of the economy —falling inventories, rising home sales and increased consumer confidence — some economists tentatively have begun to say the economy may be near a turning point.

"This (monthly jobs number) will be the last really bad economic statistic in this downturn," declared Mark Zandi, chief economist at Moody's Economy.com. "We'll look at other negative numbers, but this will be the last bad one."

President Barack Obama acknowledged some of the green shoots Friday, while at the same time warning Americans to "expect further job losses in the months to come."

"Although we have a long way to go before we can put this recession behind us, the gears of our economic engine are slowly beginning to turn," Obama said in a speech in Washington on education for the unemployed.

"Step by step we're beginning to make progress," he said.

The number of jobs lost in April was the lowest since October, although still high by normal standards. With a half-million more people out of work, the unemployment rate in April rose to 8.9 percent, the highest since September 1983, up from 8.5 percent in March.

In addition, the job market was worse than originally reported in February and March, according to revised data released Friday. The economy lost 699,000 jobs in March, up from the 663,000 originally reported, and 681,000 jobs were lost in February, up from the original 651,000.

The April jobs data followed a series of reports that show a job market that is still dismal but improving. New unemployment claims, though still very high, are down from peak levels.

“The improvement (in jobs) was widespread across all the major industries that we look at and across all the sizes of payrolls that we look at,” said Joel Prakken, Chairman at MacroEconomic Advisors, which prepares a private job report that also showed improvement. “But let's remember two things: One month does not a trend make and the green shoot is trying to put down roots in very inhospitable terrain. This is still a large decline in employment.”

Evidence of a possible turning point goes beyond job market data. Though the gross domestic product, the overall growth benchmark, declined at a 6.1 percent pace in the first quarter, there were positive signs within the report. Much of the drop came from falling inventories. With less unsold goods on hands, companies will be able to raise production quickly once demand bounces back.

Forecasters also have been looking for signs of a turn in housing. Since the collapse of the housing bubble sparked the recession, the economy can’t stabilize until the housing industry does. Though residential construction continued to plunge in the first quarter, the slide in home sales, housing starts and permits is slowing.

The Fed’s aggressive efforts to push mortgage rates lower, combined with the continued decline in housing prices, has the housing industry hopeful that after three years of misery, spring may be returning this year.

"You have tremendous demand coming from people who are entering the housing marketplace," said Joel Miller, of Wall Street Capital Funding, which finances home construction. “Right now those people are really going benefit from the stimulus and other things out there — especially low housing prices.”

A pickup in home sales typically spills over into retail sales as home buyers shop for appliances and furnish their new home. Though credit for such purchases remains extremely tight — consumer credit in March fell at the fastest pace in 18 years — consumer spending rose a better-than-expected 2.2 percent the first quarter after falling 4.1 percent in the second half of 2008. Retail sales perked up in April; discounter Wal-Mart Stores and others reported results that beat expectations.

“The evidence is growing that the recession may be bottoming out in the second quarter,” said John Ryding, chief economist at RDQ Economics.

Hopes for a turnaround follow the government’s massive response to the economy’s steep slide. Since last year, Congress has committed over $1 trillion in fresh government spending and the Fed has unleashed trillions of dollars more in lending and loan guarantees. That surge of cash is now beginning to work its way through the economy and is offsetting the trillions in lost wealth from the collapse of the stock and housing markets.

The hope is that once public money has jump started the economy, private investment will start flowing again. That would take up the slack from the lingering impact of the collapse in lending that accompanied the worst of the financial panic last fall.

Once the freefall ends, the long task of rebuilding will begin. Despite the government’s pledge to prevent another major bank failure, the results of the Treasury’s “stress tests” released Thursday show that many of the nation's biggest banks need to raise more capital to survive continuing losses on bad loans and real estate investments. Until the banks are back on a sound financial footing, it will remain difficult for businesses and consumers to get credit.

That means when the “recovery” comes, it will likely be very weak, according to many economists.

“We've gotten far ahead of ourselves in believing we'll have a very strong second-half recovery,” said Joseph Lavorgna, chief U.S. economist at Deutsche Bank Securities. “I don’t see it. I think what we'll get is a flattish kind of recovery by late in the year and the recovery really doesn't begin until next year at this time.”

Even though the pace of job losses appears to be slowing, the unemployment rate is expected to continue to rise as companies shed jobs and avoid hiring in the early stages of the recovery. Those job losses also will weigh on consumer spending and home sales. Some forecasters caution that that even if the economy begins growing again in the second half, unemployment may not peak until well into next year.

That will also make any recovery feel weaker than it otherwise would. Once the monthly job numbers move back to positive territory, the job market will have a huge overhang of the almost 6 million jobs lost since the recession began. That’s on top of the roughly 100,000 to 125,000 new jobs that are needed just to keep up with the growth in the population.

It also remains to be seen how quickly the rest of the world follows the United States out of the global economic downturn. Without growth overseas, U.S. exporters will have a tough time getting back on their feet. Unless other parts of the world match the efforts by U.S. companies to cut production capacity, there may be too many goods chasing too little demand.

“That’s one of the risks to the global economic recovery,” said New York University economist Nouriel Roubini, at RGE Monitor. “There’s been overinvestment in the last few years in capacity by China and other emerging markets, so there is excess global capacity at a time when global demand is falling — consumption, investment, residential, you name it. And therefore the global recovery is going to be weaker than otherwise.”

It also remains to be seen how Federal Reserve officials deal with the unwinding of the biggest expansion of monetary supply in its 95-year history. If that flood of money remains in the financial system too long, it could spark another round of inflation. If drained off too quickly, it could snuff out the recovery before it generates enough momentum to sustain itself. And if global investors begun to move money out of long-term Treasury debt, the Fed could face stiff headwinds as it tries to keep a lid on interest rates.

“We're still in an uncertain situation,” said Yale University economist Robert Shiller. “Right now it's looking good. But these things can reverse themselves.”

With consumer prices under control — at least for now — inflation is no longer a big worry for most savers. But if you’re one of the inflation-averse savers who bought Series I savings bonds to protect you from inflation, you just got a nasty surprise.

Regarding Series I savings bond rates (now paying 0 percent) — will the inflation or fixed rates improve?
- C.P., Wisconsin

Call this the flip side of the government’s massive efforts to prop up the banking system and get the economy back on track. Low interest rates are great for lenders and borrowers. But they’ve made life a lot tougher for savers and retirees living off a lifetime of savings.

Series I bonds (the “I” is for inflation) are designed to protect you from the corrosive effect inflation has on the money you set aside for a rainy day. If you put away $100 today and inflation sends prices higher, your $100 won’t buy as much when that rainy day arrives.

To help get around this, Series I bonds come with two separate rates attached. The index rate, which is set when the bond is issued, is like the rate on any bond. It’s fixed for the life of the bond maturity (in this case 30 years), and you collect it no matter what happens to market interest rates.

The inflation protection comes in the form of a second, inflation-adjustment rate, which is set twice a year based on the Consumer Price Index. When prices are rising, you get, in effect, an extra bonus on your interest payments to offset the impact of inflation.

But lately, consumer prices have been falling, largely due to the collapse of oil prices. From September 2008 through March 2009, the CPI fell at an annualized rate of 5.56 percent. So when the inflation adjustment for Series I bonds was reset last week, it went negative —effectively wiping out any interest you’re due from the index rate. The overall return, however, cannot fall below zero.

That means your money is still safe from inflation, but you’re getting the same return you’d get by burying it in a coffee can in the back yard. Before you dump your Series I bonds and look for a higher return, here are a few things to keep in mind.

If prices really are falling, that means “deflation” is already pumping up the real value of your coffee can savings. If prices keep falling, your $100 rainy day fund will go farther when you decide to spend it in the future. So while your earning power has disappeared, you’re not losing buying power.

In fact, you’re still getting something of a break. The current index rate on the new Series I bonds is 0.10 percent. That’s less than you’d get with, say, a short-term CD, but not by much. When the Fed decides it wants to push short-terms rates to zero, it’s pretty hard to get out of the way.

You also need to look at the index rate when you originally bought the bond. If you’re holding a bond with a 5 percent index rate, you’ll get a decent return again once prices stop falling. Keep in mind that the current drop in prices will likely be short-lived. Given the Fed’s gigantic expansion of the money supply to force rates lower, many economists are worried about a possible surge in inflation down the road. If that happens, your Series I bonds will look a lot more attractive.

If you do decide to dump your Series I bonds, you’re in luck. Normally, if you sell a bond less than five years after you bought it, you have to pay a penalty equal to three months interest. Since you’re getting no interest, you’ll owe no penalty.

It’s very hard to generalize about how long it takes to improve your credit scores. You may hear lots of pitches offering shortcuts, but we have yet to come across a company that can successfully do this. Legitimate credit counselors and federal and state regulators generally agree that these pitches are almost always scams.

There are a few basic ways to improve your credit. Some of them just take time. If you’re just starting out, the credit agency wants to see a pattern of several years of good payment history, a steady job, a stable address, etc. There’s no magic in this: People who don’t pay their bills on time or don’t have a steady paycheck tend to be a higher credit risk for lenders. That’s all the score is designed to do: help figure out how likely you are to pay back a loan.

If you have a history of bad credit, it will also take some time to get back on track and demonstrate that you’re a better risk than your financial history would indicate. If you’ve got a default or collection on your record, the impact of that recedes with time. The bigger the credit problem, the longer it takes. A bankruptcy can weigh on your score for seven years.

There are other steps you can take right away, though. The biggest involves paying down large debts, getting monthly payments under control and making sure nothing gets more than 30 days overdue. For that, you may need to sit down with an accredited counselor and work out a budget and payment plan.

The National Foundation for Credit Counseling can help you find a legitimate, non-profit credit counseling agency near you. Many of these folks will help you at no cost; some charge a small fee to help them cover expenses.

This is another one of those perverse examples of the Law of Unintended Consequences. If you’re having credit problems, what could make more sense than canceling some of your accounts? As you point out, this would seem to make you’re a better credit risk because you have less chance of running up more debt.

Alas, this is not necessarily the way your banker sees it. The reason is that the banker is looking at how much debt you’re using relative to the overall amount of credit you’ve been approved for. Here’s why canceling your accounts can make you look like a bigger risk:

Let’s say you have five cards with a $1,000 limit on each one and a $500 balance on one of them. With all five accounts open, you’re using just 10 percent of your total credit limit. Now, if you close the four cards with a zero balance, you still have $500 in debt, but only $1000 in available credit. Now you’re using 50 percent of your available credit. That’s what sends off alarm bells at the credit agency.

Here’s a better solution. Take the cards you don’t use and cut them up but leave the accounts open for awhile. As you pay down your outstanding balance, gradually close off the unused accounts one by one. And if you don’t pay an annual fee on those accounts, you might want just leave them open. You never can tell when you may need a little extra credit for a rainy day.

Sometimes “not so bad” is good enough.

That’s the way investors seem to be reacting to the lasted round of recession-battered corporate profits. With results now in from some three-quarters of the companies in Standard & Poor's 500 index, first quarter earnings reports have generally been better than analysts’ sharply marked-down forecasts.

The stock market has taken all of this as another “green shoot” of optimism, shoring up a rally that market bulls are taking as a sign of a bottom.

But a closer look at the numbers indicates that the investors’ profit enthusiasm may be premature. While about half of companies beat forecasts, those profits were still well below last year’s already weak performance. Overall, profits are down 36 percent from the first quarter of 2008, according to S&P.

That’s the seventh straight down quarter and the worse record since 1998.

That’s not as bad as the 63 percent profit plunge in the fourth quarter of salt year. With the economy slogging through the worst recession in decades, companies and analysts scaled back forecasts accordingly. Some market watchers think the bar was set so low, it shouldn’t come as a surprise that hundreds of companies managed to jump over it.

“I haven’t seen anyone who is impressed with earnings,” said Steve Grasso, a trader with Stuart Freeman at the New York Stock Exchange. “They’re more interested in how low the expectations were.”

The initial enthusiasm over profit improvements was also dampened by a closer look at where they came from. To slow the slide in profits, companies have slashed costs largely by shedding workers and cutting back hours for those still on the payroll.

Last week, the Labor Department reported that its Employment Cost Index, a broad measure of wages and benefits, bumped up by just 0.3 percent in the first quarter. That was the weakest gain since records began in June 1982. Cuts in worker benefits, including pensions, also helped bolstered profits; the Labor Dept reported that benefit costs rose by just 0.5 percent.

But with consumers still hunkered down, sales continued to fall. Overall, companies in the S&P 500 have posted a 12.5 drop in revenues compared to a year ago — just 89 of the 341 reporting by the end of last week posted a gain in sales.

“You cannot drive sustainable growth by cutting costs,” said James Bevan, chief investment officer at of CCLA Investment Management, “You need to see stronger revenue growth to drive long-term growth because cost cutting delivers a one-off change upwards in profitability, but not a sustainable uplift.”

One of the brightest corners of the profit picture came from the nation’s battered banks, which are still reeling huge losses in real estate loans and bad investments backed by mortgages.

After reported record losses in the fourth quarter, some of the most troubled players surprised Wall Street buy posting profits, including Bank of American and Wells Fargo. Citibank, one of the weakest of the big banks on government life support, logged a smaller loss than expected.

But some analysts advised taking those reports with a large grain of salt, thanks to an accounting rule change that kicked in late in the first quarter, giving them more leeway in how they “marked” the price of assets and liabilities on their books. Some banks were able to book large earnings based on the decline in the price of their bonds.

“This is pure accounting nonsense,” according to Zacks Research Director Dirk Van Dijk.

Other factors that helped shore up banks results in the first quarter may not be sustainable, according to Tom Forester, manager of the Forester Value Fund.

“My concern is: What do bank earnings look like next quarter?” he said. “I think they got kind of a one-time bump from (mortgage refinancings), which helped a lot of them. There was a moratorium on mortgage foreclosures which helped their first quarter earnings quite a bit.”

Other industries continue to get hammered by the deep recession. Slack demand and falling commodity prices took a 70 percent bite out of the profits of companies making raw materials, according to Zacks Investment Research. Falling oil prices curt Exxon Mobil’s profits by more than half. Energy companies overall saw profits drop 56 percent; companies selling discretionary consumer items saw earnings shrink by 55 percent form a year ago, according to Zacks. Even health care companies — typically reliable earners in good and bad times posted flat results.

Though corporate executives are hoping the profit outlook improves later this year, many have stopped offering Wall Street any forecasts at all. Those that are talking about the outlook are guarded.

Once the slide in profits does begin to ease, corporate America will have plenty of rebuilding ahead. The extended slide in profits has drained many of their rainy day cash cushions and made it harder to roll over their debts.

Though there are signs that the overall credit market is easing up, some 40 corporations worldwide defaulted on their debt in April, the highest second highest pace since Standard & Poor's began keeping track in 1981. So far this year, more than 100 issuers of corporate debt have defaulted.

“The precipitous increase in defaults reflects a pronounced decline in economic fundamentals and earnings prospects," Diane Vazza, head of S&P’s Global Fixed Income Research, wrote in a report on the numbers. "Historically, defaults have continued to escalate even after signs of economic recovery. This cycle will be no different."

With Chrysler now in bankruptcy court fighting for its life and GM slashing operations as it runs low on cash, owners and potential buyers of GM the car makers vehicles are understandable nervous about whether their warranties are still good. For now, at least, they're covered.

With Chrysler now in bankruptcy court and GM running out of cash, owners of those model cars are covered in the short term. On Friday, the judge overseeing Chrysler's bankruptcy filing approved the company's request to continue funding its warranty programs for new and existing cars and trucks. Without those warranties, Chrysler says, it would make buying one of their cars an even tougher sell for dealers.

GM, meanwhile, has decided that after an 83-year run, Pontiac will come to the end of the road by the end of next year. General Motors had hoped to keep Pontiac going as a “niche brand.” But the collapse of car sales and the years of over-reliance on gas-guzzling SUVs and light trucks have forced big cutbacks to keep the company from running out of gas completely.

The brand enjoyed its heyday in the 1960s, when cheap gas prices and advances in engine design spawned an era of high-performance “muscle cars” that included the Grand Prix, Firebird and GTO. In the 1970s, Pontiac kept the brand’s success rolling with the Grand Am and Trans Am models.

But the brand entered a steady decline in the '80s and '90s, and GM was never able to get it back on track. Last year, Pontiac's market share slid to 2.1 percent — down from from 3.1 percent in 2002, according to industry tracking firm Edmunds.com

Pontiac isn’t the only brand that will be left by the side of the road. GM says it is going to focus its limited capital on just four core brands: Chevrolet, Cadillac, Buick and GMC. That means Hummer, Saturn and Saab will also be sold off or shut down. (The company has not announced final plans for those operations.)

According to the company’s Web site, Pontiac warranties are still good and the cars will continue to be serviced by GM dealers. Since 85 percent of Pontiacs are currently sold through combined Buick-Pontiac-GMC dealers, most people won’t have to find a new place to get service. GM says there are about 1,600 of these combined dealerships in the United States and that Pontiac parts will continue to be available “for the foreseeable future.”  Even if GM dealers eventually discontinue stocking parts for older Pontiac models, aftermarket parts makers will likely fill the void.

For other questions about the care of your Pontiac, you can give GM a call at 1-800-762-2737. (Try 1-800-263-3777 in Canada or 01 800 466 08 08 in Mexico.)

Of course no financial institution is too big to fail. Some of those now on government life-support have already failed. If or when they emerge again as going concerns they will be much smaller and pose much less risk of doing further damage to the global financial system and the economy. The ongoing shrinking of the banking industry may provide the best solution in the short term.

While there are measures in place to cope with the failure of a bank insured by the Federal Deposit Insurance Corp., the same is not true for hedge funds, investment banks, insurance companies and other financial institutions that making a living taking on risk. As regulators sift through the wreckage of the financial meltdown, that’s one big problem they’re hoping to correct.

The real question is whether these institutions became too big to succeed. For over a decade, the financial services industry promoted the idea that American banks and investment firms needed to bulk up to compete on a global stage. Alas, it turns out that size can be as much of a liability as an asset.

As banks gobbled up smaller competitors, the ones that thrived were those that figured out how to combine operations efficiently and manage and control risk across the new banking empire. The ones that continued to operate as a collection of silos found it all but impossible to keep track of how much risk was accumulating in any one corner of the operation.

All it took was too much risk in just one silo — like bad mortgage lending or credit default swaps — to spring a leak threatened to sink the entire ship. When the global credit system began imploding last September, it turned out these financial leviathans were not particularly seaworthy in a bad storm.

So why save them? The failure of any large financial institution comes with collateral damage, from lost jobs to reduced lending and the money hole left when there are too many debts and not enough assets. A lot depends on how they fail. When a bank insured by the FDIC runs aground, depositors are protected, losses minimized and healthy pieces often sold off to new buyers. That’s a much better outcome than a sudden collapse.

Some people argue banks should be allowed to sink — if for no other reason than providing a “moral hazard” that will discourage other bankers from making bad bets and taking on too much risk. But the failure of Lehman Bros. demonstrated that these institutions have become so interconnected — having swapped trillions of dollars worth of loan guarantees — that the wreck of one major player in the modern financial system can quickly swamp otherwise seaworthy vessels.

It’s kind of like the power grid: If one part fails, and that failure spreads, pretty soon the lights go out everywhere. Since you can’t have a healthy economy without a healthy lending industry, the question becomes whether the cost of preventing the failure is less that the cost of the cleaning up damage that would result from that failure.

The bigger question regulators now face is: How do we make sure this doesn’t happen again? Chopping up a big bank with a portfolio of bad loans into a bunch of smaller banks with bad loans doesn’t really solve the problem. The solution is to keep banks from getting into trouble in the first pace.

That means “too big to fail” may not be the right measure of keeping the credit system healthy in the future. It’s more likely the solution will be finding a way to make sure banks don’t become “too big to regulate.” 

There seems to be general agreement that the steep slide in the global economy and financial markets is slowing down. There’s little consensus, though, on what happens next.

Has the stock market really bottomed out? Is the recession winding down, with the economy headed for recovery later this year? And why has the outlook gotten so muddy just when all these “green shoots” started popping up?

“Whenever you’re in a business cycle adjustment, which is what we're in,  gauging the whole path of the economy becomes extremely difficult,” said Brian Bethune, chief U.S. financial economist at IHS Global Insight, an economic advisory firm.

Just as it took almost a year to declare that the current recession had begun, the economy likely will be well on the road to recovery before a bottom is declared. As the bottom of any economic cycle approaches, the signals are almost always mixed, with some data showing a positive trend and other indicators continuing to fall.

Some of those uptrends may turn out to be “false bottoms” — three months of improvement in, say, retail sales might be followed by another sharp drop. That’s why some economists have begun talking about a “sawtoothed” recovery: The graph of economic growth may not snap back like a V but follow more of a wavy line that gradually trends higher. This kind of pattern makes it even harder to proclaim “the bottom” until it's receding in the rear-view mirror.

The International Monetary Fund said Wednesday that the U.S. economy would shrink 2.8 percent in 2009 and show no growth at all in 2010, although the downturn will be even steeper in Europe.

Any economic forecast has to take government policies into account; it’s tough to find modern historical precedent to the government’s multitrillion-dollar response to the current recession. It’s even tougher to predict the course of future government policies. Given the strong backlash on Capitol Hill to the $700 billion bank bailout, the Treasury will have a tough sell getting more money, even if the banking system seizes up again.

Local economics
A lot will depend on where you live. Just as the recession didn’t arrive in all parts of the country at the same time, it will leave some regions before others. That may help explain why two top Federal Reserve policymakers last week offered sharply different economic forecasts.

Dennis Lockhart, president of the Atlanta Fed, told an economics conference he expects the recession to end by midyear with growth slowly picking up in the following months.

San Francisco Fed president Janet Yellen, on the other hand, said that while she expects “slow and tentative growth” later this year, she doesn’t think the U.S. economy is out of the woods.

Even a relatively mild recession presents challenges when forecasting — or even recognizing — an upturn. When economic data point in the same downward direction month after month, the likelihood is pretty strong that the next month will bring bad news. But as the bottom approaches, the data can be subject to frequent shifts, flashing hopeful signs one month and disappointing the next.

That’s one reason economists tend to dismiss one-month moves and rely more on a three-month moving average. A “surprise” number may be a statistical anomaly, influenced by seasonal factors. Three-month averages also help correct for inevitable and frequent revisions in past months' data. (Alas, the popular news media tend to focus more heavily on those one-month numbers.)

When the economy does hit bottom, that only means it has stopped shrinking. Until it begins growing strongly again, adding substantial numbers of jobs, it will still feel like a recession to most people. Though many forecasters expect growth to begin by the end of this year, unemployment is expected to keep rising well into 2010.

Even when employers begin hiring again, it will take a long time to absorb the five million or more people who have been left jobless by the severe downturn. As long as unemployment remains high, the pressure on confidence and consumer spending will remain.

In addition, consumers will still have to recover from the loss of trillions of dollars in wealth from the collapse of the stock and housing markets. It also remains to be seen what will replace the trillions of dollars in phony credit that helped drive the economy during the boom.  Some economists are talking about a recovery that “resets” the economy to a lower level of gross domestic product.

One thing is clear: This downturn is unlike any seen in a lifetime. The steep drop in housing prices — for decades considered an unimaginable event — cut a wide swath of damage through many sectors of the economy and the financial system. A housing rebound is usually a reliable sign of broader economic growth to come, but the recent uptick in housing sales may be flashing a false signal this time.

“A lot of the sales that are being transacted are not voluntary sales — they’re foreclosures,” said Bethune. “And so you really don’t necessarily have a strong line of sight to what’s the underlying demand.”

A pick-up in mortgage lending, usually a reliable indicator of a housing recovery, is this time around being driven by the Fed's unprecedented moves to force interest rates lower, sparking a wave of home refinancing. That will help many consumers but may not signal a strong housing rebound.

The current recession also has brought the usual steep pullback in demand for cars and new homes. As a result, there could be pent-up demand that ultimately helps push the economy forward again.

But the speed and depth of the housing collapse that began in 2006 could leave more lasting damage this time around.

“Typically once new home construction bottoms out you've got two to three years before the existing home sale market begins to show signs of life,” said Peter Sorrentino, a portfolio manager at Huntington Asset Management. “Look at the foreclosure backlog that we’ve got. And you think about all the property has to go through the mill. Clearly there are more hits  going to be taken on (bank loan) portfolios.”

Financial system weakness adds another unknown to the economic forecast: without a healthy banking system you can’t have a healthy economy. The Treasury's current "stress testing" of big banks was intended to provide some confidence to investors and consumers. But identifying vulnerable banks won’t avert the prospect that one or more of them may still fail.

“The problem here is that during periods of financial stress like the one we've seen, you can have periods of what looks like the free fall in the economy is stopping,” said Frederic Mishkin, a Columbia University finance professor and former Fed governor. “And then if you get more shoes dropping, you're in big trouble. This is exactly what happened in 1931, where the economy looked like it was stabilizing and then you went through another set of bank panics, and then a much, much more virulent phase of financial crisis, and then the Great Depression. So we're by no means out of the woods."

The recent rally in the stock market provides another hopeful sign. Stocks have generally rallied ahead of an economic recovery as investors anticipate better times to come. But stock prices have been known to flash false signals too, only to fall back again as the downturn dragged on.

Looking for a bottom in stocks can be treacherous, which helps explain why there’s so much conflicting commentary from market watchers these days. Bulls argue that the panic that swept through the financial system last fall sent stocks to unreasonably low levels; since then the market has retraced some 20 percent of that lost ground. As the economy continues to rebuild, say the bulls, stock prices will anticipate the expansion.

But bears say that expectations of a prolonged rally are premature. A lot will depend on how well companies begin rebuilding their profits; so far the results are mixed.

Investors face another important unknown in trying to decide what their stocks are worth. In good times, the relationship between stock prices and earnings is relatively high, based in part on expectations that the good times will continue to roll. But during periods of prolonged economic downturn, that P-E ratio tends to contract.

“We think the S&P (500 index) can trade between 10 and 16 times (earnings),” said Kevin Caron, a market strategist at Stiefel Nicholas. The middle of that range would equate to a Standard & Poor's 500 index of 740 — more than 100 points below current levels.

It’s still about jobs, jobs, jobs. Until the employment market starts showing signs of improvement, it will cast a pall over any “green shoots” of growth poking up through the destruction left by the worst economic meltdown since the Great Depression.

That's even though banks say they’re getting back in the black, home sales are perking up and inflation is low. It's simple: No jobs means no spending, even though President Barack Obama sees a light at the end of the tunnel.

"There is no doubt that times are still tough," Obama said in a speech to students at Georgetown University Tuesday. "But from where we stand, for the very first time, we are beginning to see glimmers of hope. And beyond that, way off in the distance, we can see a vision of an America's future that is far different than our troubled economic past."

Fed Chairman Ben Bernanke cautioned in a speech Tuesday that once the recovery begins, there still will be plenty of work to clean up the financial mess.

"Recently we have seen tentative signs that the sharp decline in economic activity may be slowing," Bernanke said. "A leveling out of economic activity is the first step toward recovery.
To be sure, we will not have a sustainable recovery without a stabilization of our financial system and credit markets."

Until the recovery takes hold, there are other potential hurdles that could slow its arrival or weaken the upturn when it begins. And even if the economy begins turning up later this year, as many forecasters expect, the underlying damage to the financial markets, to the flow of credit and to consumer and business confidence will remain.

That means that job losses, now running at more than 600,000 a month, are expected to continue well into next year.

That headwind is still clearly visible in the latest economic data. Though the stock market has rallied, consumers aren’t yet in a spending mood. The Commerce Department said Tuesday that retail sales fell unexpectedly in March.

The 1.1 percent drop was the biggest decline in three months and a much weaker showing than analysts expected. Car sales led the slump, but foot traffic was also weak at clothing stores, appliance outlets and furniture stores.

With demand weak, there’s little sign of inflation. Retailers continue to slash prices to try to boost sales. Energy and raw material producers are feeling the price squeeze as manufacturers cut production. Tuesday’s data on producer prices showed a 1.2 percent drop in March, led by a sharp drop in gasoline and other energy prices. Food prices also fell 0.7 percent.

The loss of consumer confidence is echoed by business managers in charge of hiring. Confidence among small businesses, the main source of new jobs, was stuck at 35-year lows in March, with employers stepping up layoffs even as the recession-hit economy shows some signs of improving.

The National Federation of Independent Business said in a survey released Tuesday that its index of small business optimism fell 1.6 points to 81.0 from February, the second-lowest reading in the organization's 35-year history.

NFIB Chief Economist William Dunkelberg said the survey also pointed to some early signs of optimism. Members reported credit was a bit easier to get, for example. But Dunkelberg said the overall outlook remains gloomy for now.

“The first thing I’ll look for is changes in expectations,” he said. “(Small businesses are) very pessimistic about the next six months in terms of the growth of the economy. The good news has to leak in there. Then they'll tell us sales are picking up. Then, of course, they'll start hiring people. That’s the sequence we'll look for."

The economic outlook is usually cloudiest just when it’s about to change, and the latest data are rich with conflicts. Forecasters seem to have split into two camps. There are those who believe the “green shoots” of good news are a sign that the recovery is nearing. Others suggest that it’s too soon to say things have hit bottom.

There’s wide agreement from both sides that the government’s multitrillion-dollar economic program should begin to kick in by the second half of this year. Over the past two months, that growing confidence has helped buoy the stock market, which usually begins rising well before an economic rebound is under way. But it’s not clear that growth will be sustainable once the one-time spending boost works its way through the system.

“I can understand how we're going to recover because of the stimulus program,” said Byron Wein, an investment manager at Pequot Capital Management. “But once that's through the economy, what's going to take over from that? What's going to sustain the growth? That's the question in my mind."

Those in the “glass half full” camp believe that the government stimulus will provide the spark that helps unleash over a year of pent-up demand from homebuyers who sat on the sidelines and consumers who cut spending and boosted savings. (Since the recession began, the national saving rate has jumped to nearly 5 percent from virtually nothing.)

Even the most optimistic forecasters concede that a healthy pickup in growth won’t translate quickly into a hiring boom. Before committing to full-time hires, employers typically wait to make sure a recovery is real. In the meantime, they add part-time workers or increase work hours for those already on the payroll.

That’s why job losses are expected to continue even once the recovery is under way. No matter what the data show, the economy won’t feel like it’s recovering until people start going back to work.

Here are some of the other economic forces that could delay the recovery, or weaken it when it comes:

Global recession. With its massive stimulus program, the U.S. economy may lead the global recovery. But until trading partners join in the growth, it won’t feel like prosperity.

"One of the big areas of controversy is what will happen to China,” said Wein. “I think the signs are improving in China. If the consumers in China starts to spend, that can change the world.”

Real estate prices. Though sales have begun picking up, prices are still falling in many parts of the country. Until that trend reverses course, household wealth will continue to evaporate and bank assets backed by real estate will remain under pressure. Some analysts believe the commercial real estate market, which entered the downturn later than the housing industry, may take longer to recover.

The Fed. When the panic began in September 2008, the central bank began spraying money on the global financial system like a fire company trying to tame a five-alarm blaze. So far, there’s little sign that all that surplus cash is creating inflationary pressure. But once the economy starts to recover, much of that cash will have to be mopped up again. If it drains too slowly, that surplus cash could fuel inflation or another asset bubble, or both. If it drains too quickly, it could choke off growth. In some ways, the Fed’s biggest challenge lies ahead.

It started out as a simple question.

How much money has the federal government thrown at the financial crisis since the recession first began over a year ago?

Exact figures remain elusive, like most of the way the government handles and accounts for money, and it's complicated by a simmering alphabet soup of programs aimed at revving up the economy. The bottom line also depends on whom you ask.

Turns out it would be easier to count the squirrels in Central Park than arrive at a precise answer.

So far, cash commitments made by various bailout efforts — including the Treasury's $700 billion Troubled Asset Relief Program bailout and various lending programs by the Federal Reserve — are just shy of $3 trillion, Neil Barofsky, special inspector general for TARP, told the Senate Finance Committee March 31.

But the net cost to taxpayers will be much lower — more like $356 billion in direct spending — according to an analysis published last month by the Congressional Budget Office.

An analysis by msnbc.com concludes that Congress, the Fed and government agencies have announced plans to spend $7.2 trillion to fight the economic downturn, with the vast majority of that coming in the form of loans and loan guarantees. (See graphic above.)

But the Fed and other agencies typically deflect any such attempts to total up the costs of the spending and lending.

At a March 24 House Financial Services Committee hearing, Rep. Michele Bachmann, R-Minn.,  demanded that Fed Chairman Ben Bernanke cite the constitutional basis for the central bank’s aggressive moves to stem the financial panic, saying, “This has been over $10 trillion that we're talking about.”

“I don't know where $10 trillion comes from,” Bernanke replied curtly.

The government’s response to the 16-month-old recession and financial panic has been as complex as it is vast. Dozens of separate programs and spending packages have been unleashed by the Fed, the Treasury, the Federal Deposit Insurance Corp. and other agencies. These programs fall into two broad categories: call them lending and spending.

Most of the lending, by far the biggest pile of cash, has come from the Fed. Created in 1913 after a series of devastating financial panics, the central bank was designed as the lender of last resort. Since the crisis began, the Fed has lent with a vengeance. But for each of the Federal Reserve notes (aka dollars) it has handed out, the Fed has taken back some form of collateral, usually a relatively high-quality bond—on which it collects interest.

That is, after all, what the Fed has done for the past 95 years. For most of that period, the Fed stuck to swapping cash for the safest debt securities — U.S. Treasury notes, bills and bonds. When the financial panic hit in September, lending all but dried up as panicked investors and bankers hoarded cash. The Fed responded by widening the type of securities it was willing to accept as collateral and began spraying money at the economy like a fire brigade trying to contain a five-alarm inferno.

Seizing on an obscure clause, Section 13.3 in the law that created the Fed, the central bank invoked virtually unlimited powers to expand its lending to “any individual, partnership, or corporation” when confronted with “unusual and exigent circumstances.”

The Fed’s use of that lending power has been prolific. When the crisis began in September, the Fed’s balance sheet — the accounting of how much it holds in investments against its cash loans outstanding — stood at about $940 billion. By year-end, that number had swelled to $2.3 trillion, fueled by an alphabet soup of “lending facilities” created at a pace and scope never imagined.

The Term Auction Facility, for example, expanded the list of lenders and the type of collateral accepted for cash. In normal times, the Fed lends only to an elite list of the biggest banks and “primary dealers,” which it uses as conduits to the wider financial system. Before long, the list would include a troubled insurance company and a failing investment bank that had made too-risky bets.

In normal times, the Fed’s main focus is the banking system. Before the credit panic hit, some 40 percent of lending happened outside the Fed’s purview in the “shadow” banking system.

That additional funding comes from investment funds, corporations, pensions, university endowments, wealthy individuals and foreign governments — anyone with a pile of spare cash looking to earn interest. In normal times these investors make their funds available by purchasing “asset-backed” bonds consisting of car loans, credit card debt, mortgages and student loans. But last September that “shadow” lending market all but dried up.

To get the market for these loans flowing again, the Fed stepped with the Term Asset-Backed Securities Loan Facility (TALF) as a buyer of last resort for these bonds. Starting with a commitment of $200 billion, the Fed would eventually pledge to buy as much as $1 trillion of asset-backed securities used to fund consumer lending.

The Fed also unleashed a series of other programs, some of which provided the desired calming effect with relatively little actual lending. Other programs have virtually been ended after having served their purpose.

That rise and fall of multiple lending facilities is one reason it’s tough to assign a grand total to the government’s cash commitments to the crisis. From its $2.3 trillion peak at the end of last year, the Fed’s balance sheet fell to $1.9 trillion in February. Since then it’s crept back up to $2.1 trillion. That part of the calculation remains a moving target.

For all its largesse, the Fed expects to get most of its money back when the economy and financial system recover.

Bernanke told Congress last month that some 95 percent of its loans are back by the safest, top-quality debt paper. The other 5 percent includes some risky assets put up by the now-defunct Bear Stearns and taxpayer-rescued American International Group Inc. (AIG). But even those loans will eventually pay back some of the Fed’s investment.

The Fed may even come out ahead when the crisis is over and it reverses all these loans, swapping the bonds it's holding back into cash. Though the central bank has pushed the short-term interest rates banks charge each other to near zero, the Fed doesn’t lend money for free. The interest it collects on the trillions of dollars it lends pays the Fed’s operating expenses. Any surplus goes to the Treasury to help pay for general government spending. So a true accounting of the financial bailout should add back the return on the Fed’s investment. This, too, changes from one week to the next.

What about the rest of our bailout accounting for the relatively smaller pile of money devoted to actual spending? Those figures are easier to nail down. What's less clear is how much of that money eventually will return to the Treasury.

The first major outlay came last year, when it became apparent that the economic slowdown called for some sort of government response. An initial $168 billion stimulus package approved by Congress was handed out largely in the form of tax rebates to individuals.

But a despite brief pickup in spending last summer, the economy continued to slide. When the credit panic hit in September, Congress and the White House reacted with urgency.

Warned by then-Treasury Secretary Henry Paulson that the global financial system was perhaps days from a catastrophic collapse, Congress authorized the Treasury to spend up to $700 billion to buy up mortgage-backed investments that bankers said were clogging up the system. And the
legislation directed the Treasury to spend tens of billions to help homeowners facing foreclosure who were sold dicey mortgages.

Neither of those plans materialized. After weeks of late nights and long weekends trying to devise a program to buy up “toxic” bank assets, Paulson announced a massive infusion of cash directly to banks in exchange for stock paying the government a dividend. That Trouble Asset Relief Program, or TARP, would eventually disburse some $240 billion to banks, many of which played a critical role in creating the toxic assets they were now unable to sell.

The TARP soon became a financial firewall against the spread of panic to other troubled corners of the credit system. Insurance giant AIG, with operations in 130 countries and over 100 million policy holders, announced it was on the brink of insolvency. Because one arm of the company wasn’t regulated, no one bothered to ensure there was enough money on AIG’s books to pay off all its bets.

With the aftershocks of the collapse of the failed investment firm Lehman Bros. still reverberating, Treasury and Fed officials said they had no choice but to put up billions in loans and TARP funds to keep AIG afloat. In the end, AIG received four separate government bailouts totaling more than $170 billion.

Once it became clear that TARP's original mandate to buy toxic assets had been abandoned, the ailing auto industry came calling for help. After years of a relentless rise in costs and sliding sales, the CEOs of Chrysler and General Motors flew to Washington on corporate jets asking for TARP money to tide them over. Before the Obama administration finally said “Enough” last month, some $17.4 billion in TARP funds had been shipped to Detroit.

When Congress reauthorized the second round of TARP spending, it made sure $75 billion was tagged to help homeowners in foreclosure. But instead of buying up mortgages directly and refinancing them, the program provides cash incentives to lenders who voluntarily step forward to offer struggling households more affordable terms.

The TARP program has had mixed success in getting credit flowing again. So far, there are few signs it has succeeded in getting the economy back on its feet.

So Congress and the White House decided in February to serve up another $787 billion in government spending. The hope is that much of the money will help fill the consumer spending gap left by millions of lost jobs and the twin collapses of the housing and stock markets.

Like all government accounting, tracking that spending is a lot harder than than balancing the family checkbook. For starters, that $787 billion represents spending authorized over 10 years, although most is likely to be appropriated in the first two.

Much of that money isn’t really spending; some $400 billion represents taxes that won’t be collected. Instead of just handing out tax rebate checks, this time the government is targeting tax breaks to those at the bottom of the income ladder, first-time home buyers or people who buy fuel-efficient, American-made cars.

As for the spending, the original intent was to find programs like building roads and bridges that would provide the biggest economic bang for each tax buck. It will be years before the full economic impact, and the size of the program, can be known. That’s one more reason the total tally is tough to nail down.

The biggest impact of the bailout — the size of the federal debt — may be easier account for.

When the recession officially began in December 2007, the total public debt outstanding stood at $9.149 trillion. As of April 1, 2009, the figure had risen to $11.110 trillion. The difference  comes to $1.961 trillion.

Which is about as good an accounting of the true cost as any.

There are lots of good people out there who can help you get a better mortgage. And then there are the scammers. How do you tell the difference?

There are many honest, qualified and caring professionals who are trying to help the millions of American homeowners who are struggling with their mortgages and at risk of losing their homes. And they’re very easy to find. (More on that in a minute.)

Unfortunately, there are also hundreds — probably thousands — of unbelievably sleazy con artists who are posing as legitimate housing counselors and inflicting even more pain and suffering among homeowners already in financial distress. 

The first round of mortgage fraud — the mid-decade wave of rogue lending that arguably got us into this mess in the first place — has now been replaced by a second, even more despicable scam called “foreclosure rescue.” These folks often refer to themselves (not completely erroneously) as “foreclosure specialists.” What they specialize in is ripping off people who are desperate for help at one of the most vulnerable points in their lives.

Part of the problem is that the victims of this scam are such easy targets. Once you get in trouble with a mortgage, it becomes a matter of public record — even at the earliest “pre-foreclosure” stages. To get started on this fraud, all it takes is a trip to the local town or county clerk’s office to compile a fresh list of potential victims. Many states make life even easier for the scammers by requiring lenders to publish foreclosure notices in the newspaper.

There are variations on the “rescue” scam, but you should be aware of the common elements and red flags. The first is the demand for a large, up-front fee connected to sweeping promises to resolve your mortgage trouble in short order. This is the “if it sounds too good to be true” red flag.

The next warning sign is any “solution” that involves you signing over the deed to your house. There are several very plausible scenarios scammers use to sell homeowners on this idea, but no legitimate housing counselor will ever suggest you do so. Ditto for instructions to make mortgage payments directly to the counselor. Or offers to buy your house and rent it back to you. Or advice to not contact your lender or lawyer and work only through the mortgage counselor.

If you hear any one of these statements, promptly stand up and leave — or hang up and don’t call back. No “Thanks for your time” is required on your part.

To contact a legitimate counselor, go to the Web site for the Department of Housing and Urban Development — which certifies legitimate housing counselors — to find an accredited agency near you. You can also get a referral from the National Foundation for Credit Counseling, a nationwide network of local counseling agencies that help people with a broad range of consumer lending issues. Most homeowners who get in trouble with a mortgage also have other credit problems. A qualified credit counselor can help you with those, too.

If you’re having trouble, there’s no need to wait to find a good counselor to get started. Contact your lender as soon as you think you may need help. If you’re behind, don’t ignore your lender’s letters or calls; the longer you wait, the harder it will be to get your loan modified.

But there are no guarantees. Despite the government’s recent commitment of $75 billion to promote loan modifications, the program is voluntary. If a lender modifies a loan to a more affordable monthly payment, they get paid a government bonus. But there’s no requirement that they do so.

For more information on foreclosure fraud, tips on how to talk to your lender and how to get real help, check out our interactive guide to rescue scams.

Spending that dollar is the most effective way to get the economy growing again.

A lot depends on where you spend it, of course. If the person you pass it along to stashes it under their mattress, you’ll get less stimulus bang for your buck than if you go out to dinner and use it to tip the waitress or buy groceries or give it to your mechanic to get your car fixed. The more times that dollar moves along before it takes a breather in a savings account, the more impact it has. Economists call this the “multiplier effect.”

Most of the economic activity in the U.S. (about two-thirds or so) involves people buying stuff from one another or paying someone else to do something for them, like preparing a tax return or making a cheeseburger. About an eighth of GDP comes from federal, state and local governments spending your tax dollars. The rest comes from the value created by people making things, growing food, putting up buildings — that sort of thing.

The main reason the economy is in recession is that consumer spending slowed sharply when the boom in house and stock prices turned to bust. Too much of that boomtime spending was based on phony money — credit that never should have been lent, or house and stock prices that ran up too far, too fast.

Not only is that extra spending power gone (for now, anyway), consumers have gotten very nervous about the future. So they’re stashing a lot more money in savings. Consumer spending has also taken a big hit from the millions of jobs lost since the recession began 16 months ago. Those lost wages take even more spending out of the economy.

There’s nothing wrong with consumers saving more money — it was inevitable after the savings rate actually went negative during the boom. And some of the money you stash into savings eventually helps the economy grow. If the bank that pays you a little bit of interest on your CD lends the money to a young entrepreneur who starts a clothing line and hires six people, that creates more economic output.

The problem is that banks aren’t lending as much as they usually do because they’re still cleaning up the mess they made by lending too much money to too many people who now can’t pay it back.

Stashing money away for retirement is also a great place to put your money. It will eventually have a positive economic impact when you retire and start spending it. To the extent that your personal retirement savings puts less pressure on the Social Security system, you’ll also be doing the economy a favor. But that impact won’t be felt for a long time.

In the meantime, do your patriotic duty: Treat yourself and a friend to a night out. Don’t forget to leave the waitress a nice, big tip.

With the value of the dollar jumping up and down against other countries' currencies, what if the world just agreed to use the same currency? It sounds like a simple idea. But like many simple ideas, it would come with all kinds of unintended consequences.

The Chinese proposal for a single global currency was part of Beijing’s effort to take a more prominent place among world powers at the recent G20 meeting. And they have legitimate reason to float the idea of replacing the dollar as the “reserve” currency — the medium of exchange used for the majority of financial transactions around the world.

As the holder of some $2 trillion in dollar-denominated savings the Chinese government has reason to be concerned about the long-term strength of the dollar. One time-honored method of reducing large government debt is to gradually inflate the currency to reduce the real value of that debt. That would also devalue that big pile of Chinese savings.

The dollar’s role as a reserve currency also gives the United States a dominant role in the global economy. That also means other countries are subject to U.S. fiscal and monetary policies over which they have no control.

So it’s no surprise that China would like to see another entity — it suggests the International Monetary Fund would be a good choice — issue a single global currency that would be used by all countries in place of the dollar. There would be many advantages to this. But it has about as much chance of happening as the adoption of Esperanto as a common global language.

A nation’s currency serves several purposes, one of which is a global proxy for the depth, strength and productivity of its economy and the stability of its political system.  For all of the problems facing the United States, investors around the world believe the dollar is the safest place to park their wealth. That’s why, for the moment, interest rates on dollar-denominated debt like U.S. Treasuries are so low.

Currencies are also valued based on trade flows; if the Japanese yen is relatively weak compared to the dollar, and American car buyers can buy a higher-end Japanese model for the same price in dollars, they will choose the Japanese car. That means that countries that are more productive generally see the value of their currency strengthen, which gives people who earn wages in that currency more buying power when they buy products priced in other, weaker currencies.

This makes the Chinese proposal for unified currency somewhat ironic, given that for many years, China artificially suppressed the value of its currency, the yuan, to make its products more competitive when priced in other currencies. With a single, unified currency, countries no longer have the luxury of devaluing their local currency to make their product more competitive.

There are other problems with a unified currency — as countries in the Eurozone are learning. Though the first 10 years of sharing a single currency went relatively smoothly, cracks have begun appearing on the continent as the global recession deepens.

One of the original goals of the Euro was to raise the overall productivity of the European economy, as weaker, smaller countries had to become more competitive with larger, stronger countries. In fact, the reverse is true. Weaker countries enjoyed higher purchasing power without having to produce more goods and services. Overall productivity growth slowed in Europe from 1.6 percent a year before the euro to half that pace since.

The Euro also suffers from the fragmented political structure that governs the economy it represents. Since each member country can issue its own debt, the euro is used in 16 different bond markets. Each country sets its own tax and spending policies; some countries now carry debts larger than their gross domestic product. 

So while they’ve been freed of the impact of currency fluctuation, euro countries now face a different — in some cases more painful — impact from the whims of global investors. Borrowing costs in heavily indebted countries like Spain, Greece, Ireland and Portugal are much higher than of Germany, which has accumulated the largest pile of savings.

That presents these countries with some painful choices they didn’t have to deal with back in the days when they could devalue their local currency. Italy, for example, faces some stark choices, according to a 2006 report by the Center for European reform, a London-based think tank. It can continue to muddle along as the slowest growing economy among euro countries. Or it could boost productivity, chiefly by cutting wages. Or it could leave the euro, devalue its debts and create its own currency. Doing so, however, would make it much more difficult to borrow.

Other euro countries with high debts face similar downward spirals. Those debts increase costs, forcing tax increases or spending cuts. Cutting future borrowing costs means raising productivity — either through layoffs or wage cuts or both. None of those choices is likely to win much support on Election Day.

Unless and until the world had a single government to maintain uniform fiscal and monetary policies, it's hard to see how any independent body would be granted sufficient powers to make a workable global currency — especially in times of global recession when the most painful choices are required. (This is what ultimately began the collapse of the gold standard in the 1930s.)

And as long as the global economy consists of a collection of local economies governed by multiple countries, a single global currency would do little to eliminate the resulting imbalances that result from the different economic policies pursued by those sovereign nations.

With layoffs happening everywhere in an order to cut costs and stay in business, has the government made any cuts? They aren't very efficient.
— Curt, Lindstrom, Minn.

Yes, government employment began shrinking from a peak in August 2008, according to the Bureau of Labor Statistics. In March, the sector lost another 5,000 jobs.

Like the rest of the economy, government employment has its ups and downs. Still, it has roughly tracked the growth of the nation's overall population. From 1980 to 2008, the latest figures available, the population grew by about 39 percent and the government workforce grew by about 35 percent.

Which is more or less what you would expect. The more citizens who demand services from their government, the more people it takes to provide those services.

As for the productivity of those workers, that’s a little harder to get at. The government stopped measuring productivity of government workers in 1994. That’s when productivity throughout the work force — public and private — began making great strides due in part to technological developments like the personal computers and the Internet.

Pre-1994, though, government productivity didn’t measure up very well. From 1987 to 1994, output per employee among government workers rose 0.4 percent a year. That compares with gains in output of 1.5 percent a year by "nonfarm business" workers and gains of 2.2 percent a year by manufacturing workers during the same period.

If readers can point us to more recent data on government worker productivity, we’ll include it in a future column.

Treasury Secretary Timothy Geithner made the rounds of Washington talk shows Sunday to make the case that the government’s efforts to bailout the financial system are on track. Geithner also said the Treasury has about $135 billion left in bailout funds and that, if more is needed, “we’ll cross that bridge when we come to it.”

Geithner and the Obama administration have faced withering criticism from some members of Congress for their handling of the $700 billion financial rescue program approved last fall. On Sunday, he defended the need for massive government intervention to get credit flowing again to reverse the deepening recession.

"The classic lesson of financial crises is governments wait to act,” Geithner told NBC’s "Meet the Press." “They wait too late. And that means more damage to the economy, higher deficits in the future and greater cost to the taxpayer. And we’re not prepared to take that approach.”

(Msnbc.com is a joint-venture of Microsoft and NBC Universal.)

In concert with the Federal Reserve, the Treasury has unleashed trillions of dollars in loans and spending in a multi-pronged effort to fix the credit markets and get the economy growing again. The list includes direct investments in banks, financial incentives to get lenders to stop foreclosures and, most recently, a plan to let private investors borrow government money risk-free to buy up dicey loans and other investments that are clogging the banking industry’s books.

“Credit is like the blood — it’s like the oxygen of any economy,” Geithner said. “For us get the economy growing again we need to makes sure there’s going to be credit available to business and families across the country.”

Geithner said the government’s efforts are already beginning to show results in the mortgage market, where rates have fallen. The typical American family that refinances to a lower rate can save roughly $2,000 a year, he said.

“That’s a substantial amount of resource they can spend on thing that will help to get this economy growing again,” said Geithner. “Where we’re acting you’re seeing progress and impact.”

Geithner said the Treasury estimates it has about $135 billion in funds left from the so-called Troubled Asset Relief Program — or TARP — money Congress authorized in October. That includes money the Treasury expects to get back from banks that have already taken funds, Geithner said.

Some of that money will likely be needed to provide further relief to the nation’s ailing auto industry. President Obama is expected to announce the latest round of help for car companies this week.

Originally intended to buy up bad bank assets, the TARP plan touched off a firestorm of protest in Congress last year when former Treasury Secretary Henry Paulson abruptly changed course and gave $200 billion of the money directly to banks in exchange for stock.

Since then, there’s been little support on Capitol Hill for additional funding if the remaining TARP money doesn’t go far enough.

“We have substantial resources,” Geithner told ABC’s “This Week.” “And we’re going them use them as quickly and as carefully as we can and make sure they’re devoted to getting credit flowing again. We’ll cross that bridge when we come to it in terms of whether we need additional resources.”

Critics of the Obama administration’s massive intervention in the financial markets have also expressed concerns about the equally massive budget deficits brought on by the TARP program and the $787 billion economic stimulus package enacted earlier this year. Geithner defended the huge increase in spending by saying the investment would pay off in the long run.

“The cost of fixing the crisis is going to require larger deficits in the short term,” he said. “But the best way to make sure we get those deficits down it the future is to get recovery established and make the economy stronger going forward.”

Geithner also fended off criticisms off the government’s rescue of failed insurance giant AIG, including the payment of large bonuses to the executives who made the risky, multi-billion-dollar bets that sank the company. He said the contracts awarding those bonuses were signed before the current administration took office.

“We had no good choices,” he said. “Were a nation of laws. We cannot get the economy going again if there’s and an expectation that the government is going to come in a break contracts. It’s just not a tenable thing to do.”

The current bailout plan, he said, will provide for greater accountability from bank managers and include conditions to protect the taxpayers.

And while he said he understands the anger and frustration with the Treasury’s programs, Geithner said the harsh personal criticism has not been unexpected.

“This job comes with a lot of heat by definition,” he said. “There’s nothing surprising in that.”

Geithner also said he expects that one silver lining to the financial crisis will be a stronger economy less reliant on unsustainable borrowing.

“When we get though this people are going to care less about what they make, more about what they do, what they achieve with what they make,” he said. “And that will make this country stronger.”

After months of speculation and false starts, the Treasury Monday announced a new plan to deal with the so-called "toxic assets" that have been weighing down the financial sector and clogging global credit markets.

The announcement by Treasury Secretary Tim Geithner was greeted by a big rally on Wall Street but leaves unresolved some major hurdles that have plagued the rescue plan since October, when the Bush administration first floated an idea to deal with the troubled assets. And the new plan leaves unanswered the biggest question echoing from Wall Street to Main Street: Will it work?

With private investors still loath to step up and buy mortgage-backed securities and related assets, the latest Treasury plan shifts much of the risk to taxpayers. By partnering with the government, a few big investment funds will have a chance to profit off the toxic assets, sharing any proceeds with the government. But if the investments don't pay off, taxpayers will bear most of the risk.

“There is no doubt the government is taking risks,” Geithner told reporters. “You can’t solve a financial crisis without the government taking risks.”

In addition to the risk of taxpayer losses, there is also the risk that the government could set such a low price on the toxic assets that it could actually worsen the credit crunch.

The new plan will draw on up to $100 billion in funds already approved by Congress under the  Troubled Asset Relief Program, as well as additional funding from the Federal Reserve. The government will match private investment dollar-for-dollar, and the Federal Deposit Insurance Corp. will put up significant backing, up to $6 for every $1 invested, in exchange for a fee.

The FDIC funding will be in the form of “non-recourse” loans, meaning private investors will be allowed to walk away from their investment if it goes bad, leaving the government with the failed investment and any losses on the loan.

After months of preliminary discussions with potential investors, the Treasury is now moving quickly; private firms have to apply by April 10, and the government will respond by May 1. Some of the nation’s biggest money management firms, including PIMCO and BlackRock, are considered likely candidates. The Treasury is expected to limit the list to a half-dozen firms at most.

What's the 'market' price?
At the height of the housing boom, investors couldn’t get enough of the mortgage-backed bonds Wall Street was churning out by the boatload because these investments offered a good return for what seemed like little risk.

But when it became apparent that sloppy mortgage lenders had doled out hundreds of billions of dollars to people who couldn’t pay it back, no one wanted to touch investments backed by mortgages. With no way to sell them, banks are now stuck with trillions of dollars worth of assets they can’t properly value. That’s clogging up the global flow of credit.

Though roughly 90 percent of mortgage holders are still making payments, investments backed by mortgages are selling for only 30 to 60 cents on the dollar. The reason is that — with unemployment rising and home prices falling — no one knows which mortgages will be the next to default. So banks have been forced to write down the value of these investments and take huge losses to cover the write-downs

The Treasury is hoping that by jump-starting the private market with a massive shot of government investment and lending, prices of these assets will stabilize and banks can either sell them off or assign them a more realistic value on their books.

The plan still faces a major hurdle that’s dogged rescue efforts since the Treasury first unveiled a plan to buy mortgage-backed bonds last October. If banks in the deepest trouble need to raise cash by unloading their troubled assets on the cheap, much the way they're dumping foreclosed houses at distressed prices, that “market” price for one set of bad loans could force other banks to take bigger write-downs on their holdings.

Banks may also have second thoughts about selling their “toxic” investments at any price, because bankers believe that most of these assets won’t be toxic forever. Since most mortgage holders will eventually make their payments, many of these investments should recover much of their lost value once the housing market and economy stabilize. If the Treasury purchase program sets a market price that’s too low, banks could decide to sit on these investments for years — producing the opposite effect the Treasury is trying to achieve.

Some market watchers say that with the banking system showing early signs of stabilizing, the government may not face the same urgency it did when the crisis began last fall. A sharp cut in interest rates engineered by the Federal Reserve has helped big banks shore up their battered balance sheets. Ailing Citigroup and Bank of America, for example, reported this month that they broke into the black in the first two months of this year after posting tens of billions in losses since the financial crisis began.

The Treasury's buyback plan also could be affected by a proposal now working its way through Congress that would change the so-called “mark to market” accounting rules that force banks to take big losses on investments that may some day recover much of their lost value.

With Congress in an uproar over bonuses paid to executives at bailout-recipient AIG, some potential private investors also have been reluctant to sign on for fear that the rules may change after the game has begun. The Treasury is trying minimizing that risk by promising firms that participate in the purchase plan they won’t be subject to executive compensation caps added to the original TARP plan.

But some on Wall Street fear Congress may yet enact rules that undercut the appeal of partnering with the government.

“The dark cloud on the horizon is this congressional hysteria against pay and redesigning the terms of a contract after they've been written," said Steve Bartlett, CEO of the Financial Services Roundtable, an industry lobbying group. "I think Wall Street is just sort of justifiably holding back because of that."

As anger in Congress has risen, the odds have fallen on the possibility of additional bailout funding. But key portions of the Treasury's plan don’t require congressional approval. That’s because the program draws much of its funding from the independent Federal Reserve and from the FDIC, which can draw on its own assets.

Despite the unimaginably large pile of money being funneled into the financial system, some of those involved in the plan say that — even if it works — it’s only a down payment on the eventual solution.   

“Its fair to be optimistic; that’s the way Americans should be leaning," said Bill Gross, chief investment officer at PIMCO, one of the nation's largest bond funds. “But the hole here is a $5 trillion-plus whole in terms of assets and capital destruction.  I think we’ve only gone about half of the way and the will be additional programs to come.”

There's widespread agreement among the world's biggest countries that the current global financial and economic crises require global solutions. But as leaders from twenty of those countries gather this weekend in London, that may be about all they can agree on.

The upcoming meeting is the last of a series of preliminary sessions before an April 2 summit that was called to try to reverse the downward spiral in the global economic and financial systems.

There’s little debate over the scope and urgency of the problem. And all parties have called publicly for a unified approach to economic stimulus programs, coordinated efforts to bail out the battered financial system and tougher, comprehensive rules to prevent the global financial system from running off the rails again.

When the time comes to work out the details, the limits of global harmony quickly become apparent.

“I think they’re pretty disunified,” said Simon Johnson, a professor at MIT’s Sloan School of Management and former chief economist at the International Monetary Fund. “But they don’t obviously want to present that too publicly.”

After months of preliminary work, several major fault lines have opened, largely between the U.S. and European countries, say analysts. The Obama administration, represented this weekend by Treasury Secretary Tim Geithner, has been pressing European countries to boost spending. For their part, the Europeans have been urging quick action on tightening financial regulations. 

Officials on both sides of the Atlantic have been teeing up the issues this week. On Tuesday Federal Reserve Chairman Ben Bernanke outlined the issue facing U.S. financial regulators, but pointedly lowered expectations for the April G-20 summit.

“I think it's asking too much for a meeting like that to come out with detailed proposals in many different areas,” he said.  

Bernanke focused much of his speech on the need for a more centralized approach to U.S. regulations that could more closely monitor increased risks to the entire financial system, not just the risks faced by individual banks. 

But so far, no one has figured out how to pull that off.

“The fact that the best idea they can come up with is a 'college of regulators' — which essentially means air miles for the regulatory industry — suggests that we are not seeing any coordinated action,” said Tom Vosa, head of economics research for nabCapital in London. “That’s not surprising because different countries have different histories of their banking system. The structures are entirely different.”

Given the complexity of those different regulatory systems — not unlike the multiple federal and state financial regulations in the U.S. —  it’s hard to envision a single global regulator with the sweep and authority to undertake the kind oversight being discussed, according to Sebastian Mallaby, a senior fellow at the Council on Foreign Relations.

“This G-20 meeting in April 2 is not going to resolve financial regulation,” he said. “It’s just too difficult and too complicated. There’s been some noise from the Europeans saying,  ‘Gee, we’ve got to regulate hedge funds’ and so forth. That’s because they want to change the subject from the fact that they ought to have more fiscal stimulus.”

In response to U.S. calls for more government spending, the EU has said it is doing its part with a package that amounts to between 3 and 4 percent of Europe’s gross domestic product. The $780 billion amounts to about 5.5 percent of the U.S. GDP, but is spread over two years.

While the U.S. is expected to continue to urge European countries to spend more, that will likely be a tough sell. With the exception of Germany, Great Britain and France, most European governments’ finances are already stretched to the limit.

As the EU’s largest economy, Germany is expected to play a critical role in propping up  Europe’s economy and ailing banks. But analysts say that with lingering memories of the hyperinflation that gave rise to Nazi Germany, there’s a strong cultural aversion to easy-money policies. The current coalition government also faces an election in September that has dampened enthusiasm for a big spending package. 

“People are divided on whether the Germans are posturing while preparing sensibly for these very difficult and increasingly likely contingencies or whether they’re totally asleep at the wheel,” said Johnson. “I guess we’ll find out.

Smaller Eurozone countries that have been slow to boost spending have another reason to drag their feet, say analysts. Some would rather let other, bigger countries do the spending, as long as it boosts demand for everyone’s exports.

“The risk at the moment is that if one or two countries do fiscal packages, that’s simply going to boost the export market for countries which haven’t,” said Tom Vosa, head of economic research at nabCapital in London.  “That’s why in the U.S. they’ve put in those 'Buy American' provisions to stop those leakages from happening.”

Those “buy local” restrictions on stimulus spending could backfire if they open a round of trade retaliation that could further slow the global economy.

All politics are local
Much of the conflict is being driven by politics back home, say analysts. The European focus on regulation, said Johnson, plays well among voters who believe the crisis was caused by excessive spending and risk-taking by American. 

“The story they want to tell about the crisis — that American finance got out of control and they’ve now got to be reregulated and the initiative of the Europeans and that (Europe) saved the day. Of course nothing could be further from the truth,”  he said. “Their banks were just as much involved in causing the problems as were the U.S.”

While the response to the crisis in the U.S. has occasionally bogged down over bickering between two political parties, the Europe Union faces the much more daunting task of forging consensus among its 27 member countries. Fault lines are already opening. Heavy borrowing by eastern European countries with weaker economies, for example, has left them saddled with debts they can’t pay to banks in richer countries that now face heavy losses.

Local conflicts also loom as Europe tries to develop a unified approach to shoring up its financial system, said Mallaby. 

“When taxpayers put money into a bank they tend to want to say ‘In return you’ve got to start lending in our country to stimulate demand so we don’t lose too many jobs,’” he said. “If everybody says that to their banks, then it just exports the credit crunch to other places in Europe. This is the financial sector equivalent of ‘Buy American’ or ‘Buy France’ instinct.”

The debate over European banking bailouts is further complicated by the scope of the resources that each country can bring to bear. Despite the staggering cost of the $700 billion U.S. TARP bank bailout, that figure is still a relatively small portion of the roughly $14 trillion U.S. economy. Some European countries now face the prospect of bailing out banks that are substantially bigger than their entire economies.

One solution being proposed is a doubling of the International Monetary Fund’s emergency account to $500 billion. That’s forced the G-20 countries to look to newer, emerging market countries like China for help. But that’s revived a contentious debate over giving those countries more IMF voting power.

While expanded IMF funding could provide an important financial backstop, it’s not the most appealing solution for the countries that end up tapping the fund for a bailout, according to MIT's Johnson.

“It’s the complete failure of a country and of a system of government if you have to go to the IMF,” he said. “It’s the most humiliating experience you can imagine, having these faceless bureaucrats, many of whom are my good friends, tell you what to do. It’s horrible.“

The Obama administration is trying to craft a plan that would give the government direct ownership of some banks without scaring away private investors who remain a potential source of badly needed capital.

Call it what you want, but no one wants to call it nationalization.

Worries about possible bank failures have intensified in recent days, prompting a broad and steep selloff in the stock market. In response, the five major federal bank regulators issued an unusual joint statement Monday morning, declaring that “the U.S. government stands firmly behind the banking system during this period of financial strain.”

After months of sliding from one crisis to another, and after a government injection of nearly $350 billion, the nation’s banking system remains fragile. The share prices of the biggest, most troubled banks, including Citigroup and Bank of America, have fallen into the low single digits, helping push broad stock market indexes to their lowest levels since 1997.

Souring loans on the books of many banks will yield more losses that could wipe out the remaining value of those shares, rendering the banks insolvent. Some fear that the biggest banks in the worst shape already have insufficient assets to meet their obligations.

Ever since the financial meltdown began over a year ago, banks have been struggling to shore up their capital base to withstand continued losses from loans gone bad. Initially confined largely to home mortgages, there are rising concerns about possible defaults on other types of debt, including commercial real estate loans, student loans, auto loans and credit card debt.

Late last month, the International Monetary Fund projected that worldwide banking industry losses may reach $2.2 trillion, up from a previous estimate of $1.4 trillion. The report estimated that the capital shortfall needed to cover those losses for U.S. and European banks alone was at least a half-trillion dollars.

"Going forward, banks will need even more capital as expected losses continue to mount," the bank warned.

It’s uncertain how much more capital will be needed. Part of the problem is that it is extremely difficult to value the “troubled” assets on the banking industry’s books. For example, some borrowers who are current on their loans today are at risk of defaulting if the economy continues to deteriorate. But if they do not default, the loan could be worth the full value.

That’s why the Obama administration is undertaking a “stress test” of troubled banks’ financial statements before dispensing the second half of a congressionally approved $700 billion to rescue the industry. The goal is to try to get a better estimate of how much more financial damage may be inflicted by the deteriorating global economy, and in turn, whether the package may need to increase.

In good times, banks turn to the capital market to raise additional cash. But private investors have been spooked by banks’ continuing losses and uncertainty over how much further the global economy will deteriorate.

So far, the capital needed to backstop ailing banks has come largely from the federal government’s financial rescue plan. The government already has injected nearly $250 billion into hundreds of banks in return for preferred shares of stock, which don’t come with voting rights. The hope was that the money would provide banks with a short-term cushion as they raised private capital without having the government take a true ownership stake.

But private investors remain leery of putting up fresh cash, in part because they fear the government will eventually have to resort to buying large chunks of common stock. That would almost certainly wipe out existing shareholders.

The government’s latest plan, called the Capital Assistance Program, involves swapping taxpayer money for a new class of stock that doesn’t represent direct ownership. But if a bank’s financial health deteriorates, the government would be able to convert those shares into common stock with traditional voting rights and the control that goes with them. After going to great lengths to avoid having the government own direct stakes in banks, the new round of investment amounts to what could be called “standby” ownership.

Under the latest plan, the government will monitor a troubled bank’s books and, if it determines the bank needs to raise more capital, it will give the bank a chance to seek private investors. If private money can’t be found, the government will provide capital in exchange for “mandatory convertible preferred shares.” The government could convert those shares to common stock, if needed, to cover future losses. By doing so, it would also increase its direct ownership of the bank.

The plan is expected to be applied first to Citigroup, which already has taken $45 billion of federal bailout funds in exchange for preferred shares, along with another $300 billion in federal guarantees. Published reports Monday said Citi was preparing to give the government common shares in exchange for the preferred shares, giving the government an ownership stake of as much as 40 percent. With that much control, the government would have effectively nationalized the bank.

Citigroup stock rose nearly 10 percent on the news, closing at $2.14 a share.

Nationalization is not unheard of in the United States. When railroads stopped providing intercity passenger service in the late 1960s, the government set up Amtrak to take over those routes. Some countries have state-owned airlines to provide service not available from for-profit carriers. But the Obama administration has said repeatedly it wants to avoid full nationalization at all costs.

“Because our economy functions better when financial institutions are well-managed in the private sector, the strong presumption of the Capital Assistance Program is that banks should remain in private hands," bank regulators said Monday in their joint statement.

But others, including former Federal Reserve Chairman Alan Greenspan, have said that nationalization of the nation's weakest banks may be inevitable.

"It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring," Greenspan told the Financial Times in comments published last week.

The Obama administration's sweeping plan to stop foreclosures is expected to help millions of Americans save their homes from the sheriff’s auction. But as the broad outlines of the plan sift through the lending system, it’s already clear that millions more won’t be helped.

With as many as 10 million households expected to face foreclosure in the next four years – more if the job market continues to deteriorate – the scope of the problem is just too big for the measures announced so far.

That means that not all of those who are eligible for help will get it.

Despite the government’s pledge to standardize the process, the decision to modify a loan to make it more affordable still rests with individual lenders, loan servicers and investors. That means that two homeowners in comparable situations dealing with different servicers may get two different outcomes.

“There's $75 billion targeted for this program, and there is a much bigger hole than $75 billion,” said David Resler of Nomura Securities International. ”So who do you pick?”

The $75 billion plan is intended to slow foreclosures by offering a package of financial incentives to prod lenders and mortgage servicers to modify more loans. Another $200 billion will be spent to provide more capital to mortgage giants Fannie Mae and Freddie, and raise by $50 billion the limit on how many loans those agencies can acquire.

Banks and mortgage servicers are already gearing up for the expected flood of calls from millions of desperate homeowners. Until the details of the plan are finalized March 4, it’s too soon to know exactly who – and how many – will benefit from the plan.

But officials in charge of the plan acknowledge it isn't big enough to help everyone facing the prospect of foreclosure. The plan's funding, in fact, represents only about 8 percent of the expected $1 trillion in residential mortgage losses, according to projections by Goldman Sachs. (That figure doesn’t include losses on mortgages owned or sold by government mortgage giants Fannie Mae and Freddie Mac.)

While the program is widely seen as an improvement on the lending industry’s voluntary efforts to date, it’s far from clear how many of the 9 million homeowners the plan is targeting will get help. Much depends on how private lenders, loan servicers and investors who hold mortgages respond. To date, the logjam in modifying loans has centered on the loan servicers hired to collect payments from homeowners and dole them out to investors.

Servicers who modify loans say they risk getting sued by investors, who may claim the changes in terms cost them money. The Obama final plan did not include earlier proposals to offer servicers legal protection from those lawsuits.

Critical plan details – including the government’s standard guidelines for modifying a loan – have yet to be worked out. Those guidelines are intended to speed the glacial pace of negotiations created by legal complications that ensued when hundreds of loans were bundled together in a pool and sold to thousands of investors.

“Right now we're caught between the borrower and the investors,” said Jeannine Bruin, a spokeswoman for ResCap, a GMAC unit that servicers roughly 2.8 million home mortgages. “We’re just waiting for further specifics on those guidelines.”

In the meantime, banks and loan servicers like ResCap, which is already making 5 million outbound calls a month to homeowners, are bracing for a heavy volume of incoming calls sparked by the announcement of the foreclosure relief effort.

“Fortunately, even before the plan came out we had started hiring and increased our lending and servicing staff by 40 percent,” said Bruin. “Now we need to anticipate what kind of calls are going to come in. How do we route the calls? What’s the most efficient way to handle the volume? What kind of materials will callers have received? Should we be more proactive in terms of contacting them?”

Officials in charge of the program acknowledge that, while the plan is expected to help millions, an unknown number of those callers won’t get helped. And it may take months for them to learn the final decision.

“We're going to see that as we go through this process, that some of these houses are empty, and they're going to be foreclosed on," said James Lockhart, director of the Federal Financing Housing Agency, which oversees Fannie Mae and Freddie Mac. “But to the extent we can save a homeowner, we can help save their neighborhood and their community.”

The administration is hoping to help two major groups of homeowners who are at risk of losing their homes. The first are those whose income isn’t big enough to keep up with their monthly payment. Some were tricked into signing loans that ‘reset’ to unaffordable payments; some were approved for a loan that consumed more than half their monthly income; some lied about their income on the loan application; and others have lost their job since taking on the loan.

Some of these borrowers will be helped by government payments to lenders aimed at reducing the borrower's monthly payment to 38 percent of their income through various means, including stretching out the term of the loan to 40 years or reducing the interest rate. The government will then further reduce the monthly payment to 31 percent of a borrower’s monthly income.

But many homeowners won’t qualify. For starters, they’ll have to show that 31 percent of their income will cover a monthly payment for the full principal amount at 5.1 percent interest. Those who were too overextended to begin with, or who have lost their jobs, won’t be able to sustain the lower payment and won’t be eligible.

The plan also only applies to owner-occupied homes. Those who may have rented out their house because they can't afford the mortgage will be considered "investors," none of whom will be eligible.

Mortgage modifications made under the plan expire in five years. The hope is that the housing market and borrower incomes will have recovered by then. If not, the payment reverts to the higher, unaffordable level.

“Having these modifications unwind after five years might spur the problem down the road, having it reappear just as the housing market and economy are beginning to recover,” said John Taylor president of the National Community Reinvestment Coalition.

A second, and growing, group of borrowers now owe more on their mortgage than their house is worth. Roughly one in five homeowners with mortgages are in this category.

Many have tried refinancing to a lower rate, but lenders currently won’t loan more than 80 percent of a home’s value. The Obama plan would raise that limit to 105 percent of the current market value on loans held or sold by Fannie Mae and Freddie Mac.

That will help homeowners who are “mildly” underwater, but not those who owe 105 percent or more of their home’s value. The offer is being extended only to loans held or sold to investors by Freddie Mac and Fannie Mae. The majority of the most troubled loans were funded and sold to investors by Wall Street banks and other large lenders, who aren't required to adopt the new maximum loan-to-value ratio.

For homeowners who are more deeply underwater, the holder of the mortgage would have to agree to cut the principal amount back to 105 percent of the home’s value. About three-quarters of homeowners underwater owe more than 10 percent over what their house is worth, according to Goldman Sachs. 

So far, lenders have reacted coolly to cutting principal; there’s little in the plan to warm them up to the idea.

“I would expect that term extension, rate reduction will continue to be the primary tools used to lower the monthly payment, just because it has the biggest bang for the buck,” Michael Heid, co-president of Wells Fargo Home Mortgage, told CNBC.

Homeowners who do convince their lender to forgive part of their principal face another hurdle in a falling real estate market, according to Resler.

“It might get them from under water to above water for now,” he said “but how much of a percentage decline from here would it be to put them back into the current situation?“

The comprehensive overhaul of the government’s financial bailout plan announced Tuesday is designed to succeed where other plans have failed by unifying a sometimes piecemeal set of policies. But as outlined by Treasury Secretary Tim Geithner, the plan was disappointing in its dearth of detail.

Since the financial crisis began unfolding in September, efforts to resolve it have involved multiple agencies including the Treasury, Federal Reserve and  Federal Deposit Insurance Corp. A shotgun approach to fixing the problem has tried everything from pouring money into the banking sector to helping homeowners renegotiate mortgages to save their homes.

“Everything was scattershot, hit and miss,” said former Fed governor Frederic Mishkin. “Now the feds have to go in big time and get this mess cleaned up. I think that there's an understanding in the administration that this is what needs to be done. But, boy, the details surely matter here.”

The latest plan, wide in scope, applies some fixes to existing measures and introduces a few new ideas. But as presented it is short on detailed solutions to some of most critical problems that have stymied past efforts.

Wall Street seemed to share that assessment. Although the announcement of the plan was anticipated for weeks, disappointment over a lack of key details contributed to a sharp sell-off in stocks, with the Dow Jones industrial average down 381.99 points for the day.

Geithner hinted in his speech that additional measures — and dollars — may be needed to get the global economy back on track.

“I want to be candid: This strategy will cost money, involve risk and take time,” he said. “As costly as this effort may be, we know that the cost of a complete collapse of our financial system would be incalculable for families, for businesses and for our nation.”

By underscoring the severity of the problem, Geithner may help lay the groundwork for calls for future sacrifices from voters — and additional spending from Congress. But keeping the plan open-ended also will extend the uncertainty that has undermined investor confidence as the government has moved from one policy to another.

“I think you've got to assume it’s the next step in the process, but I don’t believe it's the last stand,” said Anthony Fry, an investment banker at Evercore Partners. “”I think we are in a developing situation."

The Geithner plan covers four broad areas:

New capital for banks
As banks have lost upward of $1 trillion in mortgage-related assets, they have less money to lend — which has meant calling in old loans and cutting down on new ones. Until they can build up a more solid capital base, lending will remain tight and the economy can’t get growing again.

Last year’s Troubled Asset Relief Program was supposed to solve this problem by swapping those bad assets for cash or solid assets like Treasury securities. But since no one could figure out what the banks' bad assets are worth, the Treasury instead opted for a quick fix by giving them more than $250 billion in fresh capital in return for stock.

That drew fire from Capitol Hill and Main Street. After taking taxpayer money, banks showered bonuses on executives, paid dividends to shareholders and bought up other banks. The head of the TARP oversight committee, Elizabeth Warren, told a congressional panel last week that after handing out $254 billion, the government only got back $176 billion worth of stock. Critics also said decisions about which banks got funded were inconsistent.

The new plan will continue to provide capital and provide some increased oversight — including creation of a uniform “stress test” applied to any bank that gets money to see if it has the financial strength to survive the ongoing meltdown.

The process may also help the government come up with a better accounting of how much bad debt is out there, information banks have hoarded as tightly as cash.

But the plan stops short of applying hard restrictions on what banks can do with TARP money, including wider caps on executive pay. Instead, the Treasury will require more public disclosure on a Web site that will track where the money goes. The hope is that public disclosure will prompt bankers to adhere to the government’s goal of boosting lending to get the economy moving again.

Buying bad assets
The revised plan makes a renewed effort to get bad assets off bank books but sets aside a proposal to make direct purchases through the formation of a giant government “bad bank” to warehouse these assets until they recover some value. Instead the Treasury — possibly in conjunction with the Federal Reserve — will set up an "aggregator bank” and try to get private investors to step up and buy these assets.

The plan is relying heavily on private investors in part because the $350 billion left in the TARP program is not nearly enough to buy remaining the $1 trillion — or more — in bad assets. Geithner said the aggregator bank will need at least $500 billion to get started. But it’s unclear how the private investors will be convinced to put up that much money.

“We are exploring a range of different structures for this program and will seek input from market participants and the public as we design it,” Geithner said.

That leaves unanswered another of the thorniest problems that have plagued financial bailout efforts to date: how to put a price on assets that no one wants to buy. Because these assets have long-term payout schedules, most will be worth something once the housing market and economy recover. But if the price is set too high, investors — or taxpayers — will lose money. If set too low, banks holding similar assets will have to take even bigger write-offs, likely forcing many into insolvency.

“The reality here is we're going through an exercise which has never been tried before,” said Fry, “which is banks are looking at a huge range of assets, many of which are paper assets and which have to be valued at a particular moment in time. (The banks) have to make huge assumptions about where the economy is going to be. And we’re expecting to do that across the financial community. This is not a simple exercise."

New private lending
Though banks have cut back on direct lending, the private investors who supply trillions of dollars to the capital markets are also hoarding cash. Some 40 percent of lending to consumers is made by bundling car loans, credit card loans and student loans into pools that are “securitized” — converted to bonds — and then sold to investors. The latest bailout plan would expand a program already under way at the Fed to guarantee these investments to get investors back into the market.

The Fed has had some success with this approach. A move last fall to backstop the so-called commercial paper market that large companies rely on to raise short-term capital has recently made it easier for those companies to borrow.

Foreclosure mitigation
In unveiling the governments’ new plan, Geithner was shortest on detail about proposed solutions to most fundamental cause of the financial meltdown — the relentless rise in foreclosures and fall in home prices. Following up on a proposal introduced in the House last month, Geithner said the new plan will include $50 billion to stop foreclosures. The details of how it will be spent, he said, would be announced “in the next few weeks.”

Efforts to unwind the foreclosure mess to date have come largely from private industry, including the industry-sponsored Hope Now Alliance. Mortgage giants Fannie Mae and Freddie Mac, now under government control, also have begun to try to standardize the process of modifying mortgages to more affordable terms. But some 2 million more homes were foreclosed last year and, without more aggressive measures, as many as 3 million more could be lost this year — adding to the already glutted inventory of unsold homes.

“I don't think we've seen a big enough push for it by the private sector,” said Steve Preston, former housing secretary in the Bush administration. “We still have somewhat of an impasse between the people who are sending you your mortgage bills, your servicers, and people who own your mortgages. That's an impasse we have to break.”

The government is expected Monday to announce new terms for the ill-fated $700 billion financial bailout package, including pay limits on top executives at banks that take taxpayer money. Based on past efforts to rein in executive pay, the search for loopholes will begin before the ink on the new rules is dry.

If the government requires a $500,000 cap on executive pay for companies that are receiving a federal bailout, do you think that will include their bonus as well? It seems that in many situations that the bonus is more than their base pay.
— Tom, Cincinnati, Ohio

That’s just one of many loopholes that will likely doom the government’s efforts to cap executive compensation — a mission Congress has been trying to accomplish for nearly two decades.

Let’s start with the question of who, exactly, is going to be subject to those limits. Bankers who have already taken government bailout funds before the restrictions went into place won’t be covered.

The salary caps also apply only to “top executives” which refers to your place on the organizational chart, not the size of your paycheck. It’s not uncommon for the biggest, multi-million-dollar payouts to go to traders or investment managers who generate substantial profits that work on lower rungs of the corporate ladder. (Some compensation experts suggest top executives subject to the limits could ask for a different title that takes they out of the reach of pay restrictions.)

It’s not the first time Congress has tried to narrow the gap between the highest- and lowest-paid workers in corporate America. As executive pay packages began to soar in the early 1990, Congress passed a law in 1993 that limited a corporation’s tax deduction for executive pay to “only” $1 million.

To get around the limit, companies began sweetening top executives paychecks with stock options — which let you wait to buy company stock until after you’re sure it’s gone up. But you get to buy the shares at the price they traded on the day you got the option, making it a no-lose bet.

That brought on a stock options scandal in which companies would “backdate” the official record of when the stock option was granted. Now, you didn’t even have to wait for the stock to go up. The company just picked a past date when the stock prices was low and let you buy now-higher-priced shares for an instant profit.

There are plenty of other “workarounds” to pay limits, including a variety of forms of “deferred” compensation. One simple way is to beef up a pension so future payments don’t count as current compensation. To get around restriction on current pay, some companies “gross up” key executive salaries, essentially having the company pick the tab for paying their income taxes.

There’s a cottage industry out there of “compensation consultants” who are themselves paid very well to come up with these arrangements. No matter what limits Congress comes up with, it’s a pretty good bet these experts will find a way around them.

Just like the old saying: If you build a ten-foot wall, someone will always come along with an 11-foot ladder.

There’s no rule that says you have to be behind on your mortgage payment to get help from your lender modifying your loan to more affordable terms.

That's the real problem: There are no rules.

Two years after the housing market began to come unglued by a wave of rogue lending, Congress is still discussing various proposals to try to head off another wave of foreclosures that is expected to crest this year and next. Many of the loans written during the height of the lending bubble are schedule to “reset” to higher payments between now and 2011.

Unless something is done to diffuse this ticking bomb, the continued flood of foreclosed homes will push prices even lower, delaying the end of the housing market’s slide. And until the housing market recovers, it’s hard to see how the larger economy can get back on its feet.

So far, the government’s effort to get lenders to modify mortgages has had little impact. Part of the problem is that the process of securitizing mortgages created such a complex financial mess that no has figured out how to unscramble it. It’s the flip side of the problem that has stymied government efforts to clean up the mess of “toxic assets” clogging up the banking system. Those are the very assets backed by mortgages that need to be modified — which the $700 billion bailout has failed to address.

The revised terms of the second half of that bailout could include measures to try to stop foreclosures. (Details are expected to be released Tuesday.)

Last month, a bill in the House called for spending as much as $100 billion of the remaining bailout funds to prevent foreclosures. But the proposal was short on details of how it would work.

Some Democrats in Congress are also working to get funding for plan proposed by FDIC Chairwoman Sheila Bair, who developed a program to help homeowners after the government seized the failed IndyMac bank. The plan involves providing government guarantees for lenders who participate in modifying loan terms. It also provides a $1,000 bonus per modification to the lender as a financial incentive — one of the so-called “carrots” the government is considering.

The ultimate solution, thought, will likely require some kind of “stick” to get lenders moving more aggressively to modify mortgages. The most effective proposed so far — dubbed “mortgage cramdown” by the lending industry — would let bankruptcy judges modify loan terms from the bench, just as they do with every other form of debt involved in a bankruptcy.

The lending industry claims the measure would raise borrowing costs because of the higher risk that a borrower would end up in bankruptcy court. Academic studies dispute that claim.

In any event, it might not be such a bad idea for the lending industry to charge higher rates to risky borrowers — or maybe not lend to them at all. If those policies were in place before the mortgage bubble spun out of control, we probably wouldn’t be left with so many bad mortgages to clean up.

Friday’s dismal report on the rapid loss of jobs in January has added new urgency to the government’s efforts to reverse one of the worst economic downturns in memory.

But even if Congress and the White House can agree on a huge program of fresh spending and tax cuts to get the economy going again, it could take years to create enough new jobs to rehire the idle workers and keep up with growth in the labor force, economists say.

The U.S. economy has been shedding about a million jobs every two months, and there are no signs that pace will ease up soon. New figures published Friday morning showed the U.S. economy lost 598,000 jobs in January, the most since the end of 1974, pushing the U.S. unemployment rate up to 7.6 percent.

“There can be no sugar-coating this report,” John Ryding, chief economist of RDQ Economics, wrote in a note to clients. “The rate of job losses massively intensified in November and there has been no change in trend since then.”

Job losses in the last two months of 2008 were worse than originally reported; revisions in the government data showed businesses cut 577,000 jobs in December and 597,000 in November. That brings to 3.6 million the total number of jobs lost since the recession began in Dec., 2007.

The data provided fresh evidence of the urgency for government action to try to head off the loss of millions more jobs. As President Barack Obama announced a new economic recovery advisory board Friday, he said the jobs data demand action and that it's "inexcusable and irresponsible" for Congress to delay his economic recovery package. He cautioned that recovery won't come quickly.

"No single act can meet the challenges of this moment," said Obama. "This process is just the beginning of a long journey back to progress and prosperity."

The White House is also scrambling to revise a $700 billion financial rescue program that has drawn fire for failing to spur banks to ease tight credit and lend more to businesses and consumers. Treasury Secretary Timothy Geithner is expected to deliver a speech on Monday outlining the new plan.

Evidence began mounting before Friday’s report that the pace of layoffs may be picking up speed. The number of workers filing their first claim for jobless benefits last week was much higher than expectations — up by 35,000 to 626,000, the highest level in 26 years.

And it's taking longer for those who lost jobs to find new ones. The average time it took for an unemployed person to find new work — full or part time — rose to 19.8 weeks in January, compared with 17.5 weeks a year ago, according to government data.

Big companies announced over 240,000 layoffs last month, a seven-year high, according to  Challenger, Gray and Christmas, an outplacement firm. As job cuts deepen, they’re also widening to industries that had been holding up relatively well.

"We're certainly seeing layoffs coming from all corners of the economy," said John Challenger, the firm's CEO. "That's one of the things that is really unique about what's happening right now. It's not just automotive and banking and housing. We're seeing it in pharmaceuticals and telecom and heavy equipment."

For much of the past two decades, the bulk of job creation came from small businesses, which account for more than half of all private sector jobs. While large-scale layoffs at big companies are getting the biggest headlines, weakness in the job market is now spreading to smaller companies, according to Joel Prakken, chairman of Macroeconomic Advisers, which manages a monthly employment survey conducted by payroll processor ADP.

"Early in this episode, the job loss seemed concentrated in the larger firms," said Prakken. "But in the last several months, they've spread quite aggressively to medium- and small-sized outfits. That leaves no doubt the recession has been spread beyond the epicenter of housing and mortgage-related finance out into the mainstream economy."

Government employment, which has held up relatively well, is also beginning to be hit by the widening budgets gaps faced by state and local governments. Though the economic stimulus package is expected to help states pay the rising cost of Medicaid and jobless benefits, there is little it can do to offset the decline in tax revenues lost to slower consumer spending, lower employment levels and declining property values.

Halfway through their fiscal year budgets, 42 states and Washington, D.C., face deficits of more than $46 billion – on top of $48 billion cuts already made to close budget gaps, according to the Center on Budget and Policy Priorities. Forty-one states are projecting shortfalls of another $88 billion. In all, combined budget gaps for the remainder of the current fiscal year and the next two years are estimated to total more than $350 billion, said the CBPP. Because they can’t borrow to make up for those deficits, states have to close shortfalls by cutting spending or raising taxes.  

That means states now have few options left except cutting their payrolls. In California, state agencies were scrambling to implement the first employee furloughs in California history, ordered by Gov. Arnold Schwarzenegger to save money in the face of a massive budget crisis. The furloughs, involving some 90 percent of the state's 238,000 employees, come after months of negotiations to try to solve the state's budget shortfall, which is projected to reach $42 billion by June 2010.

Local governments also face the prospect of job cuts as falling housing values cut deeply into local property taxes, the main source of funding for many municipalities. Until the housing market finds a bottom, those revenue losses will continue to pressure city and town budgets. The increased tax burden on homeowners will also act as a drag on consumer spending, further postponing the economy's recovery.

One bright spot in the economic data this week came with a big gain in productivity for the fourth quarter of 2008. But there was a cloud around that silver lining: The gains were the result of a steep drop in employment and hours worked that outpaced the 3.8 percent drop in economic output. Much of that output represented a build-up in inventories that will create a drag on the economy in the current quarter.

That has left the economy “on the verge of a massive inventory cycle the likes of which has not been seen since the early 1980s,” Merrill Lynch economist David Rosenberg wrote in a note to clients. “Businesses are swamped with excess inventories, blindsided as they were by the abruptness of the downturn in both global and domestic demand.”

In some ways the job market is even weaker than the official data suggest. Many companies are trimming payroll costs by cutting back hours, a change that may not show up in the  unemployment rate reported by the Labor Department. The so-called “headline” jobless rate also doesn’t include workers who have become so discouraged they given up looking for a job; or students who have gone back to school to sit out the recession.

With those groups are taken into account, the level of “underemployment” is approaching 14 percent, according to Jared Bernstein, a top economic adviser to Vice President Joe Biden.

"Over 20 million people are either unemployed or can't find the hours they want," said Bernstein. "That means almost everyone we're talking to knows somebody who is experiencing that downturn firsthand."

All of which adds to the urgency of the stimulus package working its way through Congress, which could be worth more than $900 billion.

Most mainstream economists believe the boost from the stimulus package — along with aggressive moves by the Federal Reserve to get credit flowing again — will stop the economic slide this year. But the growth rates seen earlier this decade, funded by trillions of dollars of unsustainable borrowing, are not expected to return for years.

Part of the reason is that, while the early effects of the stimulus may be felt quickly, it could take several years for the full economic impact to kick in from from longer-term infrastructure spending. Even "shovel-ready" projects like rebuilding roads and bridges will take years to complete.

Meanwhile, the labor force continues to grow about 1.2 percent a year, meaning that there will be that many more job seekers when the recovery kicks in. Without a new source of growth, the recovery won't be able to create enough jobs to go around.

“It may well be 2010 before you make a dent at the unemployment rate — meaning jobs as measured by the household measure — growing fast enough to absorb currently unemployed as well as newly entered workers and those who re-enter the work force," said Stuart Hoffman, chief economist at PNC Financial.

That means that even when economic output and consumer spending begins growing again, the economy will continue to feel like it’s in recession for the millions still looking for a job.

With the government committing hundreds of billions of dollars to help get the economy moving again, small business owners are wondering: Is there anything in this bailout that's going to help me?

The answer, according to small business advocates, is not enough.

If you mean: “Is the government handing out cash to small businesses the way it’s showering money on the banking industry?” the answer is no. To get any of the $700 billion Congress has approved so far for the Troubled Asset Relief program, you pretty much have to be a bank that’s in deep trouble because it made loans to people who couldn’t pay them back.

You also have to be “too big to fail” — which rules out help for the roughly 12 million companies with less than 500 employees (according to 2006 Census data, the latest available). Collectively, these companies employ more than 70 million people — or about half the total U.S. workforce.

But Congress is considering some measures that could help small businesses as part of an $819 billion stimulus package that has been approved by the House and is now before the Senate. According to small business groups, the measures are mostly too small and indirect.

“If they’re looking for a bailout, there’s not anything in here for them,” said Todd McCracken, president of the National Small Business Association.

There is some indirect help — mostly through changes in the tax code. One provision would let small business owners write off the cost of buying new equipment right away instead of deducting it gradually as the value depreciates over several years. But that won’t help companies that can’t afford to buy more equipment as their business dries up.

The measure also includes a “tax loss carryback.” That means that if your small business had a profit in, say, 2005 or 2006, and you’re now losing money, you can use that loss to offset profits in past years — and get back the taxes you paid on those profits.

If you’re one of those small businesses whose credit has recently been cut off by a bank, the bill has a provision designed to help you get a loan. The package includes close to $500 million in additional funding for loans guaranteed by the Small Business Administration.

The minimum guarantees would be increased from 60 percent of the loan to 95 percent, which eliminates much of the bank’s risk. The plan also would eliminate fees charged to both lender and borrowers to cover the cost of loans that go bad.

Unfortunately, these measures probably won’t be enough to restart small business lending, because banks are still having a hard time selling off existing small business loans in the secondary market, which would free up cash to make more loans, said McCracken.

"We’ve been arguing that the government should buy those loans," he said.

The Federal Reserve said last week it is “prepared” to buy those loans, but so far it hasn’t moved ahead with that plan, he said.

Small businesses may get some help from planned massive spending on infrastructure and other public projects, but they’re going to have a hard time outbidding larger firms that can price more aggressively, according to William Rys, tax counsel at the National Federation of Independent Businesses.

Rys said the NFIB has been pressing Congress to include a “payroll tax holiday” — letting businesses and workers stop paying taxes for a short period to speed the impact of proposed tax breaks.

“It puts money back into the business and puts money back in the employee's pocket,” he said. “So it has the double benefit of helping both sides of the equation.”

So far, the proposal isn’t part of the bill making its way through the Senate.

You can’t do anything to shrink the deficit — the difference between what Congress spends every year and what the Treasury collects in taxes each year.

You can, however, help your Uncle Sam pay down the $10 trillion national debt, which is the accumulation of all the deficits the government runs every year.

You can send them cash. Or you can buy one of their Treasury securities, give it back to them, and let thme know they don’t need to pay you back. Or you can leave them money in your will.

You can also send the Treasury “real and personal property, made only on the condition that the property be sold and the proceeds used to reduce debt held by the public,” according to the Treasury’s Web site. So if you’re cleaning old junk out of the attic and can’t be bothered with selling it on Craigslist, consider sending it along to your Uncle Sam.

Or they’ll take a check. Make it out to the Bureau of the Public Debt, and in the memo section, let them know it’s a “Gift to reduce the Debt Held by the Public.” Send it to:

Attn Dept G
Bureau Of the Public Debt
P. O. Box 2188
Parkersburg, WV 26106-2188

You can be pretty sure it’ll be used according to your wishes. While Congress can be pretty careless with our tax dollars, the Treasury keeps very good track of where it all goes. (They’re actually pretty fussy about accounting; everything is tracked to the last penny.)

Last year, for example, charitably minded folks like you donated $2,189,358.89 in gifts specifically for the purpose of paying down the national debt. (That's $2.2 million.) That reduced the overall debt by about 0.00002060321 percent.

But hey, every little bit helps.

The latest reading on the economy showed that the gross domestic product shrank at a rate of 3.8 percent in the fourth quarter, the worst result since 1982.

The slide wasn't as bad as the nearly 6 percent drop many forecasters had been expecting. But the better-than-expected performance was the result of a build-up of unsold inventories — which means businesses will have to cut production that much further to cope with the rising backlog of unsold goods.

The report was just one more indication that as the recession has spilled over into the new year, it may be picking up speed.

As the government advances historic measures to revive growth, the data point to an economy that is getting worse. It’s far from clear the government actions — including a massive stimulus program and major intervention in the banking system — will stem the slide and restart the economy by year-end.

But even if it does, analysts say the recovery — when it comes — will likely be weak and slow.

With home prices continuing to fall and layoffs rising, the sharp pullback in consumer spending is a powerful force driving the economic contraction. That spending pullback will continue for some time to come, according to Stephen Roach, Morgan Stanley’s Asia chairman.

“The biggest force on the demand side of the world economy — the multiyear compression of the American consumer — is going to be ongoing,” he said. “This trend has only just begun.”

The ongoing retrenchment by American consumers makes it unlikely spending will return to pre-recession levels for many years. During the height of the lending boom, consumer spending surged to roughly 71 percent of gross domestic product — up from just 66 percent in 1990.

Since much of that spending was based on unsustainable borrowing, the post-recession economy will remain smaller until that shortfall can be made up from other sources of demand. With the rest of the world also in recession, at the moment, it’s hard to see where those other sources of demand will come from, analysts say.

The root cause of the recession — the collapse of the housing industry — shows no signs of letup. Prices fell by a record 18 percent in October 2008, according to the latest Standard & Poor’s Case-Shiller index, and analysts say prices could continue falling well into next year. A pickup in existing-home sales in December was due largely to homes being bought at cut-rate prices in foreclosure.

“In fact the downdraft is probably gaining steam,” said Michael Englund, chief economist with Action Economics. “We are assuming going into 2009 we may be seeing some bottom, but we certainly are not seeing any sign yet in any of the reported data.”

The homebuilding industry — a key driver of the economy — is suffering one of its worst downturns in history. On Thursday, the Commerce Department reported that the pace of new home sales fell to an annual rate of just 331,000. Even after dropping 76 percent from a peak pace of 1.38 million homes sold in July 2005, analysts say they don’t see a bottom yet.

“(New home) sales will continue to drop because of falling prices for existing homes, tighter credit and a deteriorating economy,” according to Patrick Newport, an economist with IHS Global Insight.

That deteriorating economy has also brought a massive wave of layoffs that also shows no signs of letup. The Labor Department reported Thursday that a record 4.85 million people were collecting regular unemployment benefits in the latest week. That doesn't include about 1.7 million people getting benefits through an extension passed last summer; that puts the total number of people on unemployment closer to 6.5 million. Millions more are working reduced hours or have exhausted jobless benefits.

All this has brought a sharp pullback in consumer spending — the lifeblood of the U.S. economy. To make matter worse, it appears that businesses are also cutting spending. Orders from the private sector for durable goods — from delivery vans to office computers — fell 5 percent in December. The fourth-quarter GDP report showed a 28 percent drop in business spending on equipment.

Until recently, the combination of a weak dollar and strong demand from overseas provided a big boost for exports, helping to blunt the falloff in consumer spending. But the recession has now gone global; U.S. exports fell by 20 percent in the last three months of 2008.

So the U.S. government has become the consumer of last resort. Congress and the White House spent this week scrambling to enact an $819 billion package of tax cuts and government spending on everything from repairing crumbling roads and bridges to aid to cash-strapped states facing jobs cuts if they don’t get help soon.

But pouring $800 billion into an economy will have only a limited impact without a healthy banking system. That has prompted the White House to ready a new plan to shore up banks battered by losses related to “toxic assets” backed by real estate and consumer loans. The latest proposal — setting up a giant, government-run “bad bank” to buy up these assets still faces the thorny question that stymied the original $700 billion Troubled Asset Relief Program: How do you decide how much the government should pay for assets that no one wants?

Despite general agreement that these investments will be worth something when the economic and credit markets recover, no one wants to buy them today, so there is no market price. The hope is that taking these bad assets off the banking industry’s books will spur more lending.

But the plan comes with two big risks. If the government pays too much, history will eventually record that taxpayer dollars were squandered in the biggest boondoggle ever. If the government pays too little, that price becomes a hard “market price” — which banks are required to use when they “mark to market” the value of these assets. That could bring a huge wave of writedowns that forces much of the banking industry into insolvency.

“We have consistently been wrong in valuing these assets,” said Joseph Stiglitz, a Nobel-winning Columbia University economist. “The private sector won't touch them with a 10-foot pole. If we had listened to these guys a few months ago and taken the assets off of their books then, we would not have had the massive losses that we're seeing in the banks' books today.”

Some economists say these two measures won’t work without a third critical component: government intervention in the housing market to stop the ongoing wave of foreclosures. Each new home lost puts further downward pressure on prices and puts a bigger damper on consumer spending.

Rep. Barney Frank, D-Mass., head of the House Financial Services Committee, has proposed devoting as much as $100 billion of the remaining TARP funds to slow foreclosures.

The hope is that with the banking system on a better footing and hundreds of billions of fresh government spending, the economy will begin to right itself in the second half of the year.

But even if it works, the plan likely won’t restart private-sector hiring until well into next year — typical of the “jobless recoveries” that have followed the last two recessions. Even after economic indicators begin turning upward again, business managers want to make sure the recovery is sustainable before bringing workers back on their payrolls.

Friday’s employment report — showing another half million jobs lost in December — confirms an already bleak outlook for the job market and adds urgency to President-elect Barack Obama's plan for a massive economic stimulus package.

But analysts say that even with fresh federal stimulus of $775 billion or more the job market probably won’t pick up again until early 2010.

The U.S. unemployment rate jumped to 7.2 percent in December, the highest since early 1993. For all of 2008, the economy lost a total of 2.6 million jobs. That was the most in one year since 1945, when nearly 2.8 million jobs were lost.

Some 1.9 million of those jobs were lost in just the last four months of the year.

"The situation is dire," Obama said during a news conference Friday to discuss additional appointments for his administration. He added that "this is the moment to act and act without delay."

The latest data show that virtually all sectors of the economy are being hit with job losses.

“In the last several months you can see that the job losses have spread sharply to the service economy, which tells you that the recession is rippling out into all parts of the economy — not just focused on production of durables,” said Joel Prakken, chairman of Macroeconomic Advisers, which jointly produces a private tally of jobs with payroll provider ADP.

As the pace of job losses has increased, so has the sense of urgency for a huge government spending package to get the economy back on track. Details are still sketchy, but in a speech Thursday Obama painted broad outlines of the kinds of programs he wants Congress to approve as part of his plan to “create or save” 3 million jobs.

The package would include tax cuts for individual and businesses, along with massive investments in energy, education, health care and infrastructure. Congressional leaders have said they hope to have the package ready by early February.

Local governments, small businesses, homeowners and other consumers could get additional financial aid from an ongoing overhaul of the $700 billion financial rescue program past by Congress last year. The program has come under attack from members of Congress who are critical of how the first half of the money was allocated and calling for changes that broaden its scope. Under the original program, congressional approval is needed before the second half can be spent.

No matter how much money is committed, the downward economic spiral will be difficult to break. Consumers — many who have been laid off or fear for their jobs — have pulled back on spending. That has cut into sales of goods and services, leading to a vicious cycle that results in yet more layoffs.

“Unfortunately, that’s the scenario we see ahead,” said Bernard Baumohl, chief global economist at The Economic Outlook Group in a note. “Even if Washington enacts and then implements the (economic stimulus) program fairly quickly, don’t expect any sharp rebound in job creation anytime soon. At best, we expect the economy to emerge from recession in the second half, but the recovery in employment will take longer.”

That outlook is shared by forecasters at the Federal Reserve.

“Amid the weaker outlook for economic activity over the next year, the unemployment rate (is) likely to rise significantly into 2010,” according to minutes of the Fed’s December meeting of policymakers released this week.

Most economists say they don’t expect hiring to pick up again until well after the economy begins to show clear signs of recovery. Until then, job losses from deteriorating sectors like commercial construction and retail sales are likely to outnumber any new jobs the Obama stimulus plan may create to rebuild roads or develop alternative energy technology.

“The bigger question (about the stimulus program) is not the direct job creation, but can the combination of monetary and fiscal policy shock the economy back to life, causing growth in private-sector jobs?” said Ethan Harris, co-head of U.S. economics research for Barclays Capital. “Our guess is that by the fourth quarter of this year, jobs will start to slowly recover, but there will be more than 2 million jobs lost between now and then.”

One of the cornerstones of the proposed stimulus package is a massive investment in public works projects. The hope is that projects that have already won approval — and are lacking only funding — can produce quick results. A report from the U.S. Conference of Mayors last month listed more than 11,000 so-called “shovel ready” projects in 427 cities.

But it remains to be seen what kind of guidelines would be used to move projects to the top of the list. Obama acknowledged those concerns in his speech, exhorting Congress to "put the urgent needs of our nation above our own narrow interests."

State governments — facing huge budget gaps as sales and property taxes have fallen — are also pressing Congress to include direct aid in any stimulus package

“Aid to state government is important for preserving jobs,” said Mark Zandi, chief economist for Moody's Economy.com. “If you don’t give aid, governments are going to cut all kinds of programs and have to lay off people as well.”

Savings those jobs also means preserving consumer spending and avoiding more defaults on mortgages, car loans and credit card bills. Zandi figures that every dollar spent on state aid would generate roughly $1.36 in benefit to the economy.

To further backstop state and local governments and avert budget meltdowns, Obama this week proposed having the Fed buy municipal bonds to help cut borrowing costs. The program would be similar to the Fed’s move last fall to buy commercial paper, which many companies rely on to manage their cash flow.

It’s not clear whether the stimulus package will be able to boost employment in the ailing housing industry. Dozens of homebuilders descended on Capitol Hill this week to lobby for mortgage subsidies and tax breaks for home buyers. The National Association of Realtors is also pressing Congress for relief to reverse heavy job losses in the brokerage industry.

Economists generally agree that a sustained economic recovery won’t be possible until the housing market stabilizes.

“The fact that housing prices have kept falling so dramatically is one of the reasons the financial system is not recovering," said Frederic Mishkin, a Columbia University economist and former Fed governor. “So steps along those lines — to either lower mortgage rates or increase demand for housing — should also be a part of this package. “

Rising unemployment is exacerbating the home foreclosure situation. A record one in 10 American mortgage holders was at least a month behind on payments or in foreclosure at the end of September, the latest month available. Credit Suisse predicted last month that more than 8 million foreclosures would occur over the next four years, representing 16 percent of all U.S. mortgages.

Congress is pushing to head off foreclosures on several fronts, including a measure to allow bankruptcy judges to modify loan terms on residential first mortgages. The measure, which was twice defeated during last year’s debate over a housing relief bill, got a major boost Thursday when Citigroup agreed to support it with some modifications, including a requirement that only existing mortgages qualify.

For the past quarter century, many individual investors followed a fairly simple investment strategy: set aside regular savings to invest, buy a diversified basket of holdings and ride out the occasional pullbacks by staying focused on very long term returns. That conventional wisdom generally paid off.

Now, with the stock market rallying after a crushing 40 percent decline last year, that strategy seems to be making a comeback. But there are very unconventional forces at work today that may derail that method.

After last year’s heart-stopping plunge, the stock market has gained about 25 percent since it bottomed in November. That stoked confidence among some investors and financial advisers that the worst may be over and investors who bailed out last year should now go bargain hunting.

“Stocks are cheap right now. There's a lot of cash on the sidelines, and earnings are washed out,” said Rob Morgan, a market strategist for Clermont Wealth Strategies. “We've got ingredients for positive things to happen.”

But there are also signs those traditional market signals may be flashing false positives. Here are five reasons to tread carefully.

The coming economic revival
The biggest force propping up stocks now is widespread confidence that the government is moving aggressively to revive the battered economy and credit markets. That confidence rests heavily on reports that the incoming Obama administration is readying a massive package of tax cuts and government spending to pull the economy out of its tailspin. Merrill Lynch economist David Rosenberg has dubbed the market’s recent market gain a “shovel-ready rally” — one that assumes the economy will get back on track by the middle of this year.

“The market may be focused less on the patient right now and more on the cure,” he wrote this week. “This, in turn, means that the doctors better come up with something that is going to turn the economy around.”

But the positive impact of the stimulus package is far from assured. Since last spring, the government has thrown $165 billion in stimulus and rebate checks at the economy, along with $350 billion to buy up bank assets — all on top of a $1 trillion-plus pump priming by the Federal Reserve, which also has pushed short-term interest rates to near zero.

So far, the results have been mixed. Consumers used their rebate checks to save or pay down debts, not spend. Banks have used their newfound billions to bolster battered balance sheets, not lend.

With most economists looking for those measures to begin working by the second half of the year, any delay in that recovery could spell big trouble for investors, according to Joe Battipaglia, a market strategist at Stifel Nicolaus.

“Investors can get very impatient — read that as they become very nervous — when the stimulative activity doesn't take hold, where the Federal Reserve has stayed at zero for a long period of time yet the private sector is still in contraction,” he said.

Fed to the rescue
As the market waits for Congress to act on more stimulus, the Fed has been aggressively pumping money into financial markets.

Investors have also been conditioned to believe that when the Fed floods the system with money, the market responds. Perhaps the most dramatic demonstration came following the Crash of 1987. Stocks dropped 508 points, or almost 23 percent, on Oct. 19, 1987. When word spread that the Fed had opened the financial sluice gates, stocks surged the very next day.

Since it began pumping money in September, the Fed hasn’t loosened up the gears of the economy. Businesses are still cutting jobs and consumers are keeping their wallets shut. Despite committing over $1 trillion, through a maze of lending programs unprecedented in the Fed's 96-year history, economic data continue to point to a steep decline.

“It's impossible given all the government intervention to really figure out what's going to happen this year and when bottoms of markets are going to take place,” said Doug Dachille, CEO of First Principles Capital Management.

Buy and hold
The conventional wisdom of modern investing also holds that investors who hang on during market pullbacks will be rewarded eventually. Bullish advisers are also quick to point out that the biggest gains often occur early in any rally, and that it can be difficult to see them coming. Until recently, market pullbacks were relatively short-lived, which helped support the “buy and hold” philosophy adopted by many long-term investors for a generation.

But over the years, that long-range approach has been less reliable. During protracted periods of economic breakdown, like the 1930s and 1970s, short-lived market rallies were followed by devastating pullbacks — leaving buy-and-holders with negligible gains. That kind of market calls for an entirely different set of investing skills, according to Tobias Levkovich, chief U.S. equity strategist at Citigroup.

"You can get very significant rallies, but investors who stick with a buy-and-hold strategy are probably not going to be the winners,” he said. “It's people who can trade more effectively."

Cracked nest eggs
The bull market that began in 1982 was fueled in part by a dramatic shift in retirement savings after the creation of individual retirement accounts like company-sponsored 401(k) plans. Most participants who opted to make regular contributions followed the “buy and hold” strategy,  making relatively few changes to their holdings. That steady stream of cash helped the stock market produce one of its strongest 25-year gains in history. More recently, the popularity of 529 college savings plans have created a new pool of savings that flowed into stocks.

But last year's historic stock market pullback — the worst annual performance since 1931 — may have soured some of those investors to stocks for a long time.  Investors who are near retirement age have limited time to bear additional losses. Some 36 percent of Americans 45 and older say they’ve stopped putting money into a 401(k), IRA or other retirement account — up from 20 percent in October, according to a recent survey from AARP.

Younger investors who are starting to build retirement accounts may think twice before investing heavily in stocks after seeing the recent losses.

And as more baby boomers reach retirement age, they will become sellers of stocks. Many of them are saying they already lost a large portion of their retirement savings and will have to work harder to make ends meet with what they have left.

“We don't know if we will live long enough to see any recovery,” wrote one msnbc.com reader from Pennsylvania. “I guess the only answer to our dilemma is to die 10 years sooner than we had expected.  Or perhaps us old folks can get a job as Wal-Mart greeters.”

Are stocks really 'cheap'?
One of the most compelling arguments for putting savings into stocks today is that they are “cheap” by historical standards. Indeed, with the Standard and Poor’s 500 index marked down roughly 40 percent since it peaked in October 2007, stock prices look almost as cheap as this year’s post-holiday closeouts at the mall.

But that assumes investors will continue to value stocks roughly the same way they’ve done for the past 25 years. One of the simplest ways to judge how much a stock is worth is to look at the underlying company’s profits.

Based on one of the most widely followed measures, the ratio of stock prices to earnings for the S&P 500 stood at about 15 at the end of the third quarter, the latest available earnings. That’s near the average price-earnings ratios tracked by S&P since 1936. So the conventional wisdom argues that as the economy recovers next year and companies begin posting higher profits, stock prices should follow.

But that scenario assumes investors will continue to pay the same price for each dollar of earnings that they’ve a paid for the past 25 years. During that period, the p-e ratio for the S&P 500 has ranged between 10 and 46 (during the height of the tech bubble) and it averaged over 21 (higher than the long-term norm).

Since 1936, the stock market has traded for extended periods at a p-e ratio well below the long-term average of 15.7, however. From January 1977 until September 1982, for example, the S&P 500 never traded above 10 times earnings, and the average for that period was 8.3.

Analysts surveyed by S&P currently expect that multiple to continue to fall next year — to 12.8 times earnings. If the economy were to hit another prolonged bad patch like the 1970s, and that price multiple continues to fall, it could be some time before the stock market finds a bottom.

As Congress and the incoming Obama administration work out the details of a massive economic stimulus plan, some readers are asking: Where is all this money going to come from? How long can we keep up with all this borrowing? And why should my tax dollars be spent to clean up the mess made by other people’s mistakes?

Just how long can the U.S. government sustain all this borrowing and spending? First of all, basic revenues and expenditures are out of balance, generating the large annual federal deficit. Now, we have one or more bailout programs, plus a stimulus package or two; and on top of all that, all the governors want a $1 trillion bailout. How long can this go on?
— Tom Kwiat, Address withheld

The only honest answer: No one knows. For the past few decades, a number of economists, analysts and a few members of Congress have been pressing to balance the federal budget; some have called it a national security issue. During that period, the U.S. economy enjoyed one of its longest economic expansions in history — interrupted by two relatively mild recessions. The takeaway for some: Rising national debt isn’t a problem as long as the economy keeps growing at roughly the same pace.

Proponents of this idea argue that the overall level of debt is less important than its relationship to the size of the U.S. economy. If you’re carrying a $5,000 credit card balance with an annual income of $30,000, your debt load is going to ease considerably if you get a new job that pays $60,000. In fact, you could then double your debt and carry the same load on a percentage basis.

Today, the U.S. national debt is about two-thirds of its gross domestic product. We’ve seen much higher: During World War II, the debt hit 120 percent of GDP.

But when the war was over, defense spending plunged and the economy surged, bringing the ratio back down to 60 percent by the early 1950s. That’s about where it was in the late 1980s and early 1990s before concerted efforts by Congress and the White House balanced the budget and cut that ratio below 60 percent. In the past eight years, heavy tax cuts and spending on the war and prescription drug benefits pushed the percentage back to the mid-60s.

That ration is almost certainly headed higher. On top of the ongoing, multibillion-dollar shortfall between taxes and spending for government services, the congressionally approved bank bailout program will add at least $700 billion to the debt. Now Congress and the White House are considering a plan that would add another $675 billion to $775 billion in relatively short order. That would push the overall national debt closer to 85 percent of GDP.

The gamble is that the economy will begin growing again and the government will recoup some of the borrowed money by selling off assets it is buying in the bank bailout program, bringing the debt-to-GDP level back down to (roughly) currently levels.

Even if the bet pays off, there’s a real risk of nasty side effects. For starters, there’s only a certain amount of hard money (savings and investment) around the world for Uncle Sam to borrow. As the U.S. soaks up this cash, there’s less money for businesses to borrow and grow or for homeowners to buy houses. That forces interest rates higher — reversing the stimulus effect the Federal Reserve is trying to engineer with lower rates.

Churning out more debt also increases the amount of dollar-based investments flowing through the global financial system. It’s not exactly the same as printing dollars, but the effect is similar. As the global system is flooded with dollars — and investors start wondering how Uncle Sam is going to pay all this back — the value of the dollar falls.

If it falls a little, that’s not a bad thing — it helps U.S. exporters sell goods overseas. But if the value of the dollar falls too far, so does its purchasing power — even if demand for goods and services remains sluggish during a recession. That’s where inflation comes in. And if you have inflation in a recession, you get stagflation, the disease that left the U.S. economy and stock market in ruins throughout most of the 1970s.

Even if policymakers manage to navigate successfully through the current recession and the trillions in new debt bring the desired economic recovery, this is not a great time to raise the level of debt relative to GDP.

That’s because another multitrillion-dollar bill is coming due — no matter how well the economy recovers. As baby boomers retire and begin making claims on the Social Security and Medicare systems, the government will be forced to borrow heavily to meet those obligations. Unlike the surge that sent debt levels above GDP during World War II, that level of borrowing for decades of Social Security and Medicare payments just isn’t sustainable.

As the problem comes into clearer focus over the coming years, it could get more difficult to convince the rest of the world to lend their money to the U.S. Treasury.

Why should those of us who purchased cars and homes based on our budget have to help out the builders, lenders and people who made commitments they obviously could not afford?
— Don W., Hesperia, Calif.

Because if we don’t, we won’t have an economy to produce more homes and cars for our kids.

No matter who you think is to blame, no matter what you think about the importance of letting businesses and people fail, we’re past the point where that debate matters much. There will plenty of time for that later — after the economy is stabilized. At the moment, there are few signs that’s happening.

The hope is that the government’s massive intervention can break a downward spiral that shows no signs of letting up in the short term. Falling house and stock prices have destroyed trillions of dollars of wealth, which has forced companies and consumers to cut back. Those job losses have further cut into spending and home buying, which is bringing more layoffs.

So far, trillions of dollars have been dropped on the economy by the Federal Reserve. The Treasury has pumped $350 billion in taxpayer funds into the banking system. And Congress and the incoming Obama administration are prepping a massive spending package to fill in the gap created by the shutdown of consumer spending.

In the midst of all this, we’re getting a bonus: Crashing oil prices have slashed prices at the gas pump. That’s freed up an estimated $250 billion in consumer spending power. Every hundred billion helps.

This flood of money will take time to work its way through the system; some of these programs will work more quickly than others. The Fed’s effort to push mortgage rates lower is barely under way, and rates already have fallen sharply. On the other hand, there’s evidence that banks are hanging on to much of the money they have received.

It all goes well, these measures should begin to have the desired impact by the middle of next year. A lot, though, can go wrong.

On top of the list is a new surge in foreclosures that is just now getting under way and expected to continue through next year unless something can be done to prevent it. As long as lenders keep dumping houses on the market at distressed prices, more home equity will be destroyed for all homeowners, spending will continue to shrink, jobs will be lost and the economy will remain in its downward spiral.

The collapse of the housing market showed no signs of easing in November as sales of new and existing homes plunged and prices took their biggest hit on record.

Despite aggressive government efforts to lower mortgage rates, other forces appear to be weighing on the market and prolonging one of the nation’s deepest housing downturns ever.

As the housing-led recession deepens, job loss worries have pushed many potential buyers out of the market. And the relentless pace of foreclosures increases the glut of unsold homes and pushes prices lower, as lenders price them aggressively to get them off their books.

“I’ve never seen a broad-based falloff in home sales like this in tracking the market in 24 years,” said Thomas Lawler, who follows the housing market at Lawler Economic and Housing Consulting. “It’s just horrendous.”

Sales of existing homes fell 8.6 percent, far more than the 1.6 percent drop expected, to an annual rate of 4.49 million in November — the slowest pace in more than 17 years. The median sales price fell by 13.2 percent from a year ago, the largest in the 40 years records have been kept, to $181,300. The price drop was probably the largest since the Great Depression, said Lawrence Yun, chief economist for the National Association of Realtors.

The steep drop in prices, combined with a recent plunge in mortgage rates, has made housing more affordable than it’s been in years. But those forces so far have not been powerful enough to spark a housing rebound.

“The real problem, to me, is the employment outlook for a lot of these would-be home buyers sitting there questioning whether or not they want to commit given the uncertainty in the economic environment,” said Steve Ricchiuto, chief economist at Mizuho Securities. “And whether they will continue to have their jobs or even if their spouses will continue to have their job going forward.”

The job market shows little sign of improving soon. In a separate report, the Commerce Department Tuesday confirmed that the nation's gross domestic product shrank by a half-percent in the third quarter. Private forecasters such as IHS Global Insight estimate that GDP will fall at a 6 percent rate in the current quarter and 4 percent in the first quarter of 2009, with a smaller contraction coming in the second quarter.

“(The economy) will get a lot worse before it gets better,” said Nariman Behravesh, chief economist at IHS Global Insight. “Assuming that the incoming Obama administration does enact an $850 billion fiscal stimulus package quickly, it will do little to stop real GDP growth from dropping like a stone in the first half of 2009, but could help to turn things around in the second half and provide a basis for sustained growth in 2010.”

Even among those would-be home buyers who still have a job, the pool of qualified borrowers is substantially smaller than it was just a year ago. Banks have learned from the mistake of lending to people who can't afford to pay back their mortgages and have gotten extremely choosy about who they approve for a new mortgage.

“That's a big issue right now — getting the 4.5 percent (mortgage) rate that’s out there,” said David Goldberg, a housing industry analyst at UBS. ”You have to have pristine credit, and not that many buyers do in terms of the marginal buyer who needs to come into the market. That’s a big problem for builders right now."

Home builders have slashed the pace of housing starts, and construction has slowed to a crawl. Yet the inventory of unsold homes remains at historic highs as lenders dump more foreclosed homes on the market. More than a year of public and private efforts to help keep people in their homes still hasn't slowed the pace of foreclosures.

More troubling are recent signs that even some homeowners who succeed in convincing their lender to rework their loans eventually lose their homes anyway. In some parts of the country as many as half of those homeowners who rework their loans eventually “redefault” on their loans.

“When you see the data and you see the total amount of redefaults going up each month by whatever measure we use, it's clear that something is not working right,” said John Dugan, the comptroller of the currency, whose office regulates federally chartered commercial banks. "I don't think we've seen the worst yet, because we're going into a worse economy.”

For now, the government’s primary strategy for boosting the housing market has been a massive effort by the Federal Reserve to lower interest rates. At its latest meeting, policymakers said they had let a key short-term rate fall to zero and would try to force down rates on mortgages and other long-term loans.

The Fed's announcement of its policy shift helped push mortgage rates to their lowest level in 37 years. That has sparked a refinancing rush by existing homebuyers looking to lower their monthly payments. But many homeowners with unaffordable loans can’t refinance because they are stuck with hefty “prepayment” penalties on their old loans or because they don’t qualify under now-stricter lending standards.

Some analysts doubt that low mortgage rates alone will be enough to get housing sales moving again among new buyers.

Lenders are looking for substantially bigger down payments, especially in areas of the country where home prices are higher than the limits for FHA-backed loans, which allow low down payments. The historical requirement that a borrower put down 20 percent of the purchase price — widely abandoned during the housing bubble — is returning. That’s forcing many would-be first-time buyers to the sidelines until they can save up that down payment.

To help spur sales, the battered home building industry is pressing Congress to provide relief in the Obama administration's promised economic stimulus package. The industry proposal, called Fix Housing First, would include a move to offer mortgages at 3 percent interest and provide a $22,000 tax credit to help buyers come up with a down payment.

The latest call for the proposal came from Ara Hovnanian, CEO of Hovnanian Enterprises, one of the nation’s largest homebuilders. Last week, the company reported a 48 percent drop in revenues from a year ago for the latest quarter, due to falling home prices and lower sales. More than 40 percent of buyers who signed contracts during the quarter walked away from the deal amid growing concerns over the economy and rising unemployment, the company said. Hovnanian has cut its work force by 65 percent since the peak in 2006, and said more reductions could be ahead if home sales continue to decline.

"Declining home prices are what caused much of the financial and economic turmoil that we are faced with today," Hovnanian told Wall Street analysts on a conference call to discuss the company's latest financial results. "If the government wants to enact a stimulus policy that will get to the root cause of the problem, they need to fix housing first."

Unemployment is soaring, consumer spending is shrinking and both the stock and housing markets are on track for one of their worst years on record. As 2008 comes to a close, the economic outlook for the coming year is pretty grim.

But a panel of economists surveyed by msnbc.com says that — maybe, if all goes well — we could be closer to the end of this recession than the beginning. Now 12 months into a downturn that appears to be deepening, there are early signs that the elements may be coming into place for a convincing recovery. That “best case” forecast calls for the worst of the downturn easing by the middle of next year, with slow but steady growth in the second half of 2009.

“We do have a number of forces that could come together to produce what could be a fairly strong recovery,” said Nariman Behravesh, chief economist at Global Insight.

One of the major forces pushing the economy back on a growth track is a historic series of moves by the Federal Reserve to pump trillions of dollars into the financial system. Another is the huge package of tax cuts and government spending — some believe it could approach $1 trillion — that the incoming Obama administration could have in place by early next year. And the recent plunge in oil prices has provided what amounts to a $250 billion-a-year rebate for consumers who have sharply reined in spending.

“All this put together is massive,” said Behravesh. “So there is now the distinct possibility — if the timing is right — it could all hit at the latest in the second half of the year, and you could actually have a real pop in growth.”

To be sure, the ongoing recession — even in the best case — could go down as one of the worst since the Great Depression. Even if a recovery arrives in mid-2009, job growth will likely lag even as the gross domestic product begins expanding again. And it could take years to repair  damage to the financial system and impose regulations to prevent another meltdown.

But as historic as the financial panic and recession turn out to be, the government’s response has been unprecedented.

Since the crisis began in September, the Federal Reserve has let interest rates fall to near zero and announced a variety of measures to flood the economy with cash, trying to fill the void left by the collapse of the credit bubble. The idea is to take the pressure off the battered balance sheets of American companies, banks and households.

The Fed’s efforts have been bolstered by an allocation of $700 billion in taxpayer funds, about half of which has been committed through the Treasury's Troubled Asset Relief Program to help banks, insurance giant AIG and automakers.  Though some lawmakers who authorized the program have been frustrated with the continued sluggish pace of private lending, rates have fallen and there are signs the credit markets are beginning to thaw. Last week, 30-year mortgage rates fell to their lowest levels since 1971.

With the benchmark overnight lending rate already near zero, the Fed has pledged to keep pumping cash into the financial system and “employ all available tools” to get the economy growing again.

Getting those trillions of dollars into the hands of consumers and businesses takes time. But as the wave of cash begins to filter down over the next six months, the result could be “an abrupt reversal in conditions by the end of the new year,” according to Mike Englund at Action Economics.

“We have yet to benefit from the effects of TARP investments and Fed efforts to take private sector debt onto the public balance sheet,” he said. “And the new administration may be planning a massive stimulus package of as much as $1 trillion that could hit just as the economy is actually already bouncing.”

Though most of our panelists expect a return to growth in the second half of 2009, there’s less certainty about how strong that recovery will be.

“I think confidence returns by the summer and growth rebounds sharply by year's end,” said Joel Naroff of Naroff Economic Advisors. “I don't believe the economy can get out of this mess by growing slowly and steadily. We need a sharp increase in growth to keep both the financial and real estate sectors of the economy from cratering.”

That sharp increase in growth could be fueled by a pent-up demand, especially for housing. With so many buyers sitting on the sidelines for so long, a clear sign of a bottom in housing prices — along with substantially lowered mortgage rates — could spark brisk demand for housing and revive the moribund homebuilding industry.

Those low rates won't help the millions of homeowners facing foreclosure who are stuck in unaffordable mortgages with onerous "prepayment" penalties; without additional government relief, more than three million more homeowners are expected lose their homes in the next two years. The glut of empty houses could postpone a housing recovery until well into 2010.

But if that foreclosure wave can be stopped, a return to more normal levels of home buying would help spur demand for a variety of other products — from building materials to home furnishings and appliances.

“With massive monetary and fiscal stimulus and a big plunge in energy prices, the U.S. economy may be like a rusty gate: unable to turn in the short run, but then swinging wide open in the second half (of 2009),” said Ethan Harris, co-head of U.S. economics research at Barclays Capital. “Remember, in a normal recovery from a big recession, growth is above 5 percent for a year or so. That sounds like fantasy stuff from where we sit today, but it is possible.”

Economists on the msnbc.com panel were less optimistic about a recovery in the job market. All 12 expect the unemployment rate to end 2009 substantially higher than the current 6.7 percent rate; some see unemployment at 9 percent a year from now.

That pattern follows the performance of the job market in the last two recessions, including the so-called “jobless” recovery after the 1991 recession and the “job loss” recovery of 2001, when the unemployment rate didn’t peak until nearly two years after the economy pulled out of its millennial slump.

“This relates to the intense pressure that a lot of businesses are under to remain competitive and improve productivity,” said Behravesh. “So I think it could very well be that this time around as well we will see job growth lagging the recovery in a significant way."

For the first time in its history, the Federal Reserve has set a target for short term interest rates as low as zero percent. The moves signals that the central bank has entered a new phase in its campaign to revive a battered U.S. economy. Here's what the Fed is up to:

No. Pushing the federal funds rate down to zero doesn’t mean everything comes with zero-percent financing. It means banks can now raise cash — for very short periods — without paying interest.

Think of the Fed's target as the wholesale price of money. Banks and other lenders will still charge more than zero interest when they lend it to you and me. That’s how banks make money. But borrowers with very good credit will be able to get a great deal on a short-term loan.

The problem is that with the economy shrinking, businesses cutting back and banks worried about getting their money back, lenders have become stingier about providing credit. To get the economy moving again, the Fed typically cuts the cost of money to encourage more borrowing.

Not exactly. Short-term interest rates already had fallen below the Fed’s latest 1 percent target before Tuesday's move cutting that target to a range of zero to 0.25 percent. The Fed normally achieves its target by buying and selling Treasury securities to move cash in or out of the financial system.

But short-term interest rates have been falling sharply since the financial markets went into a tailspin in September. With Tuesday’s announcement the Fed was essentially acknowledging that it can’t control interest rates any more.

In a full-blown global market panic, investors around the world have dumped other holdings — from stocks to corporate bonds — and stampeded into U.S. Treasury securities. That’s because, despite the turmoil in the U.S. economy and heavy borrowing by Uncle Sam, Treasury debt is still considered the safest place to stash cash.

Like all debt securities, the interest rate on Treasuries moves lower as demand pushes up the price.

Demand has been so strong, in fact, that at times the return on short-term Treasuries has gone negative — meaning investors are so afraid of the financial markets that they’re willing to lose a little money just to make sure they got most of it back.

That’s what happens when so many investors want to buy debt from the Treasury — in effect, lend it money — that they’re willing to take a little less when the debt matures.

Besides, when you’re talking about the real cost of borrowing, you can't just look at the nominal interest rate — the sticker price, if you will. Instead, you have to factor in the future spending power of the money you’re borrowing.

In normal circumstances, the spending power of cash is gradually eroded by inflation. So if you’re paying 4 percent interest on a loan when inflation is running at 2 percent, your true borrowing cost is only 2 percent — because you’re paying off the debt with money that has lost 2 percent of its spending power.

Last year, when inflation was running at 4 percent, and the Fed targeted short-term rates at 5.25 percent, that meant the real cost of short-term borrowing for banks was about 1.25 percent. Since then, the Fed has been cutting rates and, more recently, inflation has been coming down. That means the normal impact of rate cuts — spurring lending and getting the economy growing — has been less pronounced.

It means that it'll still cost you something to borrow, even if the sticker price of short-term borrowing fall to to zero. That's what happens when inflation — a steady rise in prices — turns to deflation and prices keep falling.

With the threat of inflation gone for the moment, the Fed is now worried that deflation may take hold. Deflation turns everything upside down; instead of losing spending power, your money is worth more as prices fall. If that keeps up, people postpone purchases to get a better price; companies sell less stuff and have to cut production and lay off workers, those workers can’t buy stuff, and the cycle continues.

It also makes it more expensive to borrow because you’re paying back your debt with dollars that are worth more than they were when you borrowed them. If prices continue falling at 1.7 percent — and interest rates are at zero — the true cost of borrowing is 1.7 percent. That works against the Fed’s efforts to make borrowing cheaper and get the economy moving again.

It shifts gears. Plan B involves flooding the economy with trillions of dollars in cash, which the Fed began doing in September. Through a variety of special “facilities” the Fed has been buying up debt that no one else wants to buy. It’s already bought more than $1 trillion worth and says it plans to buy more.

This is called “quantitative easing.” It means the Fed makes money easier to get by providing it in vast quantities. The hope is that now that battered banks have been pulling back from the aggressive lending that got us into this mess, all this money sloshing around in the system will find its way into the hands of businesses and consumers that are having trouble getting loans.

The honest answer: No one knows. The last time anything like this was tried, Japan’s central bank cut its short-term target rate to zero for five years — from 2001 to 2006 — to fight a nasty bout of deflation that was touched off in the 1990s by a collapse in real estate prices.

The prolonged recession in Japan has been called the Lost Decade. Most economists believe the Fed’s aggressive policy to flood the U.S. economy with money will help get the economy back on track by sometime next year. There’s a significant lag effect in any Fed move.

But we won’t know for some time whether the zero interest rate policy — combined with quantitative easing — will be enough to do the trick.

The Federal Reserve's decision to cut its target for short-term interest rates to as low as zero reflects the reality of a central bank scrambling to apply a new  set of monetary tools to battle the deepening recession.

“These are extraordinary times that call for extraordinary measures,” said Robert McTeer, former president of the Dallas Federal Reserve Bank.

In an unprecedented move, Fed Chairman Ben Bernanke and his colleagues Tuesday set a new target range for overnight lending between banks at zero to 0.25 percent, down from the previous target of 1 percent.

The decision was just one of several bold and unexpected steps announced by the Fed. In an unusually extensive statement, the central bank acknowledged that the weakening economy called for an expanded range of responses and pledged to use “all available tools” to get growth back on track.

Those tools include an aggressive buying spree of public and private debt securities that the central bank began in September. The Fed reiterated Tuesday that it intends to buy “large quantities of agency debt and mortgage-backed securities” and announced that it is considering buying longer-term Treasury securities. In addition the Fed will consider other “ways of using its balance sheet to further support credit markets and economic activity.”

Over the past three months of financial crisis, the Fed has unveiled an alphabet soup of new programs — from the Term Auction Facility to the Commercial Paper Funding Facility — with one common goal: buying up debts that no one else wants and swapping them for cash.

Those efforts to flood the financial system with cash have been far more important than the rate-setting that is usually the Fed's most effective tool. The Fed's decision to announce a target range of zero to 0.25 percent is an acknowledgement that the central bank has been unable to meet its stated target rate through normal purchase and sale of Treasuries in the open market.

Although the Fed has had a target of 1 percent since Oct. 29, the actual market-based rate has fallen as low as 0.125 percent in recent weeks due to slack demand for short-term borrowing.

With short-term interest rates effectively at zero, the Fed can do little more to lower the cost of borrowing. The hope is that by pumping trillions of dollars of cash into the credit system by buying up securities, that money will find its way into the hands of cash-strapped consumers and businesses to help revive the economy.

With more than a half million jobs lost in November alone, the government provided fresh data Tuesday on just how much deeper the recession has become.

Shrinking demand sent consumer prices last month on their biggest slide since records were first kept 61 years ago, the Labor Department reported. Prices fell 1.7 percent, due largely to the deep slide in energy costs.

In a separate report, the Commerce Department reported that construction of new homes fell in November by 18.9 percent, the biggest drop in a quarter-century. The decline pushed construction down to a seasonally adjusted annual rate of 625,000 homes, the slowest pace on records dating to 1959.

Now as banks, companies and consumers all struggle to pay down a mountain of debt taken on during the easy-money years of the first half of the decade, spending and investment have slowed to a crawl and new credit has dried up. To fill the hole created by that huge private sector debt, the Fed is now taking unprecedented levels of debt onto its own books, and swapping that debt for cash to try to get money flowing normally again through the financial system.

“We're in a change in regime in terms of policy, where the focus is switching away from the federal funds rate to other actions the Fed can take with its balance sheet to improve financial conditions and encourage the flow of credit,” said former Fed Gov. Laurence Meyer, now vice chairman of Macroeconomic Advisers.

With short-term interest rates already close to zero, the Fed has been moving to a strategy known as “quantitative easing” — essentially dumping money into the economy to make credit easier to get. Early in his tenure as a board member, Fed Chairman Ben Bernanke described the policy by likening it to dropping money from a helicopter, a speech that earned him the nickname “Helicopter Ben.”

“The (target interest) rate is the least important issue right now,” said Diane Swonk, chief financial officer of Mesirow Financial. “It will be the alternative actions — the helicopter in the sky and how much money they're going to drop from the helicopter.”

Those helicopter drops aren’t being announced with the same fanfare as the Fed’s changes interest rate policy. But they’ve been showing up in the weekly statistics the central bank provides on its balance sheet, the accounting of overall assets and liabilities.

Since the beginning of September, the Fed’s books have swollen as it has been buying debt assets from banks and corporations — paying cash in an effort to pump more money into the system. In the past three months, the Fed’s balance sheet has jumped to $2.3 trillion after holding steady for almost a year at about $900 billion.

The central bank is also shifting its emphasis on the kinds of debts it is buying. Under normal circumstances, the Fed’s so-called “open market operations” involve buying and selling U.S. Treasuries to fine tune the rate charged on short-term loans.

But the global financial meltdown has already sent private buyers stampeding to buy Treasuries, pushing rates to zero as investors seek the safety of securities backed by the U.S. government. (For brief periods, the rate on short-term Treasuries has fallen below zero, as investors accept a slight loss in return for the assurance they’ll get their money back.)

As a result, the Fed has turned to buying other kinds of debt securities, including the so-called “commercial paper” that companies and banks sell to fund their borrowing. Last month, the Fed announced it would buy $600 billion in debt and mortgage-backed securities from mortgage giants Fannie Mae and Freddie Mac. With investors shying away from mortgage-backed debt, the Fed is hoping to supply more cash to that market to try to push mortgage rates lower.

“it's beginning to matter more what the Fed buys to expand money and liquidity than how much is expanded,” said McTeer. “They've started buying other than Treasury bills to unfreeze some of these markets.”

With the economy shrinking and unemployment rising rapidly, the Fed’s move to flood the system with money will take time to have an effect. Economists expect the economy to continue to shrink at least through the middle of next year, if all goes well.

Those forecasts also anticipate another major spending program by the government to stimulate the economy.  President-elect Obama’s transition team is already working with Congress on a spending package that could approach $1 trillion, according to published reports.

“It is critical that the other branches of government step up,” Obama told reporters at a news conference Tuesday.

Under normal circumstances, this flood of government spending and asset purchases by the Fed would pose a major risk of inflation. Economists say that long-term threat is very real. But for the moment, the ongoing drop in prices of assets like housing and stocks to commodities like gasoline has pushed that inflation risk into the future.

Falling prices have also helped ease the credit burden on consumers. The sharp drop in energy prices — gasoline prices have dropped 87 percent in the past three months — has boosted consumers’ spending power buy about $130 billion, according to RDQ chief economist John Ryding.

“We’ve had a huge tax cut,” said Stuart Hoffman, Chief Economist at PNC Financial. “The catch is you've got to have a job.”

Though falling prices boost consumers' spending power, a continued slide, known as deflation, can be even more damaging to the economy. Once deflation takes hold, consumers delay purchases, companies adjust to lower demand by slowing production and cutting jobs, which causes consumers to scale back spending even more. The downward spiral feeds on itself.

The Fed is hoping to prevent that from happening by “inflating” the economy with its multi-trillion-dollar buyback of debt. But as the economy recovers, the Fed’s new strategy of “quantitative easing” will pose a new set of challenges.

At some point, once the economy begins to recover, the Fed will face yet another monumental challenge: how to drain trillions of dollars of excess cash from the economy to avoid a new bout of inflation or another credit bubble. If it starts draining money too soon, it risks throwing the economy into another slide. That means the Fed’s outsized role in managing the economy with its new strategy will likely remain in place for some time to come, according to Credit Suisse chief economist Neil Soss.

“There is no exit strategy from this entanglement, anywhere,” he wrote in a note to clients this week.

With the recession deepening, more than a few readers are offering suggestions on how to end it. Many are wondering: Why doesn't the government just give this bailout money directly to consumers? We think there's another solution the government has overlooked.

The way things are going, it might just yet. But it wouldn’t come without a cost. And it wouldn’t attack what we see as a very basic problem that the government responses have so far overlooked.

Friday’s report on employment, showing that a half-million jobs were lost — *poof* — in 30 days is a strong sign we’re entered yet another dangerous phase of economic decline. Economists who’ve been following the data for decades — and at least one journalist who has been writing about the economy for 25 years — are having a hard time comparing this recession to any in memory. If, as many forecasters are now predicting, the current recession lasts into the middle of next year, it will be the longest since the Great Depression (which was officially two recessions — one that started in August 1929 and lasted 43 months and another one that started in May, 1937 and lasted 13 months.)

Some economists are comparing what we’re in now to the recession of the early 1980s, which came on fast and hard. The recovery, when it came, was also pretty fast because the recession was, in fact, engineered by the government. It was a bit like getting knocked out before major surgery — when the anesthesia wears off, with any luck, you wake right up. A little groggy, maybe, but it's pretty quick.

The 1980-82 recession was actually two separate downturns, each brought about by the Paul Volcker Fed to kill a decade of 1970s inflation once and for all. In 1980, the Fed jacked up rates to double digits and held them there for a bit. Kind of like a teacher trying to break up a schoolyard fight.

But when the Fed let go, the kids keep on fighting — inflation shot right back up. So the Fed jacked up rates again — this time rates to 20 percent. Bond traders' phones stopped ringing; some just put in a half day and went to the movies.

When the Fed finally cut rates sharply in 1982, inflation stayed low. Hiring picked up and the stock market began one of the biggest bull runs in history. Ronald Reagan declared Morning in America and reappointed Volcker, who was a national hero. In another era, they would have thrown him a parade.

This recession is different: It’s a structural problem. The credit market is badly damaged because it's clogged with bonds backed by mortgages that are failing. Without a functioning credit system the economy can’t grow for long. If credit shut down altogether, you'd have to go back to a 19th century barter system (“Will write columns for food”).

Handing out checks was one of the first things the government tried, and it’s not a bad idea. You’re right that putting money directly into consumers' hands would help stimulate the economy if they went out and spent it. After all, two-thirds of the U.S. Gross Domestic Product comes from of consumer spending.

Suspending taxes altogether would do the same thing: Put money back in consumers’ pockets. It would carry a huge price tag, however. To keep the government functioning, the Treasury would have to borrow even more billions to replace those lost taxes. The interest on that debt alone would be another cost the government would have to bear — likely by raising taxes down the road.

Unfortunately, the first stimulus package didn't exactly go according to plan. Consumers didn’t spend their rebate checks. Mostly they paid down debt or put the money into savings. Those who did spend it used a lot of it to pay for higher gasoline prices, which means we sent a lot of the tax rebate to oil producers outside the U.S., creating little benefit to the U.S. economy.

That’s why the Fed and the Treasury have been focused on rebuilding the banks by pumping hundreds of billions of dollars into the system. The hope was that banks would start offering credit again, and we’d pull ourselves out of a slump before the recession deepened.

The problem is that banks — just like the consumers who stashed away their checkbooks — have taken the money and used it to shore up their books to ride out the storm. Credit is still hard to get.

So it’s time to try something else, and there’s an obvious place to turn: the rising pace of mortgage defaults and foreclosures. Policy makers have been debating this for a year, but so far no one has gotten serious about cleaning up the mess made by years of rogue lending and irresponsible borrowing.

As long as home prices continue falling, you can’t get the economy moving again. Consumers watching hundreds of billions of dollars in of home equity disappear aren't going to start spending until they see the bleeding has stopped. And until you put a floor under house prices, you can’t put a floor under the value of all the bad debt backed by the mortgages on those houses. That mortgage-backed debt is what’s clogging the credit system.

This is all widely recognized and accepted by most responsible economists, and the Fed has recently come around to focusing on the problem. For over a year, the government has relied on lenders to work out bad mortgages voluntarily; so far progress has been painfully slow. It’s time to try Plan B: Let bankruptcy judges modify loan terms from the bench. It’s the only form of consumer debt that currently off limits.

With that restriction lifted, homeowners probably wouldn’t even need to file for bankruptcy. The risk that a judge might offer a lender a lousy deal would likely prompt them to negotiate more aggressively on their own with homeowners trying to get out from loans with ruinous terms.

Some homeowners, of course, can’t afford their homes even with more favorable mortgage terms. If so, the bankruptcy judge could order the home sold. That’s the kind of decision a judge — not a lender — should be making.

Instead, the government’s latest “housing relief” plan would use government money to push mortgage rates down to 4.5 percent, but only for new buyers. If you’re stuck in one of the bad loans Wall Street sold you, tough luck. The best you can do is cut your losses, take a hit and sell your house. The creditworthy buyer who gets to move into your house — or buy it and rent it back to you — will do so with a subsidy paid for with your taxes.

Not exactly what the American Dream was supposed to be all about.

A recent email reached my inbox that I’m trying to determine is true or not. The first bailout was I believe $750 billion dollars to the banks to cover mortgage loans. What I got were some numbers to the effect that if you took then entire legal U.S population over the age of 18 and divided it by $750 billion you would find that the government could have given everyone about $250,000. I guess my question is would this not have helped the economy much more than bailing the banks out or would it have caused a major inflation crisis?
— Kevin W., Address withheld

This is a good example of what you might call Internet math. Kind of like those mailings that claim to be able to wipe out debt for free.

The US Census estimates there were about 185 million adults in the U.S. in 2007. If you divide $750 billion by 185 million, you get $4,054.05.

Don’t spend it all in one place.

Friday’s report showing the biggest monthly job loss in 34 years confirmed forecasters' worst fears that the decline in the U.S. economy accelerated in November, after the financial system seized up and consumers hunkered down. As the government scrambles to break the downward spiral, some economists are predicting the unemployment rate is headed substantially higher through next year.

Since the start of the recession in December 2007, the economy has lost 1.9 million jobs, lifting the number of Americans out of work to 2.7 million. At 6.7 percent, the jobless rate has now risen 2.3 percentage points since it bottomed in March 2007.

Most sectors of the economy are now losing jobs, including manufacturing, construction, financial firms, retailers, and the leisure and hospitality industries. Only government, education and health services managed to post job gains.

Friday’s report also slashed another 200,000 jobs from the numbers already reported for September and October — a sign that the economy was hit harder than first reported when the credit crunch deepened.

Economists, who had been expecting a loss of some 350,000 jobs last month, were stunned by the news, describing the report as “horrendous,” "horrific" and “eye-poppingly bad.”

“We’re scrambling around here for historical parallels,” said Robert Barbera, chief economist at ITG, an investment advisory firm.

More big job cuts are on the way, as companies slash costs to try to offset the expected drop in revenues. In just the past few weeks, major employers like AT&T Inc., DuPont, Citibank, JPMorgan Chase and Pratt & Whitney have announced steep job cuts.

"These numbers are shocking," said economist Joel Naroff, president of Naroff Economic Advisors. "Companies are sharply reacting to the economy's problems and slashing costs. They are not trying to ride it out."

Chrysler, General Motors and Ford continued to fight for survival Friday with another round of testimony on Capitol Hill, where the companies' CEOs are asking lawmakers for as much as $34 billion in emergency aid. But the auto industry has already sustained major damage. Car sales cratered to a 26-year low last month after the financial storm erupted in September.

“This is unprecedented in the history of the industry — and it happened from one day to the next,” said Mike Jackson, chairman and CEO of AutoNation, the largest U.S. chain of car dealers. “The strong will survive and the weak will be swept away by this toxic combination of Depression sales level and the lack of credit for business. It's going to be painful and unfortunate, but it does need to happen.”

What makes the latest data so worrisome is that they point to an economic decline that is picking up speed.

“The economy is now locked in a vicious downward spiral in which employment, incomes and spending are collapsing together,” said Nigel Gault, chief U.S. economist at IHS Global insight.

Consumers also are taking a hit to their finances as the collapse in housing prices and the rise in foreclosures that tipped the economy into recession show no signs of abating.

A record one in 10 American homeowners with a mortgage were either in foreclosure or at least a month behind on their payments at the end of September, according the latest survey released Friday by the Mortgage Bankers Association. The percentage of auto loans that was behind by 60 days or more rose 15.9 percent in the third quarter compared to last year, according to credit reporting agency TransUnion.

As consumers struggle to keep up with existing debts, lenders have cut credit card limits and tightened up on extending new loans, which has further crimped spending. The collapse of the stock market has wiped out trillions of dollars of personal wealth, forcing consumers to try to increase savings to make up for those losses.

All of which is accelerating the pullback in consumer spending – the main engine of the U.S. economy that accounts for roughly two-thirds of gross domestic product. Consumption dropped 3.7 percent in the third quarter; the spending pullback is expected to worsen during the holiday season that retailers rely on for the bulk of their profits. Gault expects consumer spending to shrink by 4.7 percent in the fourth quarter.

Economists already have begun comparing the current downturn to the back-to-back recessions of 1980-1982. The unemployment rate peaked at 10.8 percent then after the government pushed interest rates to high double-digits to try to break a decadelong inflationary spiral.

“You had interest rates that soared, the credit system shut down, and everything stopped,” said Barbera. “That's what this (jobs) number says, and that's what it suggests for the GDP numbers."

Before Friday’s jobs data, economists had expected GDP to contract at a sharp 4 to 5 percent rate in the current fourth quarter. Barbera said the latest data indicated the drop could be more like 8 percent.

“We're in a deep contraction with very little offset now,” said former Treasury Secretary John Snow. “The consumer is parked. China is slowing. India's slowing — Brazil, Mexico. Virtually every sector of the American economy is being affected.”

To some observers, the current economy is in even worse shape than the early 1980s recession that was brought on by the government-induced credit squeeze. Once the government cut rates, the economy recovered quickly.

Now the government has so far been unable to halt the steep decline, despite the commitment of trillions of dollars in spending, investment and loan guarantees.

The current credit drought follows the excesses of a prolonged period of low interest rates and easy-money lending that began to reverse course in 2007 and all but shut down lending in mid-September. To spur borrowing, the Federal Reserve has cut the target overnight lending rate to 1 percent and is expected to cut by as much as a half-percentage point on Dec. 16. But short term market rates have been well below the Fed’s official target for weeks.

With short-term rates approaching zero, the Treasury and the Fed are considering other measures to try to drive down the cost of long-term borrowing, including mortgage rates.

President-elect Barack Obama already has called for a half-trillion-dollar government spending package to generate 2.5 million jobs over his first two years in office, which Congress is hoping to have ready by Inauguration Day in January. The latest data may prompt enactment of an even bigger spending package.

“We had assumed a $550 billion package over three years — we will need more than that,” said Gault. “The trick will be making the stimulus effective quickly, which is difficult since infrastructure projects take time to gear up.”

Regardless of the size of the package, Friday’s jobs report heightens the urgency of an aggressive government response, said Mark Zandi, an economist at Moodys’ Economy.com.

“The only way out is for government to be extremely aggressive on every front — the Federal Reserve, economic stimulus, help for the automakers, extending out TARP money (to buy bad assets from banks) — everything,” he said.  “Because we're now in this self-reinforcing, negative cycle, and the only way out is for the government to fill the void.”

Even if the government acts quickly and stems the slide in the financial markets and the economy, some economists believe the jobless rate will top 10 percent before beginning to subside.  If this recession drags on past mid-2009, it would be the longest since the Great Depression. (The recessions of 1973-75 and 1981-82 both lasted 16 months according to the National Bureau of Economic Research.)

In any case, the eventual recovery will likely be more gradual and weaker than after past recessions, according to Stuart Hoffman, chief economist at PNC Financial.

“I think the mind-set will be different on the other side of this recession over the next couple of years,” he said. “That will prevent borrowers and would-be borrowers and lenders from saying, “Alright, game’s back on. Let’s start running house prices up and credit cards and credit limits up. It’s not going to happen.”

This week's move by the Treasury and Federal Reserve to inject another $800 billion into the financial system opens yet another chapter in the government's continually evolving response to the financial crisis. But the announcement reflects a policy that has been evolving behind the scenes at the Federal Reserve for months with little fanfare.

Add one more acronym to the alphabet soup of financial rescue programs:  zero interest rate policy, or ZIRP. But ZIRP is not just another bailout program.

ZIRP represents a major shift in the Fed's monetary policy, which typically involves managing lending rates and adding or draining cash to the banking system. But the central bank is running out of room to lower interest rates, and banks are hoarding much of the fresh cash they have received from the Treasury. So the Fed is bypassing the banking system and pumping money directly into the financial system to try to revive economic growth.

So far it is hard to tell whether it is working. A fresh ream of reports out Wednesday was not encouraging.

Consumers cut spending by 1 percent during October, faster than at any time since the terrorist attacks of Sept. 11, 2001, according to one report. A separate survey showed that consumer confidence fell this month to a 28-year low.

O
rders for costly durable goods like cars, machinery and computers tumbled a steeper-than-expected 6.2 percent in October. And t
he Labor Department reported that 529,000 workers filed new claims for unemployment benefits in the latest week, a bit fewer than the week before but still a level generally seen only during recessions.

As nominal short-term interest rates have approached zero, the Federal Reserve under Chairman Ben Bernanke has injected hundreds of billions of dollars into the economy through a variety of programs, with varying degrees of success. Since early September, the value of assets held by the Fed has exploded from about $950 billion to more than $2.2 trillion — not including Tuesday’s announced purchases.

The Fed has offered little detail about the assets it is buying, making it difficult to estimate how risky or effective the moves will be. These massive investments are aimed at heading off a catastrophic downturn, although most economists believe the economy already is in the deepest recession in more than a quarter-century.

“We have a joint venture going on between the Treasury and the Fed to essentially create a  government-sponsored banking system, if I can call it that, to substitute for the private sector banking system that is not wanting to lend,” said Paul McCulley, an investment manager at PIMCO, the giant money management firm.

Until September, the Fed’s primary response to the credit crunch and weakening economy was to slash short-term interest rates — cutting its target bank lending rate to just 1 percent from over 5 percent as recently as last year. But those rate cuts have done little to unclog frozen credit markets or reverse the effects of a housing market collapse that has wreaked havoc on the economy.

On Tuesday the government reported the nation's gross domestic product shrank by a half-percent in the third quarter — the biggest drop since the 2001 recession. Consumer spending fell by 3.7 percent, the first decline since 1991 and the worst since 1980.

Even before those figures were released, economists were slashing their forecasts. On Friday, Goldman Sachs chief U.S. economist Jan Hatzius revised his estimates to show GDP falling at a 5 percent annual rate in the current quarter and unemployment rising to 9 percent by the end of next year from the current 6.5 percent.

"The U.S. recession is set to get worse — a lot worse — in the next couple of quarters,” said Nariman Behravesh, chief economist at IHS Global Insight in a note to clients Tuesday.

Behravesh estimates that if Congress and the Obama administration pass a new economic stimulus package worth $500 billion to $700 billion, it could add about 1 percentage point to growth in 2009 and 2010. But he says it’s probably won’t come soon enough to boost growth in the first half of 2009.

“We are in the early stages of one of the worst recessions in the postwar period, even factoring in a massive stimulus program,” he said.

The Fed's efforts to flood the financial system with cash are aimed at offsetting a massive destruction of capital — from consumers 401(k) accounts to banks' balance sheets.

The falling value of financial assets — from stocks to housing to mortgages backed by those houses — has wiped out trillions of dollars in wealth. If that deflation continues, along with the recent sharp drop in prices of commodities from oil to steel to paper, the downward spiral could become much more difficult to stop.

That threat was the subject of a 2002 speech by Bernanke, then a Fed governor, in which he described a “helicopter drop” of money as one of the Fed’s most powerful tools to fight deflation and earned him the nickname “Helicopter Ben."

Now that Bernanke is chairman, the Fed has distributed billions by a variety of ways, including buying up unwanted assets through programs with names like Term Auction Lending Facility, Term Securities Lending Facility and Asset Backed Commercial Paper Money Market Mutual Fund Lending Facility.

These efforts represents the unannounced creation one of the most powerful monetary tools the Fed has ever employed. Also known as “quantitative easing,” the zero interest rate policy is designed to reduce the cost of borrowing — even after the Fed cuts its benchmark rates to zero. Last used by the Bank of Japan to try to rescue that nation’s economy from a decadelong economic slump, the policy represents a fundamental shift for U.S. central bankers.

Though the Fed’s official overnight target rate still stands at 1 percent, the rapid buyback of bad assets has pumped more than $1 trillion in cash onto the financial system in a matter of weeks, forcing the effective rate below 0.25 percent early this month. The scope of the Fed’s buyback of bad debts has been as historic as the credit crunch the Fed is trying to overcome. Since early September, the value of assets held by the Fed has exploded from about $950 billion to more than $2.2 trillion — not including Tuesday’s announced purchases.

Though the Fed’s actions may head off further damage to the economic and financial markets, they carry their own risks.

For now, the Fed has had little trouble raising trillions of dollars to fund its buying spree. In theory, the central bank can raise as much cash as needed simply by issuing more of its own Federal Reserve notes — also known as dollars.

Much of the Fed’s spending money so far has been coming from “supplementary financing” from the Treasury, which continues to see strong demand for its own notes as investors around the world seek shelter from the financial storm. During the worst market turbulence, demand for Treasury notes has been so strong that interest rates on those notes have fallen below zero —which means investors are willing to lose a small amount of money in return for preventing bigger losses. That demand has also sent the value of the dollar soaring.

“We have a lot more latitude in expanding the Fed's balance sheet now that the U.S. dollar —and six months ago it was not the case — today is the undisputed reserve currency of the world,” said Diane Swonk, chief economist at Mesirow Financial, a Chicago-based investment management firm.

For now, the dollar’s strength is a vote of confidence from global investors. If that confidence wavers, the Fed could find itself with a lot less room to maneuver.

Over the longer term, the Treasury and the Fed are trying to use the same leverage —essentially, using borrowed money — that got the financial system into trouble in the first place.

That credit, or liquidity, is supposed to fill the void created by the collapse in the credit bubble created by the private sector. For the time being the Fed and the Treasury may have no choice but to step in as “lender of last resort.”  But at some point, the Fed will have to drain that cash out of the system or risk creating another credit bubble. It’s far from clear what impact the unwinding process will have.

”When you look at the scope of what the Fed is doing, I think the market is much more concerned about the long-term effects right now,” said Atlanta-based investment adviser Scott Kays.

The other major risk of dropping trillions of dollars onto the economy from a helicopter is that all that money could sow the seeds of massive inflation when the global economy begins to recover. But at the moment, the rapid contraction in lending and economic growth is helping to push inflation fears farther into the future.

“When I look out five to 10 years, my gut tells me that there's got to be some sort of inflation payback as a consequence of all this money creation,” said Paul McCulley, a portfolio manager at PIMCO. “That's just a visceral feeling that I think we all have. But over the next year or two, I simply don't see it. It's further and further out on the horizon.”

After years of punishing increases in the cost of energy, consumers are rejoicing these days at the sharp drop in prices at the pump. Not only that, but prices are dropping for clothing, transportation and housing, according to the government's latest report on consumer prices. With money tight, the price declines are a welcome relief.

But be careful what you wish for. If price declines continue and become more widespread, there’s a risk the downward trend could feed on itself in a spiral that can take on a ruinous momentum. It’s called deflation. And some economists are warning the threat is increasing.

“A benign decline in prices amidst a sluggish but recovering economy would be unwelcome but tolerable,” Merrill Lynch economist David Rosenberg wrote in a note to clients this week. “But the price slashing now under way as the consumer beats a hasty retreat could allow that corrosive deflationary spiral to take hold — something the Fed wants to avoid at all costs.”

Although the risk is still considered relatively small, concern about deflation is one reason stocks have been hammered this week, sending the broad Standard & Poor's 500 to its lowest close since 1997 Thursday. The rapid slowdown in the economy, coupled with the collapse of housing and financial markets, has increased the threat of a broad, sustained drop in prices.

While deflation might sound welcome, in fact it can be devastating to borrowers, banks and businesses. The Great Depression in the 1930s was accompanied by deflation of 10 percent per year, reflecting the widespread lack of demand.  Falling prices in the 1890s made it impossible for farmers to keep up with mortgage payments, as Fed Chairman Ben Bernanke noted in a 2002 speech on the topic.

As prices fall, consumers and businesses become less willing to spend and invest, worsening the economic downturn, as happened in Japan's "lost decade" of the 1990s.

A sustained drop in prices hurts in two ways. First, because consumers and businesses anticipate prices will continue to fall, they would likely cut back further on spending and investment. Why shell out $1,200 for that flat-panel TV today when you can get it for $800 six months from now?

As spending dries up, the economy starts to shrink; about two-thirds of the U.S. gross domestic product is based on consumer spending. As GDP shrinks, so do the companies providing those goods and services for consumers. As companies shrink or go out of business, unemployment rises. Out-of-work consumers have less money to spend, which cuts deeper into the economy. Once the cycle takes hold, it's very difficult to stop.

Deflation brings another, potentially bigger problem for an economy swollen with too much debt. Inflation is good news for anyone who owes money because, as prices rise, spending power is eroded and the real value of money declines. When inflation is rampant, you get to pay back the $1,000 you borrowed last year with dollars that are worth a little less each year.

That debtor advantage is turned upside down if deflation takes hold. As prices fall, the spending power of your money goes up. But so does the real value of your debt — because you have to pay it back with money that has increased in real value.

Several forces are combining to create downward price pressure. The sharp slowdown in global growth has cut demand and created an oversupply of commodities — from oil to scrap paper — sending prices of those commodities crashing. That can translate into falling prices of finished goods.

The recent sharp pullback in consumer spending puts added pressure on producers to cut prices as they try to spur sales. Consumers will likely continue to hold back on spending as long as unemployment rises and household wealth shrinks due to dropping asset values.

If deflation were to take hold, the impact could be even worse than the 1970s inflation outbreak that devastated the economy and destroyed wealth for nearly a decade. Federal Reserve policymakers could find themselves in a tight spot. Just as higher interest rates are the antidote for inflation, lower rates are the government’s main weapon against deflation.

But having already slashed the benchmark overnight lending rate to just 1 percent from 4.25 at the beginning of 2008, the Fed is running out of room to cut rates further. In fact, as worried investors have moved piles of cash into short-term Treasuries in the past few weeks, the Fed has missed its target, and the market has pushed short-term rates to just 0.25 percent.

Fed officials are keenly aware of the deflation risk. On Wednesday, Fed Vice Chairman Donald Kohn said the “most likely outcome” was that the economy will not see an outbreak of deflation. But he said Fed policy should be focused on making sure that doesn’t happen.

"Some people have argued that we should save our ammunition, that interest rate cuts aren't effective," he said. "I think that were we to see this possibility, that we should be very aggressive with our monetary policy, as aggressive as we can be."

If deflation were to take hold, the Fed wouldn’t have to do all the heavy lifting; government policies on taxing and spending could also provide a major deterrent.

The recent, huge injection of hundreds of billions of dollars into the banking system should help offset deflationary pressures. Tax cuts could help, along with further increases in government spending on rebuilding roads and bridges. As the government pumps money into the economy and financial system that generally boosts inflation and should limit the odds that deflation could take hold.

Deflation worries surfaced earlier this decade as the economy was emerging from recession after the bursting of the Internet bubble and 9/11 terrorist attacks. Deflation concerns played a role in the Fed’s decision to keep interest rates low after the economy began recovering. Though the recession officially ended in November 2001, the Fed kept cutting rates and did not begin raising them again until June 2003.

The following month, current Fed Chairman Ben Bernanke, then a Fed governor, told a group of economists meeting that deflation was not a serious threat because “financial conditions in the United States today are sound.”

“Deflation can be particularly harmful when the financial system is already fragile, with household and corporate balance sheets in poor condition and with banks undercapitalized and heavily burdened with nonperforming loans,” he said in that speech.

This week a 13-year-old reader from Topeka wants to know: What is the government going to do about paying down the gigantic national debt? We wish we had a better answer. Another asks: What happens if investors stop buying all our debt?

You are quite right to be concerned, Leobardo. I wish more members of our government shared that concern. The only honest answer is: There is no plan.

You’re also right about your generation inheriting the debt that has been generated by my generation. If you haven’t already, maybe you want to sit your parents down and have a little talk about it.

As of Nov. 13, the U.S. national debt was $10,578,639,151,691.13 (that’s $10.5 trillion) and growing by about $3.8 billion every day. About $6.2 trillion of that debt is from Treasury bonds sold to a variety of investors, including foreign governments.

Another $4.3 trillion is held by our own government – mostly in the Social Security and Medicare trust funds. These funds have been collecting more than they spend, saving for the day when my generation retires and starts collecting retirement checks and needs health coverage to pay our doctor bills and buy medicine. Those savings could have been stashed in a bank account. But the Treasury needs the money to make up for the years the government spent more money than it collected in taxes. Voters like to see cuts in taxes, not in services.

Though $10 trillion looks like a big number, keep in mind that the U.S. economy is generating about $13 trillion every year, which means the debt is about 80 percent of GDP. On that basis, we’ve seen it go higher in the past; during World War II , the national debt was more than GDP.

If our government can figure out how to set taxes and spending at the same level, and the economy keeps growing, the debt will get smaller in relation to the economy. If that happens the burden on your generation won’t be so bad. The only way to do that is to raise taxes or cut services - or both. It doesn’t look like that’s going to happen any time soon.

The government isn’t alone in borrowing too much money. American consumers have borrowed $11.5 trillion in mortgages and another $2.5 trillion in credit card, car loans and other debts. Banks and Wall Street investment firms borrowed tens of trillions of dollars more to create complex investments that now are worth a lot less than everyone thought.

Now, the Treasury and the Federal Reserve are using trillions of dollars more to try to clean up the mess. As they do, the debt pile probably will grow. Some day, that will have to be paid back too.

Even when all that debt is paid off, your generation will likely face another big debt problem. Remember the money that the government has set aside for Social Security and Medicare benefits? It’s not going to be nearly enough to pay the bills for those of us who will be relying on Social Security to pay for retirement and on Medicare to take care of us when we get old and sick. There are various estimates out there. The government’s own accountants at the GAO figure it will take another $40 trillion.

Earlier this year, Richard Fisher, the president of the Dallas Federal Reserve, gave a speech in which he figured Social Security will need another $13.6 trillion to cover retirement checks to people like me. Medicare will need something like $85.6 trillion to pay our medical bills.

Borrowing money to enjoy a better life today has, until very recently, become ingrained in the American way of life. As we’re now finding out the hard way, it’s not sustainable. And when the bills come due — as they’re beginning to now — life gets much tougher.

We’re been through hard times before, and we’ll get through it this time. The good news is that, like the generation that preceded mine and lived through the Great Depression, it’s almost certain that your generation will be more responsible about borrowing money.

As for what’s being done to fix this mess, there is no good answer. These problems have been known for some time, and our government has spent years debating what to do about it. So far, it hasn’t come up with a solution. If nothing is done soon, it will be the greatest failure of my generation. And you’ll have every right to be extremely angry about it. I know it won't help much, but my generation owes your generation a huge apology.

If or when investors lost their appetite for U.S. Treasury debt, you would notice the change.

If investors gradually decided they didn’t like our debt, the Treasury would simply increase the amount of interest paid on newly issued debt. This is how long term interest rates are determined. (The Federal Reserve sets only very short-term interest rates that apply to banks lending to each other. Banks also peg their so-called prime rate to the Fed’s short-term rate.)

Every time the Treasury auctions debt, it takes bids from investors who want to buy it. Whoever bids to accept the lowest interest rate wins the bid. That helps the Treasury keep borrowing costs low.

Demand for Treasury debt has its ups and downs. When the dollar is falling, for example, investors usually want a higher rate to make up for the impact of that falling dollar on their investment. Those higher rates push up the cost of other long-term loans like mortgages.

Credit has become much harder to get — but not because of a lack of investor interest in Treasuries. The problem is that banks are afraid to lend because the system is still riddled with private debt — mostly backed by mortgages — that may go bad. Most mortgages will be fine, but they’ve been so scrambled up in complex pools of securities that no one knows exactly who’s holding the bad ones. It’s kind of like someone offering you 10 glasses of water and then telling you one of them is poison — but they can’t tell you which one. That makes it pretty risky to take a drink.

The good news is that, despite the current financial turmoil, a rapidly slowing economy and huge the levels of U.S. debt, investors around the world are still snapping up Treasuries as fast as they’re printed. For the time being, the U.S. Treasury is still seen as the safest place to put your money. That strong demand has helped give the dollar a big boost in value against other foreign currencies.

It’s impossible to predict how long that will last. These days, it’s impossible to predict just about anything related to the economy or financial markets.

Friday's dismal employment report underscores the urgent need for President-elect Barack Obama to act quickly to get the economy back on track. But as the devastating economic downturn gains momentum and spreads around the globe, there is a growing concern that any actions under the new administration will have little impact in the short term.

Voters made clear they want the new Congress and the Obama administration to make the economy a top priority. More than six in 10 voters surveyed in exit polls cited the economy as the most pressing issue facing the nation, and nine of 10 said the economy is in bad shape. The other four major issues cited as most pressing — Iraq, energy, terrorism and health care — were picked by one in 10 or fewer.

The latest evidence of the downturn's severity came Friday, when the government reported the nation's employers slashed another 240,000 jobs in October, pushing the unemployment rate to a 14-year high of 6.5 percent. The economy has shed about 1 million jobs so far this year in a downturn that appears likely to be the worst recession in decades.

Obama met with economic advisers Friday amid widespread calls for fresh steps to halt the economy’s rapid deterioration and begin to turn things around. There’s no shortage of ideas: tax breaks for businesses, massive spending on roads and other infrastructure projects, government support for the ailing auto industry, tax credits for new home buyers and aggressive government intervention to backstop failing mortgages, among others.

But it will take time for any of these measures to begin to have an effect. And in the meantime, the latest economic data suggest that things are getting worse.

Consumers — who account for two-thirds of U.S. economic activity — have pulled back sharply in just the past few weeks, as job losses and the turmoil in financial markets have left them spooked. On Thursday, retailers reported steep drops in October sales. Carmakers also saw sales plunge last month, with General Motors posting a 45 percent drop, and Ford and Chrysler reporting comparable pullbacks.

Government support may help the Big Three survive the storm, but there is little government can do to stop it in the coming months.

Dealers face several major problems selling cars. The worsening job market has potential car buyers putting off a purchase until things get better. The panic in the markets that began in September has only made matters worse. Those few customers who are stepping up to buy are having a much harder time getting financing from lenders who have sharply tightened their underwriting standards.

The result, according to AutoNation CEO Michael Jackson, is a downturn beyond the auto dealership chain’s “worst-case scenario.”

“At least we had planned for worst case and were operating for worst case,” he said. “But clearly, we're past that now. The financial panic that has occurred deep into the down cycle for housing and automotive is past worst case.”

The slump has spread well beyond the battered auto and housing industries to the wider economy, sending the gross domestic product into reverse in the third quarter and signaling that a recession is likely under way.

Initially concentrated among the battered housing and construction industries, job cuts have now spread to most sectors, from retailing to professional services. About the only sectors showing growth are health care and government. With dozens of states aggressively slashing budgets to fill gaping deficits, government job losses are expected to increase.

Obama’s economic policies likely will have even less impact on the widening global slowdown. Over the long term, efforts to expand trade and coordinate oversight of global financial markets may have a positive impact. But the short-term global outlook is “dismal,” according to Howard Archer, chief European economist for IHS Global Insight.

“It is apparent that the heightened financial crisis is having a serious dampening impact on already struggling Eurozone economies and is significantly intensifying the danger of deep, extended recession,” he wrote in a recent note to clients.

Even the perennially vibrant Chinese economy is feeling the effects of the global downturn. Economists at Credit Suisse are forecasting that China’s GDP growth could be as low as 5.8 percent in the fourth quarter of this year, down from 11.4 percent in 2007.

That global slowdown could feed on itself as lower consumer demand crimps trade flows between countries. The Credit Suisse economists note that when one country is in recession, imports typically fall as consumers cut back, but exports hold steady as demand remains strong in overseas markets.

But with most economies slowing around the world and the dollar rising, demand for U.S. exports is expected to fall. That could bring yet more U.S. layoffs.

The latest economic data provide mounting evidence that the collapse of the housing market and turmoil in financial markets have tipped the U.S. economy into recession. The question now on the minds of consumers, business owners and politicians: How deep is it going to be, and how long is it going to last?

This week’s report showing a 0.3 percent decline in gross domestic product confirmed that the economy has shifted into reverse. With job losses rising, and consumer confidence falling to levels not seen in decades, the reversal appears to be picking up speed.

The latest bad news came Friday when the Commerce Department reported  that personal spending fell by 0.3 percent last month, the biggest decline in more than four years. That followed flat readings in both July and August, contributing to the worst quarterly performance in 28 years.

Although a recession is not official until a panel of economists determines when the economy peaked and began shrinking, many analysts believe a recession has been under way for months.

“We are now entering the harshest part of the recession,” Nigel Gault, chief U.S. economist for IHS Global Insight, wrote in a note to clients after the release of the GDP data.

One reason for concern is that the figures released this week do not reflect the October Panic that swept through the global financial markets as the credit system virtually shut down.

"The economy has deteriorated sharply since that time, particularly in October,” said Diane Swonk, chief economist at Mesirow Financial. “And now, even as credit markets begin to heal, we have to undo that damage, and that damage means that the economy's going to get worse before it gets better."

The Federal Reserve and Treasury have stepped up efforts to get banks lending again, and the Fed this week made another, largely symbolic, reduction in the interest rate target for short-term loans between banks. With that rate now at 1 percent, Fed Chairman Ben Bernanke and his colleagues are running out of ammunition to get money moving again through the financial system.

Congress is debating another economic stimulus package, including proposals to provide hundreds of billions of dollars for overdue upgrades to roads, water projects and sewer systems. That investment will help but probably will not be enough to offset growing gaps in dozens of state budgets. Those deficits will almost certainly being a cutback in state spending and hiring — one of the last sectors of the economy to show growth.

“There simply is no easy out for the financial markets, the economy or policymakers,” Wachovia chief economist John Silvia wrote in a note to clients. “The great American financial workout continues. “

As businesses saw their credit dry up in September, the Fed stepped in to guarantee the so-called commercial paper that big companies rely on to manage their day-to-day cash flow.  More recently, consumers are seeing the crunch spread to credit cards, which has begun to put a crimp on their spending. Thursday’s GDP report showed that consumer spending — which accounts for about 70 percent of all U.S. economic activity — fell 3.1 percent in the quarter ending Sept. 30, the biggest drop since 1980.

One big reason is that consumers have less money to spend. Job losses and plunging home equity have eaten into purchasing power. Investors have lost an estimated $2 trillion in retirement savings alone since the stock market embarked on a sickening plunge last month. Rising home equity and an expanding stock market were two of the key factors that fueled the economic expansion that began in late 2001.

The reversal of those factors will make it difficult to get the economy back on track. Efforts to rescue the banking system have focused on building up capital and writing down bad debts. Now American households are embarked on the same painful process by tightening their belts, putting further pressure on consumer spending.  It remains to be seen how long that process will take.

“This is going to be a long, protracted retrenchment,” said former Fed Gov. Lawrence Lindsey. “The key is going to be (that) consumers have no choice but to cut back. They can't get the credit that they've used to fund themselves. And so, over two years, I think we're going to see a significant retrenchment in consumer behavior.”

Consumers are also likely to cut back as long as they’re worried about losing their jobs. The unemployment rate already has risen to 6.1 percent from 4.7 percent a year ago, and it is likely to rise further. The jobless rate last peaked at 6.3 percent in 2003, hit 7.8 percent in the 1991-92 recession, and rose to 10.8 percent in 1982.

The economy already has shed at least 760,000 jobs this year; numbers for October will be reported Nov. 7. Other recent recessions eliminated anywhere from 1.6 million to 2.8 million jobs.

Just this week American Express announced plans to eliminate 7,000 jobs and Motorola said it would eliminate 3,000.

There are a few bright spots in outlook. The plunge in oil prices has taken some of the pressure off consumers at the gas pumps. The drop in housing prices continues, but the pace of the decline seems to be slowing, and falling prices appear to be drawing some interest from buyers.

There is little consensus among economic forecasters as to how long this recession will last. A lot depends on how long it takes for home prices to stabilize; news that the government is at work on a comprehensive plan to help reverse the rise in foreclosures could go a long way to helping the housing market find a bottom.

Recent recessions have lasted from eight to 16 months, although there was a period of back-to-back recessions that lasted nearly three years in the early 1980s.

“I think that we are almost a year into this recession,” said Robert Barbera, chief economist at ITG. “So, you could have it ending in the middle of next year and it would be a record length recession."

The Federal Reserve's interest rate-setting committee announced Wednesday that it was lowering its target overnight rate by a half-percentage point to just 1 percent.

But as central bankers continue to wield a wide variety of monetary tools these days, the rate cut might not make all that much difference. For now, the rate-setting policy that has historically been one of the Federal Reserve’s bluntest and most powerful instruments looks more like a paring knife.

Since the credit crisis took hold of financial markets last month, the Fed has tried almost everything, including paying hundreds of billions for mortgage-related investments, commercial paper and other assets no one else wants.

The latest cut in the overnight lending rate for banks is almost ceremonial. While it might help boost morale a bit, some analysts suggest the Fed should stay on the sidelines and retain the ability to cut rates in the future if needed.

“It doesn't matter what the Fed does,” said Rich Berg, chief executive officer of Performance Trust Capital Partners, a Chicago-based bond trading firm. “The market rates are going to be the market rates. Why waste the bullet now? Why not save those bullets?”

But others say the largely symbolic move is still important.

“The sentiment of investors, of consumers and everybody that's involved in this country is at a low,” said Peter Costa, a stock trader at Eckhart & Co. “We all know that it's not going to make any difference in the credit markets. But it is going to be something that's going to be significant that the government is still being proactive.”

The widely expected cut in the so-called federal  funds target will have little impact on the actual short-term cost of borrowing by banks, though some businesses and consumers may catch a slight break if they borrow at variable rates tied to the target.

In normal times, the Fed manages the interbank lending rate through the purchase and sale of Treasury securities to add or drain cash to the banking system. But with the financial storm raging, the Fed has had mixed success keeping monetary policy on course and hitting that target rate. As a result, financial markets already have cut short-term rates for the Fed.

“They could go more, because the actual fed funds rate is already much lower than the targeted fed funds rate,” said former Fed Gov.  Robert Heller.

Cutting the fed funds rate to 1 percent matches the lowest level reached during the housing boom and naturally raises concerns that the Fed may be repeating a mistake that led the way to the current crisis.

But few seem worried about that threat because economic and market conditions are very different, according to former Fed Gov. Wayne Angell.

“I don't think this will be the mistake that it was in 2003,” he said. “Because this time we have deflation in housing, and we have a serious commodity price deflation that says to them, ‘You’d better get with it.’”

Those deflationary pressures may give the Fed breathing room to cut rates further. But cutting the target rate won’t address one of the most troubling dangers the economy now faces: the sharp pullback in consumer confidence and spending.

On Tuesday, the Conference Board reported that its widely watched consumer confidence index fell to 38, its lowest level since the index was introduced in 1967. The level was down from a 61.4 in September and 95.2 a year ago.

“(The) shockingly weak reading on confidence no doubt reflects the fears of a financial and equity market meltdown,” said John Ryding, chief economist at RDQ Economics, in a note to clients.

Consumers also are spending less because they have less to spend. Rising unemployment means households have less purchasing power. Falling home prices have wiped out much of the equity consumers had been tapping during the boom.

And there are few signs of a bottom in home prices. One closely watched index released Tuesday showed that urban home prices tumbled nearly 17 percent in August from year-ago levels.

Earlier this month, the Fed cut its target rate by a half-point in a coordinated move with central bankers around the world. European Central Bank President Jean-Claude Trichet said Monday a rate cut next month is "a possibility" now that the price of oil and other commodities have fallen.

But rate cuts might not be enough to head off a downturn in Europe as a housing slump and the widening financial crisis weighs on economic growth there. As the advanced economies of the developed world grind to a halt, much depends on the emerging economies of Asia and Latin America — where U.S. central bankers have no control over monetary policies.

At a securities industry conference in New York Tuesday, John Lipsky, a senior official at the International Monetary Fund, said the IMF is forecasting that next year "100 percent of global growth is going to come from emerging economies."

Lipsky said the IMF has $200 billion in reserves to help try to head off the economic downturn in those economies. But it’s far from clear that will be enough, he said.

“The virulence with which the emerging market economies have been hit first by the financial turmoil and secondly by the threat of a significant slowdown in the advanced economies has been striking,” he said. “It's happened so quickly. Happily we're in a position to respond quickly, but we can't take for granted that we're anywhere near an end."

What's behind the current turmoil in the world's financial system? How did it happen? And what lies ahead? I'm John Schoen, senior producer for msnbc.com's Business team. Join me for a Q&A session here on Newsvine where we'll look at some of the causes and possible solutions to the crisis. Feel free to post your questions here in advance, and please remember to vote for your favorite questions by clicking the small arrow in each comment box. And check out the latest installments of my weekly column, The Answer Desk.

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After a tense weekend that raised further doubt about the strength of the U.S. mortgage market, the stock market drew some reassurance from news that the Treasury and Federal Reserve stood ready to come to the rescue of mortgage finance giants Freddie Mac and Fannie Mae.

But, despite a relatively mild Monday selloff, there was no question that a bear market is well underway, the latest sign that the economy is probably in recession. If history is any guide, both the economy and the stock market have a way to go before they hit bottom.

Stock prices have been near bear-market levels for weeks but officially landed there last week when the broad Standard and Poor's 500 index fell to more than 20 percent below its October peak level. The more narrow Dow Jones industrial average already had fallen more than 20 percent from its latest peak, the standard definition of a bear market.

Bear markets and recessions often go together. When companies see bad weather ahead and mark down their profit forecasts, investors take cover and sell stocks.

But the relationship is not perfect. The market has seen big pullbacks before without the economy tipping into recession; the Crash of 1987 is one of the best recent examples. Conversely, in the back-to-back recessions of 1980-82, one of the worst downturns of the past 50 years, the S&P 500 index was actually higher at the end of the event than when it began.

Over the past hundred years, the average bear market has lasted a little over a year and seen stock prices fall by about 30 percent. By that measure alone, investors can expect stock prices to continue to continue falling.

Corporate profits, meanwhile, are coming under pressure. And because stock prices generally are heavily influenced by corporate earnings, the bear market isn’t likely to end before those profits begin to recover.

That’s why, over the next few weeks, investors will be looking carefully at not only at what companies report they earned in the second quarter, but the guidance they give for the next few quarters. Those forecasts have been getting progressively worse so far this year.

“When we started the year, we thought we would see about a 4 percent increase in earnings for the S&P 500 in the second quarter,” said Sam Stovall, chief investment strategist for Standard and Poor's Equity Research. “Now based on new guidance, additional writedowns and so forth we're looking for closer to a 10 percent decline.”

A lot, of course, depends on how well or poorly the economy performs. Though the latest data show the GDP has turned in small gains in growth, a series of six months of job losses and a five-month decline in industrial production point to an economy that is shrinking.

Merrill Lynch economist David Rosenberg is among those who believe that a recession is already under way.

Although the nation's gross domestic product rose 1 percent in the first quarter, according to the government, Rosenberg said in a recent report that he expects that figure to “undergo massive revisions.” When the final numbers are tallied, the results could show the economy began shrinking late last year. Such revisions marked the beginnings of both the 2001 and 1990-91 recessions, said Rosenberg.

Even as economic growth appears to have stalled, higher prices for oil, food and other commodities are fueling higher inflation both in the United States and around the world. That’s forced the Federal Reserve to halt a series of interest rate cuts deigned to keep the economy moving. Central bankers in Europe and elsewhere already have begun raising rates in an effort to curb inflation.

“Stagflation is the word — certainly here in the United States — and it's more or less breaking out all over the world,” said Allen Sinai, chief economist at Decision Economics, referring to the dreaded combination of stagnation and inflation.

“And it's putting central banks in a real bind," he said. "For (economic) growth they need to cut rates, but they can’t possible do that. At the end of the day, central banks have to raise rates to fight inflation.”

Fed officials will get another reading on prices this week, with back-to-back reports on the latest monthly data on wholesale and consumer inflation. That news could place the Fed further in a bind; a reading showing rising inflation would increase the need to raise interest rates to try to tamp down price increases.

But raising rates could worsen the ongoing global credit crisis — including the fragile condition of mortgage finance giants Fannie Mae and Freddie Mac. On the other hand, lowering rates to calm the credit markets risks stoking inflation.

As the latest round of corporate earnings reports are released in the next few weeks, investors are bracing for more bad news as financial giants like Merrill Lynch and Citigroup Inc. are again expected to write off billions of dollars of assets. Since last year, banks have written down nearly $300 billion.

“We have to consolidate, recapitalize and resize the entire financial system,” said Sinai. “It is broken, it is cracked. It will take a long time to fix it. You overlay that on what's going on in the economy, and the recession that we are already in and have been in, and the equity bear market is just going to last with occasional interruptions.”

As they work to rebuild damaged assets, banks are also coping with a big drop in profits. Financial stocks in the S&P 500 last year generated $61 billion of earnings; this year, the number is fall below $25 billion, according to S&P.

With a sizable portion of their assets backed by home mortgages, the continuing decline in home prices will prolong the rebuilding process. And with banks under pressure, they’re lending less money to potential home buyers — which further delays the recovery in the housing market.

"You're going to have further price drop as the value of (banks’) collateral is impaired and the mortgages are held on the banks balance sheets will become worthless," said Kevin Caron a market strategist at Stifel Nicolaus. "So it's a self-propagating negative cycle that is going to be difficult to break, but eventually it will come to an end."

Earlier this year, the hope was that aggressive rate cutting by the Fed, coupled with $107 billion in tax rebate checks, would help the economy dodge a recession. The stimulus plan seemed to have the desired effect. Last week retailers reported better-than-expected gains in sales for June.

But the final checks have been mailed and will soon be spent. Then higher prices and rising unemployment are likely to crimp consumer spending, which accounts for some 70 percent of  U.S. economic activity.

“Discretionary spending of all kinds — restaurants, movies etc. — are going to get scaled way back in the next six months to a year,” said Nariman Behravesh, chief economist at Global Insight. “And that will have a dramatic effect on consumer spending and the overall economy.”

Rising food and gas prices, falling home values and more job losses are making readers pretty gloomy. So just how bad is the current economic slump compared to other downturns?

There have been five official recessions in past 35 years. The most recent ones were fairly mild. So if you were born after 1965, you haven’t been through a nasty recession as an adult. Yet.

For some people, the mild 2001 recession didn’t even feel like a downturn. Initially sparked by the bursting of the Internet stock bubble, the 9/11 attacks put consumers and employers in a gloomy mood.

But the overall economy proved to be pretty resilient — helped by a flood of money in the form of interest rate cuts by the Federal Reserve.  Unemployment — the most painful impact of any recession — peaked at 6.3 percent in June 2003, long after the recession officially ended.

Although the jobless rate was up significantly from the late 1990s, that dot-com job market was one of the tightest in memory. College kids were getting five-figure signing bonuses to work for Internet companies with no earnings. When the music stopped, some of them had to go find real jobs.

The previous recession, in 1990-91, included some of the elements we have now: A war, a soft housing market with declining home prices in some areas, a gloomy consumer and a jobless rate that hit 7.8 percent before the economy began to recover. (The current rate is 5.5 percent.)

But that early 1990s event was relatively short. As measured by gross domestic product, there were two-back-to-back down quarters, and it was over. In the fall of 1990 the stock market fell 20 percent — and then began one of its best decades in history.

The 1980-82 recession was a different animal. In fact, it was officially two back-to-back recessions — both of which were the result of the Fed's inflation-killing interest rate policy that would be all but unimaginable today.

In 1979, after a growth and inflation roller coaster that lasted most of the decade, short-term rates were nearly 10 percent — five times the current level — and prices were still out of control. So the Fed decided to snuff out inflation once and for all by doubling rates to nearly 20 percent in April 1980. GDP fell at a 7.8 percent rate in one three-month period.

When the Fed cut rates back to 9 percent in July 1980, the first recession of the '80s officially ended.

But the inflation monster was still breathing, so the Fed doubled rates to 20 percent again by July 1981. Now GDP fell at an 11 percent rate.

From November 1980 to July 1982, the stock market dropped 24 percent.  By the end of 1982, unemployment hit 10.8 percent.

But this time, the medicine worked. Once the Fed let go of its stranglehold the second time, the economy perked up and inflation receded. The stock market soared, kicking off one of the longest and strongest bull markets in history.

The early 1980s downturn capped the end of what was, in many ways, the worst decade the U.S. economy faced since the Great Depression, coming after another deep downturn that officially lasted 16 months and ended in November 1973. In that event unemployment peaked at 9 percent and the stock market fell 45 percent.

But those “official” recession dates don’t account for the pain caused by a prolonged run of high inflation that destroyed wealth and spending power.

Economists still debate the causes of the 1970s-era stagflation. But there’s little disagreement about the damage it inflicted. Stock prices ended the 1970s about where they began; inflation cut the dollar’s buying power by more than half. Every time you got a raise, inflation ate it up. For nearly a decade, it seemed as though there was no cure.

The source of the current downturn is very different — and may be as difficult to manage.

The current slump began with the overstimulation of consumer borrowing by both the Fed and the financial services industry. We’ve all borrowed to buy houses, cars, college educations, home remodeling, vacations, etc.

Now with home prices falling, we no longer have the home equity to borrow against. We have to pay off the bills from all that borrowing before we can spend again.

Banks are in the same boat: Thanks to deregulation, commercial and investment banks used ridiculous degrees of leverage on investments that turned out to have much less value than they thought.

This would be bad enough without the impact of commodity inflation on a global economy fueled by an entirely new set of players: developing nations. That growth has helped fuel the American borrowing binge, so we’d all better hope it continues. But as long as rapid global growth is the only option, pressure on commodity prices, including oil, will remain high and inflation a very real problem.

So far, the numbers don’t add up to the 1970s: Unemployment is still roughly half where it was then. You can still get gasoline for your car.

The worry is that we’re at the 1972 stage of the 1970s. Within the past month or so, economic forecasters have been pushing back their estimates of when the U.S. economy will recover. We now hear a lot more about a “double dip” — things perk up a bit thanks to the massive stimulus checks and rate-cutting by the Fed but turn down again in late 2008 or early 2009.

The outlook might be more promising if we saw a serious, focused government response. Our energy policy is broken, but after three tries in the past seven years it seems unlikely we’ll get a good one in place before next year.

The housing bill has been debated for a year now: We may get one later this month, but it remains to be seen how badly watered down the final version will be.

Unless the 3 million or so consumers who face foreclosure this year can get back on track, the impact on spending will continue to weigh on all of us. And until home prices begin to recover, the collective assets of American homeowners continue to decline, putting further pressure on consumer spending, which accounts for 70 percent of the U.S. economy.

About 7.8 million Americans — or about one worker in every 20  — held more than one job in June, according to the employment data released Thursday by the Bureau of Labor Statistics. Some of those people may have three jobs or more. The BLS only asks if you work more than one. And it doesn't ask why.

That’s up a bit from last June, but as a percentage of the work force, the number of people working more than one job has held fairly steady since the end of the last recession in 2001.

Unfortunately, all that the extra work — on average — hasn’t paid off very well. Adjusted for inflation, the average weekly paycheck has barely budged since then. That’s one reason American consumers are feeling so stretched: The cost of gasoline, food and other household bills is going up faster than their paychecks.

As they cope with rising food and energy costs and declining home values, more Americans took another financial hit in June: the loss of their paycheck.

The U.S. economy shed some 62,000 more jobs in June — the sixth straight month of losses. So far this year, the unemployment rate has risen from 4.9 percent at the beginning of the year to 5.5 percent in June — the highest level in more than three years.

Thursday's report also boosted the jobs cuts initially reported for May. The nation's payrolls now have shed 435,000 jobs since December.

More job losses are likely in coming months. Planned layoffs at U.S. companies last month were nearly 50 percent above year-ago levels, according to outplacement firm Challenger, Gray and Christmas.

"I think the (jobs) report tells us the economy is actually deteriorating," said John Ryding, former chief economist with Bear Stearns now with RDQ Economics. "The labor market seems to be getting worse."

Not surprisingly, layoffs are coming fastest in the sectors that have been hardest hit by the housing recession and credit crunch. The construction and financial services industries began shedding jobs last year and continue to do so. More recently, retailers, fearing a slowdown in consumer spending, have been cutting jobs too.

Boosted by a weak dollar, which makes U.S.-made goods more competitive overseas, the manufacturing sector has been holding up surprisingly well.

But that strength may be flagging. The Commerce Department reported Wednesday that orders to U.S. factories in May turned in the weakest performance in three months in May, as demand weakened for autos, heavy machinery and steel. The 0.6 percent monthly increase was less than half the gains in April and March and the poorest showing since a 0.4 percent drop in February. 

For now consumer spending, the main engine of economic growth, is holding up based largely on a heavy dose of financial stimulus from a government tax rebate that pumped $100 billion back into household budgets. Last week the Commerce Department reported that disposable incomes jumped 5.7 percent in May — the biggest one-month gain since the government handed out checks to fight recession in May 1975.

As the downturn in the housing market has picked up speed, hundreds of billions of dollars in home equity — one of their biggest single sources of savings — has evaporated. Skyrocketing oil prices have sent the cost of gasoline surging. Prices of other goods have been rising faster than paychecks.

All of which has added to the strain on household budgets. Late payments on home equity lines of credit rose to a 21-year high in the first quarter of 2008, the American Bankers Association said Wednesday.

While strapped consumers certainly can use those stimulus checks, they’ve done little to bolster consumers’ confidence in what lies ahead. Falling home prices are eating into their financial cushion. Stock prices, as measured by the Dow Jones Industrial average, have fallen since October by nearly 20 percent, the threshold widely used to describe a bear market.

A string of interest rate cuts by the Federal Reserve have done little to prompt lenders to ease up on tighter credit after years of lax lending standards.

“In America we borrow to buy houses, to buy cars, to send our kids to school, to remodel our houses to take vacations,” said Peter Schiff, chief global strategist at Euro Pacific Capital, one of Wall Street’s gloomier forecasters. “What we’re seeing right now is that we can't pay this money back. The lenders are cutting us off and this whole bubble economy that we have is deflating."

Banks are also busy unwinding the heavy borrowing used to buy mortgage-backed assets that went bust. Almost a year after those losses first began sending the financial markets reeling, banks continue to post big losses and take huge write-offs. That contraction also is weighing on the job market. Citibank reportedly is cutting another 6,500 jobs in its investment banking unit after posting losses of $15 billion over the past two quarters.

Along with consumers, private economists also are getting gloomier. Many forecasters now concede that the economic recovery they had expected to see by the end of this year will take longer than they thought to materialize.

Though consumer spending helped the gross domestic product advance by 1 percent in the first quarter of this year, that positive momentum may be short-lived once the stimulus checks are spent. Goldman Sachs chief economist Jan Hatzius expects the economy to begin turning down late this year or early next, with the unemployment rate hitting 6.5 percent by the end of 2009.

Despite the concerns about a weakening economy, Fed policymakers signaled last week that they had begun to worry more about inflation. That could signal plans to raise short-term interest rates. Already, central banks around the world — including China, India, Russia and Brazil — have begun boosting rates to try to keep a lid on inflation. The European Central Bank to followed suit at its rate-setting meeting Thursday, boosting rates by a quarter point to 4.25 percent.

Higher rates overseas put further pressure on an already weakened dollar, which has drawn some of the blame for the rise in energy prices. Some economists think the Fed’s inflation fears are misplaced. Especially if the economy is headed toward a full-blown recession.

“You’re going to have slack in the labor markets, slack in goods markets and you’re going to have a reduction in commodity prices once the U.S. recession becomes global,” said Nouriel Roubini, and economics professor at New York University’s the Stern School of Business. “Inflation is not the problem the Fed has to face.”

A lot depends on how long the housing market remains stuck in reverse. With the spring selling season over, home prices have continued to fall, wiping out billions of dollars worth of consumer wealth. That’s why job growth is so important: With less home equity to fall back on, consumers have little cushion to offset the loss in wages that comes from losing a job.

With most rebate checks paid out, there appears to be little prospect of further government response to the worsening economic outlook. Despite a recent call for more offshore drilling from the White House, there has been little talk of a formal response to the surge in energy costs, despite concerns that oil and gasoline prices may remain stubbornly high for some time to come.

Meanwhile, Congress and the White House continue a year-long effort to pass a housing relief bill to try to head off an estimated three million more home foreclosures this year. Though both sides are hopeful of passing a bill before the summer recess, it remains to be seen how far the final version will go in providing relief to those at risk of losing their homes.

POUGHKEEPSIE, N.Y. - In 2005, when Denise Bolds was looking to refinance her four-bedroom Victorian home in the Hudson Valley town of Poughkeepsie, she was intrigued by a mailing that said she'd been "pre-selected" for a loan program that could lower her monthly payments.

A single mom, Bolds lives with her 66-year-old mother and 17-year-old son, a high school senior who is headed for college. The program supposedly offered a "fixed-rate" loan with attractive terms, she said, which would help make ends meet on her salary as a social worker.

But when she got to the closing, she said, the terms had changed. The “fixed” rate of 5-3/8 percent only lasted two years, after which it could jump to nearly 12 percent, sending her monthly payments from $1,437 to more than $2,000. When she protested, she said, she was told she’d lose money she’d already put down in the application process.

After signing for the loan, she took the matter to the state banking department, which dismissed her complaint, based on the mortgage broker’s explanation that "all information was disclosed fairly and completely to the homeowner," she said.

By last summer, with college tuition bills looming and health complications that required surgery, the jump in monthly payments just wasn’t sustainable. She contacted her lender, she said, but was unable to work out more affordable terms. To avoid foreclosure, Bolds made the difficult decision to sell the house. That got her out from under the mortgage but wiped out her home equity.

“I had to make a decision: It was either (my son’s) education or the house,” she said. “I had almost seven years of equity (in my house), but I have 17 years of equity with my son. So my choice was no choice really.”

More and more homeowners face the same painful decision as the fallout from the housing and lending bust shows no signs of slowing. Foreclosures hit a record high in the first quarter, as did mortgage delinquencies, a sign that more foreclosures are coming.

Poughkeepsie is the county seat for Dutchess County, where one in every 442 households was at some point in the foreclosure process in April, according to RealtyTrac.com, which maintains a national a data base of foreclosure filings. That was the highest foreclosure rate in the state.

Congress continues to debate measures to help slow the pace of foreclosures, including extending hundreds of billions in refinancing from government-sponsored mortgage agencies to homeowners at risk of foreclosure as their loan payments jump to unsustainable levels. Meanwhile, state and local governments in places like Poughkeepsie are doing what they can to find solutions — like offering small loans to help tide homeowners over and offering counseling to mortgage borrowers in a financal bind. But their options are limited.

So far, Poughkeepsie’s economy has held up relatively well in the current economic slowdown. But unemployment began rising last year and has continued rising this year.

For some, it’s a sobering reminder of the devastating job losses in the early 1990s after IBM, the region’s dominant employer, slashed thousands of positions and left the region’s economy reeling.

Since then, as the county has worked to rebuild its economic base, Poughkeepsie has been rebuilding neighborhoods that were hit hard by the last housing recession.

“We have a beautiful Queen Annes' row right around the corner from us here in City Hall on Garden Street, which they completely revitalized,” said Poughkeepsie Mayor John Tyziak. “We have a lot of first-time home buyers who now live there and have strengthened that neighborhood.”

Now, with foreclosures rising, the momentum behind that revitalization effort is in jeopardy. Because Dutchess County didn’t experience the rapid housing development of high-growth areas like Florida and California, the downturn here hasn't been as swift or severe. But as the rising foreclosure rate has spread beyond the hardest-hit areas, communities like Poughkeepsie are beginning to feel the impact.

Homeowners facing foreclosure have several options. Much of the federal government’s response to date has been to encourage homeowners to contact their lender to try to work out more affordable terms. In Poughkeepsie, Hudson River Housing runs a homeownership program to help people facing default or foreclosure restructure their finances and try to work out a solution with their lender. Most people who contact the agency are first-time homeowners, according to executive director Gail Webster.

“They know they got somewhat extended, and they’re hoping to be able to fix it,” she said. “But if they can’t, they came from a rental unit, [so] they're going to go back to a rental unit."

In other cases, Webster said, “they do have the money, but they’re having trouble putting it all together. So you can help them by putting them in touch with a bank that can help them — instead of some kind of mortgage company that got them into trouble in the first place.”

Those who try to work directly with their lenders are finding the process slow going — partly because the rise in foreclosure filings is happening as the lending industry copes with job cutbacks that followed the housing bust.

“(Lenders) are still overwhelmed,” said Mel Spivak, a Poughkeepsie bankruptcy attorney who works with homeowners trying to head off foreclosure. “You don’t know who to deal with. Occasionally you get lucky, but there is really no contact person. There’s really no go-to person. Often when you call these lenders, it’s just a maze of voicemail.”

Some homeowners trying to stop the foreclosure process turn to the federal bankruptcy court here on Main Street, where few lenders even show up — preferring to turn cases over to local lawyers who run through stacks of filings as each case comes before the court. By that point, lenders are usually in no mood to work out a deal, according to Kathleen Silverii, who runs Legal Services of Hudson Valley, a Poughkeepsie agency that helps homeowners who can’t afford an attorney.

“Once (lenders) file the complaint, they don’t want to talk about how to work it out,” she said. “The machinery goes into motion, and it’s about litigating it. It’s no longer about ‘Let's see if you can catch up with your payments.'”

As house prices here continue to fall, some Poughkeepsie homeowners are finding they owe more than their home is worth. For some, the solution is a “short sale” — in which the lender agrees to accept less than the full value of the loan and not foreclose.

Norm MacKay, a local real estate agent for the past two decades, says short sales are making up a bigger part of his business. But while the process helps homeowners avoid the burden of damaged credit brought by a foreclosure, it doesn’t take the sting out of losing their home.

“A lot of them are having a very hard time emotionally,” MacKay said. “Some just cry and say. ‘I just can’t do it today. I’m going to lose it anyway so I will get back to you.’ But there’s terrible despair.”

Poughkeepsie is home to several dozen community groups and social service organizations that serve the mid-Hudson Valley, a region roughly midway between Albany and New York City. Here, as elsewhere in the country, the decline in homeownership has strained agencies that help the homeless, according to Silverii.

“Once people lose their homes, then (the state Department of Social Services) has to put them up and there’s a financial drain on the community just to support them,” she said. “Not to mention the loss of jobs and dislocation from children's schools and all of things that go along with it. It affects the whole community when people are losing their homes.”

Though some lenders are working out more affordable loans with homeowners at risk of default or foreclosure, progress is painfully slow. At Hudson River Housing’s NeighborWorks HomeOwnership Center, director Mary Linge says she’s working with a number of clients whose lenders are in the process of negotiating new terms — but none have have yet finalized more manageable payments.

Using funds provided by the county government and a local non-profit community group, the center recently hired another counselor to help with the increase in traffic from homeowners facing default or foreclosure. Dutchess County Executive William Steinhaus says local governments should be working on solutions that don’t rely entirely on tax dollars.

“I see us in a partnership role where there’s a shared responsibility and a shared effort to help those that maybe reasonably need some kind of assistance,” he said. “These require community solutions — not just county government solutions.”

A few state and local governments have begun to offer direct assistance to homeowners to keep up with their mortgages. For most part, these efforts have been limited to loans of $5,000 or so to make up missed payments.

Attention also has turned to trying to prevent future foreclosures. Community groups like Hudson River Housing are offering classes and providing counseling to help first-time home buyers avoid the traps that have tripped up many of those who are now losing their homes.

“It’s been shown that that people who are counseled, across all income levels — upper, middle, all the way down — become better homeowners and have a much, much lower rate of delinquencies and foreclosures,” said Albert Desalvo, community reinvestment officer at M&T Bank, a community bank with three offices in the city. “And one reason is because they don’t get snookered into these bad loans.”

New York is one of a handful of states that are tightening regulations on the mortgage industry to try to prevent lenders and brokers from selling more ruinous mortgages. Beginning this year, all mortgage brokers have to be licensed, submit to criminal background checks and take 18 hours of training, including an ethics class.

In November, New York Sen. Charles Schumer’s office estimated 50,000 borrowers in the Hudson Valley region had subprime loans totally nearly $15 billion. Roughly 30 percent of those borrowers qualified for cheaper, safer prime loans, according to that report.

Schumer is among those who have called for federal licensing and regulation of brokers. But it’s not clear whether those measures will be included in the final version of a housing bill that has been working its way through Congress for the past year.

Community reinvestment specialists like DeSalvo also say that without tough regulations, the lending abuses that contributed to the rise in foreclosures won’t go away.

“We’ve seen this coming for five or six years now,” he said. “When you get mortgage brokers doing these mortgages and tying in with appraisers and title companies and then selling the whole package directly to investors that are not regulated — that’s really where the focus needs to be. You’ve got to regulate how all this money churning is going on, and you’ve got to regulate mortgage brokers.”

And while lending standards have tightened, the mortgage marketing machine is still in full swing.

Last month, after spending over a year trying to get out from under her mortgage and losing her home to a short sale, Bolds got an e-mail pitch from a lender asking her if “paying less interest each month (would) make life just a little bit easier this spring.”

POUGHKEEPSIE, N.Y. - For Al Russo, a 30-year-old husband and father of two young boys, the trouble started about two years ago, when the shoe repair business he inherited from his parents hit a seasonal slow patch during the winter.

He’d set aside money to carry him over — just as his parents had taught him. But he had to use that money to pay for his mother’s funeral and soon began falling behind on his mortgage payments. To try to head off a foreclosure on the house he and his wife bought in 2005, he filed for bankruptcy this year at the federal court here on Main Street, representing himself. 

But on a recent spring afternoon in a standing-room-only courtroom, Russo's struggle to save his home ended after he missed a hearing in which the lender was allowed to proceed with its foreclosure action.

“There’s like no hope for me at all,” he said. “I’m going to lose everything my parents worked for, and there’s not a damn thing I can do about it.”

This city in the heart of the mid-Hudson Valley, about an hour south of Albany, has until recently largely avoided the housing downturn that has hammered parts of California, Florida, Arizona, Nevada and other regions where the housing boom ratcheted up prices the fastest and the mortgage mess has inflicted the most damage so far.

But now, with house prices falling and foreclosures rising here, both residents and local government officials are having a tougher time making ends meet. And they fear things may get worse before they get better.

Cities like Poughkeepsie, the county seat of surrounding Dutchess County, never boomed in the same way but enjoyed a slower but steadier housing expansion and stable economic growth. Until recently, it looked as though communities like this one might escape the fallout faced by housing markets that overheated at the height of the boom.

No longer.

Memories of FDR
Folks here are quick to remind visitors that President Franklin Roosevelt, who helped repair Depression-era economic damage and ushered in a new era of expanded homeownership, was born and raised in nearby Hyde Park. As the American dream of homeownership faces its greatest test in 75 years, Poughkeepsie’s leaders are working hard to minimize the wider economic damage on their community.

For starters, they’re bracing for a drop in property tax revenues as home values fall from peak levels in 2006, when the city conducted its latest revaluation.

“We are going to have to tighten our belts and look at spending across the board and tighten the way we operate,” said Poughkeepsie Mayor John Tkazyik, a 29-year-old former councilman who was elected to his new job in November, in part on his record of working to improve the region's economic development.

The housing downturn here, as in the rest of the country, represents a hangover fueled by easy lending terms that sent prices surging much faster than incomes. Though median household income in surrounding Dutchess County rose by 15 percent from 2001 to 2006, home prices surged by 82 percent, with the average selling price peaking at $409,000 in 2006. 

That average price has fallen back to $371,000. The pace of sales has also fallen; in May, home sales were 31 percent behind year-ago levels.

“Our market has had a significant correction,” said Sandy Tambone, who tracks local housing statistics at the Dutchess County Multiple Listing Service.

Now, as the spring selling season comes to a close, there’s little sign of improvement in what is typically the busiest time the year, according to Norm MacKay, a local real estate agent for 20 years.

“It’s very slow,” he said. “People are coming in with extremely low bids because everything they read and hear says ‘bad market.’”

As home prices have fallen, layoffs have risen. When the housing market began to soften in 2006, the job market here held up better than many parts of the country. But by early 2007, it had started to weaken and job losses rose through the year.

“What once was broad-based job growth — just about all the industry sectors were adding jobs — now it’s being replaced by job losses throughout most industry sectors,” said John Nelson, a labor market analyst with the New York Department of Labor.

Some job sectors are holding up relatively well, including commercial construction and professional services, a category that includes relatively high-paid professionals like accountants, lawyers and engineers. But the financial services industry in the Poughkeepsie area — including banking, real estate and insurance — are getting hit with job losses that threaten to ripple through the local economy. Several subprime mortgage lenders in the area, for example, began laying off workers as far back as March 2007, said Nelson.

“If people are losing their jobs, some of those people that live in our area - they’re going to cut back their spending,” he said. “A family that used to go out to dinner four to five times a week may cut down to just two, so you’ll see leisure and hospitality industries affected.”

This city and the surrounding county have been through tough times before.

For decades, the economy of the mid-Hudson Valley was heavily reliant on IBM as its biggest employer. So Poughkeepsie and surrounding towns suffered a major blow in 1993 when the company cut 10,000 jobs at a nearby manufacturing plant and the country lost another 10,000 from related industries, according to William Steinhaus, the current county executive, who first took office in 1992.

“To say we had a lot of houses you could have bought at that time would be an understatement,” he said.

As the national economy recovered from a housing-led recession at the start of the 1990s, Poughkeepsie’s recovery was slower. By 1998, the city had “grown accustomed to violent crime, drugs (and) prostitution,” according to a report that year in the New York Times.

Since that low point, the state, county and local governments have succeeded in rebuilding and diversifying the local economy, developing an active arts community. Today, the city is home to a half dozen art galleries. On Market Street, in the heart of downtown, the Bardavon Opera House, which opened in 1869, hosts a busy calendar of performing arts.

In 2004, Inc. magazine ranked Dutchess County as eighth-best small metro area in the nation for business. By 2005, more than $220 million in commercial and residential development had been approved or begun — more than double the combined development over the prior 10 years, according to then-mayor Nancy Cozean's 2005 State of the City Address.

But today, that revival is at risk as the national slump in home sales and the rise in home foreclosures spills over to cities like Poughkeepsie.

Local officials say that, so far, they haven’t had to make significant cuts in services.

“We put a hiring freeze in and we’ve restricted spending in other areas,” said Steinhaus. “We still have a mission: We’re still going to plow snow when we have to and send public public health nurses to senior citizens’ homes to care for them, and we’re still going to answer the phone at the 911 center.”

Unlike the federal government, which can
borrow money to make ends meet in tight times, county and city budgets have to balance every year. If sales and property taxes continue to fall, local government leaders here will face tougher choices. Until the pace of foreclosures begins to slow, the recession gripping the housing market will continue to weigh on the local economy.

“I don’t think we’ve hit bottom yet,” said Albert Desalvo, community reinvestment officer at M&T Bank, a community bank with three offices in the city. “One of the reasons it’s going to be hard to figure out the true amount of foreclosure for awhile is because it takes inordinately long in the state of New York to be completed — longer than most states. So I don’t think we’ve seen the worst of it.”

One big unknown is the fate of homeowners who are holding adjustable-rate mortgages scheduled to set to higher levels after a low, initial fixed rate. Those resets are a major factor behind the rise in foreclosure rates in Poughkeepsie and across the country. Higher monthly mortgage payments are kicking in just as as consumers face rapidly rising costs throughout their household budgets — from food to gasoline to health care.

Around the corner from Poughkeepsie's City Hall, Hudson River Housing runs a variety of housing and community development programs and has been working to minimize the damage from the rise in foreclosures. The non-profit community group helps homeowners in trouble work with lenders to negotiate a more affordable payment plan. The group also works with new home buyers to avoid the pitfalls that could get them into future trouble.

These days, traffic at the office is brisk. Last year, the office handled three or four cases a week. Today, they’re getting as many as six a day, according to Mary Linge, who heads the office. They’ve recently hired another housing counselor and have applied for additional funds from the state to meet the growth in demand.

“We’ve actually looked to some group sessions, which is unprecedented because it’s such a private matter,” she said. “But it’s the only way we're going to be able to handle everyone.”

Traffic is also brisk at U.S. Bankruptcy Court on Main Street, where some strapped homeowners are trying to stop the clock on foreclosure and work out a more manageable payment plan with creditors. As the economy weakens, the pace of filings will likely continue to grow, according to Mel Spivak, a bankruptcy attorney based in Poughkeepsie.

“We haven’t seen the crest of it yet,” he said. “Within the next six months or a year, hopefully it will peak out and maybe get better. But between gasoline prices, heating oil prices and adjustable rate mortgages, people are stretched to the bone."

On a recent afternoon, Judge Cecelia Morris heard more than 60 bankruptcy cases in a matter of hours. The circumstances that brought each debtor to court varied widely; so did their financial circumstances.

“Bad luck, dire straits and lack of planning do not discriminate — anyone can become a debtor,” Morris wrote in a recent e-mail.

Some of those who appeared before Judge Morris had worked out payment plans with lenders that were then approved by the court; others learned that their efforts to get a fresh start had failed. Morris carefully explained the reasons for each outcome, and congratulated those who had succeeded.

Since her appointment to the bench eight years ago, Morris said the change in debtors’ fortunes seems to be happening more rapidly.

“I am seeing debtors whose economic condition has deteriorated quickly — variable interest rates, all-time-high credit card interest rates and increased fees for late charges and minimum payments have driven them to seek bankruptcy protection,” Morris wrote. “The cycle from prosperity to bankruptcy seems to be much more rapid in today’s environment than when I was first appointed to the bench.”

After learning that his foreclosure would proceed, Al Russo and his wife made plans to move to Florida, where he hopes to get a fresh start working for a well-drilling company. Though he said he still has equity in his home, he doubts he’ll be able to sell it before the foreclosure process is completed.

And while he’s resigned to the prospect of starting over, he’s wary about the future.

“This is not going to get better — and not just for me,” he said. “This is going to get worse for everybody else.”   

Beyond the short-term losses from physical damage and lost business, the worst flood to hit the U.S. breadbasket in 15 years has added momentum to the recent surge in food prices worldwide.

Farmers and local officials were still assessing the damage Tuesday, as millions of acres of farmland remain submerged and thousands of Iowa residents were unable to return home due to the flooding.

Iowa Gov. Chet Culver said the state’s losses totaled in the billions of dollars, with 83 of 99 counties declared disasters and seeking federal aid. In 1993, floodwaters in Iowa, Missouri and neighboring states piled up $21 billion in losses.

The biggest economic impact — from rising grain prices — is already being felt. Corn prices at the Chicago Board of Trade soared to an all-time high near $8 a bushel Monday as the relentless rains and overflowing rivers raised fears that Midwest farmers will lose production on as many as 5 million acres, or 6 percent of the crop.

Food prices typically spike after bad weather ruins crops, but the increases are usually short-lived. This time, however, the spike follows a global rise in food prices that seems likely to last, according to analysts.

On Tuesday, the government reported that wholesale prices jumped in May at the fastest pace in six months. The Producer Price Index rose 1.4 percent, largely because of higher food and energy costs . The gain followed a modest 0.2 percent rise in April and marked the biggest increase since November.

Before the recent floods in the Midwest, corn prices already had more than doubled over the past two years; they've jumped another 25 percent in just the past few weeks.

Worldwide, food prices have risen 83 percent in the past three years, according to the World Bank. Bad weather in major grain-producing regions is part of the reason.

But growing worldwide demand — at a time when production hasn’t kept up — is also forcing prices higher, according to Sudakshina Unnikrishnan, a commodities analyst at Barclays Capital.

“Agriculture productivity levels have been stagnating for many years,” she said. “Suddenly you’ve had a situation where demand from emerging markets has been growing strong and stronger. The supply response from higher prices has been pretty abysmal: We haven’t seen production rising in response to the strong demand."

Concerns about rising demand and stagnant production have lead some grain-producing countries to halt exports, which has further crimped supplies for countries dependent on imports and driven up prices.

High demand coupled with tight supplies means that a disaster like the Midwest flooding could have a rapid and lasting impact.

“The issue of food security is becoming a big deal for a lot of food-producing nations,” said Ewen Cameron Watt, a market strategist at BlackRock Merrill Lynch. “There’s a whole host of food-producing nations — Egypt, Vietnam, Cambodia come to mind — who have effectively stopped exporting their surplus product because they’re concerned about potential shortages domestically and their effects on the domestic inflation.”

Demand for corn and soybeans also has been fueled by aggressive development of alternative fuels made from grains like ethanol and biodiesel. Higher oil prices also have raised the cost of producing grains, as farmers now have to pay more for fertilizers and the diesel fuel need to run their combines.

Higher corn prices could, in turn, make ethanol less profitable — despite heavy U.S. subsidies. Some 2 billion to 5 billion gallons of ethanol "could go offline in the next few months due to high corn prices," according to a research note from Citi Investment Research. The United States  now produces about 8.8 billion gallons of ethanol a year.

With the rise in grain prices showing no signs of letting up, investors have flocked to futures markets, adding further upward momentum to prices, according to Jonathan Barratt, who follows the grain markets at Commodity Broking Services in Sydney, Australia.

“Over the last six to eight months we’ve seen a lot of speculative money move into (farm commodities,)” he said. “With the speculators in the market that’s added weight to the movements and adding to the volatility.”

Just as high oil prices are spilling over into the prices of a long list of goods and services, higher grain prices also are putting upward pressure on other food products. The worry is that rising prices of these two critical raw materials will add further pressure to inflation.

That is making life even tougher for the Federal Reserve as it tries to keep interest rates low enough to revive a sagging economy without risking another outbreak of 1970s-style inflation. Fed policymakers hold their two-day midyear meeting next week and are expected to hold interest rates steady, due in part to the rising inflation.

“It pays for people to ignore the inflation when they’re worried about (economic) growth,” said Brian Wesbury, chief economist at First Trust Advisors. “But I’m not one of them: I’m very worried about this inflation. The core rate is accelerating, and so is the overall rate of inflation. So I just can’t see how people wouldn’t be worried about inflation.”

The hope is that a weakening economy will prevent inflation from becoming entrenched —allowing the United States to dodge another round of slow growth and high inflation that persisted through the 1970s, the worst economy since the Great Depression.

So far, inflation appears to be contained. Tuesday’s report on wholesale prices showed that after stripping out energy and food prices, which can swing widely from month to month, the so-called “core” rate of inflation rose 0.2 percent in May, down from a 0.4 percent increase in April.

One critical element that’s missing this time around from the classic “wage-price” inflationary spiral is a rapid increase in wages. So far, wages have not kept up with rising prices — one big reason that many U.S. consumers feel so gloomy about their personal financial outlook.

Those relatively tame wage increases also give the Fed some breathing room as it tries to head off raising rates to fight the rise in inflation.

“Labor costs are very weak,” said Joe LaVorgna, a senior economist at Deutsche Bank Securities. “I do believe that once this commodity story plays itself, you will see a lower headline inflation. And I hope the Fed doesn’t raise rates because I don’t believe housing market can take it, and I certainly don’t believe the credit markets can take tightening."

Is an extra couple of hundred dollars at the gas pump enough to break the budget of the average American? By itself, maybe not. But rising gas prices are just the latest in a series of blows that have consumers tightening their belts.

I have mortgage on my small home in Western Chicago and I'm sure it's going down in value, but it doesn't affect my bank account. … I still have my job (for now) and I still make the same salary (although I haven't had a raise in a couple of years). Are people walking the tight-rope of finances so closely that an extra $100 of gas each month and an additional $75 in groceries (due to inflation) is putting them that deep in a hole? That's only $2,100 per year. I can understand someone who is scraping by working at Wendy's feeling the pinch, but $2,100 a year?
— Russell S., Chicago, Ill.

It turns out there are a lot of Americans who are trying to make ends meet on a Wendy’s salary.

The average annual after-tax income for the middle quintile of wage earners (40 percent make less and 40 percent make more) was $43,799 in 2006 – the latest numbers available from the Bureau of Labor Statistics. Let’s see where it went:

The biggest single category is housing at $14,204; transportation ate up $7,662 and food accounted for another $5,614 in 2006. The Middle Quintile family’s budget also included $2,647 for medical care and $1,680 for clothing.

Gasoline accounted for $2,182 — or about $180 a month at 2006 prices. Since January, 2007, gas prices are up almost 90 percent. That’s means the Middle Quintiles are now paying $4,124 — an extra $1,942 a year.

The bigger problem is that the Middle Quintiles are looking at cost increases beyond the jump in gasoline prices. Higher prices for food, housing, clothing, medical care and other budget items have added another $1,600 to the stack of bills. So the Middle Quintiles have had to figure out how to come up more another $3,542 a year to keep the bill collectors at bay.

One solution would be to ask the boss for a raise, find a better-paying job or take a second (or third) job to make up the shortfall. But with the economy stuck in neutral — and maybe about to head in reverse — those options just aren’t available to many families. The result is that the average wage is up just 3.2 percent in the last 12 months.

That means the Middle Quintiles saw their paycheck grow by about $1,400 a year — or roughly $116 a month. Even if food and gasoline prices stopped rising today, the Middle Quintiles are still coming up short by $2,160 a year — or about $180 a month.

That may not sound like a lot to many Americans in the upper quintiles, but Mr. and Mrs. Middle Quintile have to make it up somehow. Tax rebate checks might have helped — if gasoline prices hadn’t begun surging in February before the ink was dry on the president’s signature passing the law. Even if gas prices remain where they are today, the rise in prices since February will have eaten up the entire $100 billion in rebates by the end of September.

That leaves the Middle Quintiles still looking for a way to come up with that extra $180 a month. The answer for many is to go deeper into debt. According to those 2006 spending numbers, the Middle Quintiles saw their assets increase by $10,288 – including gains on retirement savings and the value of their home. But their debt rose by $14,258. That meant they ended the year $3,970 further in the hole than they started. Today, with the stock market and house prices no longer lifting asset prices as rapidly as in 2006, the Middle Quintiles will likely see their debt balance continue to grow.

Even though there aren’t a lot of “extras” in the Middle Quintile’s family budget, at some point, their rising debt balance will force them find places to cut spending. The faster inflation rises, the sooner that will happen.

And when it does, the U.S. economy — which relies on the Middle Quintiles spending for 70 cents of every dollar of Gross Domestic Product — will also feel the squeeze.

Due to high cost of living, we dropped our vacation this year. We cut eating out from once every two weeks to once a month, we reduced from two to one entree per dinner, we eat more vegetables in place of meat, we stopped going to the movies on weekend. In sum, we are tightening our spending in every way — that's why we are not injecting our spending into the economy, saving our money to pay for fuel to go to work. Does this mean President Bush's economic stimulus plan is a failure?
— H.N. N. Fairfax, Va.

We won’t know for awhile whether the latest stimulus package developed by Congress and the White House will be able to head off a substantial economic downturn. (There's already some talk of trying another round of checks.) While the rise in gasoline prices offset most of the economic benefits of the boost in spending power, consumers are apparently still finding ways to keep shopping. The latest retail sales numbers were surprisingly strong given the pressures most consumers are felling today.

Still, the rebate checks don’t do anything to attack the underlying causes of the squeeze. Wages have been rising slowly because many American workers are competing with much lower-cost labor overseas. Their employers – from airlines to food manufacturers – have had a tough time passing along higher costs by raising prices. If companies can’t raise prices, it’s tough for them to give workers significant raises. Aggressive cuts in interest rates by the Federal Reserve were supposed to get business growing again. But the recent jump in inflation means the Fed may have to reverse course — raising rates to clamp down on prices. If they do, those higher rates won't help the economy get back on its feet.

Americans have also lost another big source of spending power that kept the economy humming though much of the past decade: the equity in the rising value of their homes. Hundreds of billions of dollars were “cashed out” through home equity loans and refinanced mortgages; that spending power has all but evaporated as house prices have fallen.

Unless and until the rising foreclosure rate can be reversed, that home equity piggy bank will remain empty for most Americans. The initial problem — exploding adjustable mortgages that left homeowners with monthly payments they can’t afford — shows no signs of letting up. Despite lending industry press releases about their ongoing efforts to work out more affordable loans, very little progress is being made to keep defaults from rising.

Based on the pace of foreclosures in May, another three million homeowners will hand over the keys to the bank this year. As the economy continues to shed jobs, that foreclosure rate could rise even further.

As those foreclosed houses hit the already glutted housing market, the problem only gets worse. Congress and the White House have been wrestling over proposals to fix the problem. Congressional leaders say they hope to have a housing relief bill on the president’s desk by July 4th, but it remains to be seen how many homeowners will be helped by the plan.

Where is the U.S. economy headed? Is the current downturn going to follow a V-shape — or maybe a U? Economists have come up with an alphabet soup of forecasts lately. We'll take a look at theirs and offer up one of our own.

When do you see the economy getting better?
— Betty, address withheld

We used to rely on our Answer Desk crystal ball for help with economic questions like this one. But no matter how much data we fed it, we couldn’t get a straight answer. So we traded it in for a flat-screen TV. Now we can watch economic forecasters come up with creative new ways to dodge the question.

Lately, they’ve been reverting to what we’ll call the ABCs of economic forecasting, assigning letters of the alphabet to their predictions.

For awhile, a lot of them were calling for a “V-shaped” recovery. This scenario calls for a sharp drop down (the left side of the V) followed by a quick recovery. The hope was that the faster the housing and credit markets hit bottom, the sooner everyone could start rebuilding.

But following the collapse of the credit markets last summer and the resulting gyrations in the financial markets, things seemed to be just muddling along. Since we didn’t get a sharp drop, the thinking went, a rapid recovery was unlikely. That got us to the “U-shaped” recovery — a more gradual slide down followed by a gradual climb back up. (A lot of the V-shaped crowd started using this one.)

More recently, we started hearing about a “W-shaped” recovery. According to this analysis, the economy turned down in late 2007 and early 2008 and we’re just now beginning to come back up to the mid-W peak, thanks to the Federal Reserve’s aggressive interest rate cuts and the flood of tax rebates now hitting the economy. Alas, this letter-based forecast suggests those measures won’t have a lasting impact. Once they wear off, the thinking goes, we're going slide down the right side of the mid-W peak before things get better again, perhaps next year.

Lately, we’ve heard another letter invoked: the dreaded “L-shaped” economy. This forecast says the economy slides along at pretty much zero growth — and stays there until mid-2009 or beyond.

If so, we’re hoping that “L” runs into a “J” sooner rather than later and gets us back on track for higher growth and lower inflation. Still, it’s hard to see how that happens as long as employment and house prices are falling and energy prices and home foreclosures are rising. The threat of ever-higher inflation could force the Fed’s hand and drive interest rates back up again — just when the economy needs the tailwind of a continued policy of cheap money.

A lot depends on how soon our government gets serious about tackling some serious economic issues. Start with a sane energy policy, maybe one that encouraged conservation and development of new sources of power instead of just helping oil companies pump more crude. (To start, you could cut the huge corn ethanol subsidies that are forcing up food prices and feeding inflation. There are other, better ways to brew the stuff.)

It also wouldn’t hurt to get serious about cleaning up the mortgage mess. With millions of homeowners stuck in ruinous mortgages facing sky-high payment resets, why not let them convert those exploding loans to fixed, market-rate mortgages they can afford?

So far, the lending industry’s voluntary “workouts” just aren’t cutting it. And if someone doesn’t defuse the alternative minimum tax bomb this year, another 20 million or so American families are going to have to figure out how to come up with tens of billions of dollars in taxes they didn’t owe last year.

Unfortunately, with the election now getting into full swing, Congress and the White House seem to be gripped with a quadrennial case of kick-the-can-down-the-road politics. Unless and until government can get its act together, The Answer Desk is calling for an “O” shaped recovery — with Washington going round and round in circles and the economy going nowhere.

Do you think all the economic info coming from Washington is true?
— Clifton D. San Angelo, Texas

As the old saying goes, “There are lies, damn lies — and statistics.”

“Truth” is a tough objective when it comes to measuring the economy, for several reasons.

First, it takes a long time to collect enough data to create a meaningful picture of what’s going on. That’s because “the economy” is really a collection of every job won or lost, every sale or purchase by every consumer, business, government agency, non-profit group, school, hospital, church, etc., the proceeds of every investment bought or sold, the manufacture of every new house, car, bedroom set, big screen TV and on and on.

That’s why pretty much every meaningful piece of economic data is a guess. In some cases, these are very good guesses — based on sound survey samples and solid statistical techniques. In other cases, the data are almost always “noisy.” If you put them all together, they sometimes — but not always — point in the same direction. That’s why economists come up with such different conclusions when they read the same set of numbers.

The other big reason economic “truth” is elusive is that much of the analysis is based a very incomplete understanding of human behavior and psychology — which can shift as rapidly as the data is collected. As oil prices have risen for the past several years, for example, it was widely assumed that energy consumers would change their behavior accordingly. Few predicted that consumers would tough it out this long before trading in their SUVs for higher-mileage cars. The latest round of layoffs in Detroit are a response to that shift; some suggest that automakers were “caught by surprise” as the market for light trucks collapsed.

Even at this stage, it’s not entirely clear where energy prices are headed: that uncertainty spills over into decisions about car purchases, how far from work we live, how far to tighten our budgets, whether to take a summer vacation, etc. So the only real “truth” is: No one knows.

Some readers insist that the “inaccuracy” of government economic data is deliberate, that the numbers are being manipulated to adhere to a political agenda or to portray the incumbent administration in a better light. There are certainly shortcomings in the way the data are collected and analyzed: Private economists sometimes take issue with the way their counterparts in government assemble the official numbers. (Various methods of “seasonal adjustments,” for example, are one of the most common sources of debate.)

But the idea that some political appointee is reviewing and editing these reports before they’re published is, in our opinion, not very credible. For one thing, these data are very closely scrutinized and compared with private, independent surveys and data sources. If you tried to cook the books, your conspiracy would have to include an awful lot of people both inside and outside the government.

More to the point, if someone is spinning the data, they should be fired. The latest numbers are hardly painting a picture of the kind of economy you’d like to see in an election year.

Despite the heavy headwinds of higher prices for food and gasoline, falling home prices and worries about losing their jobs, most American consumers are still finding a way to pay the bills. But as economists, business executives and government officials try to figure out where the economy is headed, they’re also wondering: How long can consumers keep this up?

Consumer spending, which accounts for roughly 70 percent of U.S. economic activity, continues to grow, but barely. Personal consumption was up 1 percent in the first quarter after adjusting for inflation, according to Thursday's report on the gross domestic product. But the pace of spending growth has slowed sharply from 2.3 percent in the fourth quarter of last year.

Income growth has also slowed, edging up just 0.2 percent in April — about half the rate logged in March, according to government figures released Friday. The gain would have been weaker without the boost from the initial round of rebate checks hitting taxpayers' mailboxes. Friday's report also showed that consumer spending also slowed to a crawl in April - up just 0.2 percent. After factoring out inflation, there was no gain at all.

Consumers are is no mood to spend if they don't have to; consumer confidence fell to a 28-year low in May, according to a Reuters/University of Michigan survey released Friday. The reading was the lowest since June 1980, when the U.S. economy was in shambles and short-term interest rates reached 20 percent after a decade of rapidly rising prices, erratic growth and high unemployment.

Today, rapidly rising prices for gasoline and other commodities are one of the main reasons Americans are so pessimistic about their finances. But while a number of economists — and many consumers — believe the U.S. is already in a recession, the latest data don’t yet point to an economy moving in reverse. So why are consumers so gloomy?

One reason is that after four straight months of government reports showing job losses, Americans are getting more worried about their jobs, according to Ken Goldstein, a labor economist at the Conference Board, which tracks consumer sentiment.

“If we continue to get even small decreases in jobs, these consumer confidence numbers are not going to turn around this summer or even this fall,” he said.

Though the job market is weakening, it’s still fairly strong by historical standards; the unemployment rate, at 5 percent, is well below levels reached in past recessions. Unemployment peaked at 6.1 percent in the relatively mild recession of 2001; it hit 7.8 percent in the 1990-91 recession and topped out at 10.8 percent in the 1981-82 downturn.

But the job figures don’t tell the whole story: Though unemployment is still low, incomes have not risen as fast as the economy has grown since the last recession. Gains in hourly wages don’t tell the whole story, according to Jared Bernstein, who follows labor issues at the Economic Policy Institute.

“One of the big stories in this recovery was that families weren’t able to find enough hours of paid work to get their income back in line," he said. "So the median family income as of 2007 was about $500 below where it was in 2000.

Even as wages lagged, consumer spending has increased faster than the overall economy — it now makes up roughly 71 percent of GDP — up from 64 percent in 1998.

To finance spending during that period, Americans leaned more heavily on credit cards, dipped into retirement savings and turned to their biggest source of cash — the rising value of their homes. Over the past decade, homeowners have tapped close to $1.5 trillion in rising home prices by taking out bigger mortgages to convert home equity into spending money.

Now, with home prices falling and lenders pulling back, that gigantic piggy bank is running dry. As the housing slump continues, the impact on spending worsens, accoridng to Robert Brusca, chief economist at Fact and Opinion Economics.

“The problem is what it does to the people who live in homes whose values are falling and what it does to their willingness and ability to consume goods," he said.

The housing slump has also created a lending slump. Mortgage lenders have less money to lend after investors who bought bonds backed by faulty mortgages got badly burned. Now lenders are a lot choosier about who they’ll lend to; From the peak of the lending boom, the flow of mortgage credit has roughly been cut in half, according to Brian Bethune, an economist for Global Insight.

Until mortgage lending picks up again, the housing market will have a hard time getting back on its feet. But until home prices stop falling, lenders are going to remain leery about writing a mortgage on an asset that is still losing value.

“As long as the housing market is weak the lending is not going to be there,” said Bethune. “And as long as the lending is not there the housing market is going to be weak.”

A rise delinquencies and other consumer credit problems have also begun to crimp the flow of car loans, according to Richard Apicella, who tracks car lending at BenchMark Consulting International.

“Maybe they've had a repossession in the past, or maybe they've had unfortunately a foreclosure, or the debt-to-income (ratio) that they're carrying is much higher,” he said. “When banks - which have fewer funds to lend - look at the type of person they can lend money to, fewer and fewer people are going to qualify."

With home equity shrinking and lenders pulling back, government policymakers are running out of options. Despite big cuts in short-term interest rates by the Federal Reserve, rates on many important consumer loans like mortgages and credit cards haven't fallen.

And the Fed’s rate-cutting phase appears to be coming to a close. If food and energy prices keep rising, the central bank may have to reverse course before consumers have stabilized their household budgets. That would leave the Fed with the difficult choice of raising rates to fight inflation — or leaving rates low to try to keep consumers spending.

"The adverse feedback loop that the Fed fears most — namely that a continued sharp fall in house prices produces by a clampdown in bank lending, which then feeds back into outright falls in consumer spending — that key downside risk is still very much in play," said Richard Iley, a senior economist at BNP Paribas. “So it’s very difficult juggling act for the Fed."

As dire forecasts about runaway oil prices become reality, it’s impossible to know how much higher they’ll go. But the impact of the price surge already is  being widely felt. And if prices go much higher, the damage to the U.S. economy will be deeper and wider than the fallout from the run-up so far.

Oil prices have doubled in the past year and have shot up nearly 50 percent since January to a record $135 a barrel. Much of the rise appears to be driven by speculators betting that tight supplies — or outright shortages — will push prices even higher.

Consumers — already hit with rising prices and flat wages — are being stretched further. As the Memorial Day weekend kicks off the summer driving season, gasoline prices are at record levels, reaching a national average above $3.83 a gallon. Some analysts predict the average will break past $4 as early as next week. In some parts of the country, prices are already closing in on $5.

“We're already in a mild recession,” said Lakshman Achuthan, an economist at the Economic Cycle Research Institute. “I think if we go towards $150 (a barrel), we start talking about something worse than a mild recession.”

The surge in oil prices is hitting some parts of the economy harder than others. Companies that use lots of oil have already been hurt; the recent surge will only make matters worse.

Airlines have been struggling to make a profit, even as they cut jobs and flights. American Airlines became the latest to announce it was tightening its belt another notch, saying Thursday that it plans to shrink capacity by as much as 12 percent and cut thousands of jobs.

To offset the rapid rise in jet fuel prices, the airline also said it plans to start charging passengers $15 to check the first bag of luggage for each passenger. United Airlines said it’s considering a similar move. The carriers already charge $25 for a second bag.

“(Higher oil prices are) going to send some smaller airlines into bankruptcy," said Nick van den Brul, an airline analyst at the French investment bank, Exane BNP.

Surging gasoline prices are further dampening sales at U.S. carmakers, whose product lines are more heavily oriented toward higher-profit, lower-mileage trucks and SUVs than their foreign competitors.

Ford Motor Co. said Thursday it’s cutting production by 15 percent in the second quarter of this year and another 15 to 20 percent in the third quarter.  Ford now says it won’t hit its target of getting back in the black by next year and may have to lay off more workers and close more plants.

Some parts of the economy will hold up relatively well; companies and regions that produce oil will do better. Oil companies are enjoying a spike in profits because production costs have not risen nearly as rapidly as market prices. Those higher profits could help boost local economies in regions where oil and natural gas are produced.

But those benefits will be more than offset by the negative effects of the surge in energy costs. Higher oil prices have already begun to spill over into higher costs for a variety of products and services, including food prices.

The threat of higher inflation makes life even more complicated for policymakers at the Federal Reserve, who have been slashing rates for nearly a year to try to offset the fallout from the housing slump and turmoil in the credit markets.  

The surge in oil prices could force the Fed to reverse course and begin raising rates — before the benefits of those rate cuts have had time to take hold. Minutes of the Fed's April policy meeting, released Wednesday, indicated that the central bank could start raising rates in the fall.

The biggest concern is the potential impact on consumer spending, which accounts for about 70 percent of U.S. economic activity. Consumers have already been hit by the slump in housing prices — eliminating the equity "piggy bank" that many homeowners tapped as prices were rising. Home prices fell 3.1 percent in the first quarter of 2008 compared with last year, according to data released Thursday by the government’s Office of Federal Housing Enterprise Oversight.

Another widely followed reading, the Standard & Poor’s/Case-Shiller index, has shown even larger declines for major U.S. metropolitan areas.

Rising gasoline prices are one more burden on consumers. Economists estimate that every additional penny at the pump takes roughly $1 billion out of overall spending. Taxpayers getting rebate checks designed to revive spending and get the economy moving again have already spent much of that bonus to gas up their vehicles.

So far, there seems to be enough oil and gasoline to go around: Refineries are still adequately supplied with crude, and gas stations aren’t running out of fuel.

Prices are surging as  traders see an increased risk of that happening. But that so-called panic buying could quickly reverse, sending oil prices sharply lower.

“This is all about psychology, and we are not very good at oil companies about forecasting the  psychology of prices," Jeroen van der Veer, CEO of global giant Royal Dutch/Shell, said on CNBC Thursday. “So we'd better prepare ourselves for more volatility because if this is psychology, it can change very quickly.”

The spike in oil prices also has brought calls for government action, despite the limited short-term impact those responses could have. The Department of Energy has suspended purchases of oil for the Strategic Petroleum Reserve.

But Energy Secretary Samuel Bodman said Thursday he did not support the idea of selling oil from the reserves to try to drive down oil prices.

The petroleum reserve "is meant to deal with ... the physical interruption of the flow of oil to our country. We don't have that issue today," Bodman told a House hearing.

The last such move came in September 2005, when the U.S. released millions of barrels of oil from its reserves as part of a coordinated effort by the International Energy Agency to head off possible shortages. But the amount conrolled by the United States is a relative drop in the global barrel and would likely have little impact on market prices.

The price surge has also revived debate on U.S. energy policy. Some longer-term proposals that have failed to win the support of the majority in Congress, like opening up new areas of the U.S. for oil drilling, may now get another look.

“We have to expand domestic exploration, we have to add additional new refineries, we have to add nuclear power into our electricity grid portfolio, we have give rewards for conserving energy and have to  continue to invest in research  and development,” Rep. Adam Putnam, R- Fla., said Thursday. “We have to have an ‘all of the above’ energy policy.”

The recent trajectory of oil prices — a fairly steady increase followed by a much more vertical rise — has a familiar look to it. Remember those charts of tech stocks and housing prices? It's hard not to wonder: Are oil prices forming the next big “bubble?"

Those who see a bubble forming say you need look no further than the recent run-up in the cost of a barrel of crude to the current level of about $124.

“We were only trading at $86 about three months ago and not a whole lot has changed to move us to where we are now,” said Addison Armstrong, Director of Market Research for Tradition Energy. “There's no doubt in my mind — and most other people I speak to — we are in a bubble. And it's going to deflate at some point.”  

Many making the "oil bubble" argument cite the shape of a chart to make their case. For one thing, there’s no shortage of oil; inventories rose a bit this week and remain at just about the middle of the five-year average range for this time of year. Now that the Federal Reserve has signaled it may soon end its yearlong rate-cutting spree, the dollar — whose fall had been a big factor in the run-up of crude prices — is showing signs of strength. And a sluggish U.S. economy and high gasoline prices have begun to make a dent in demand.

Overheated speculation, the most common cause of any investment bubble, has taken hold in oil trading pits, according to bubble theorists. Fearful that a cutoff in supplies could send prices skyrocketing, oil traders and their customers (hedge funds and industrial oil consumers) are willing to pay high prices to lock in supply at a predictable price. As long as those traders and industrial users think supplies are at risk, that “premium” is likely to remain.

The fears of a supply cutoff aren't without merit. There is so little excess production capacity today that the loss of a major supplier could create a shortage of oil. That has led to worries that oil prices could jump even further. Last week, a Goldman Sachs analyst created a stir by advising clients that oil prices could reach $150 to $200 a barrel over the next six months to two years, though he said the outlook “remains a major uncertainty.”  (His official forecast: oil will sell for $108 at the end of this year and gradually rise to $120 in 2010.)

Many analysts see prices moving the other way. According to the consensus forecast tracked by Thomson Reuters, oil prices are expected to end this year around $91 a barrel, falling to $90 by the end of next year and $82 by the end of 2010.

Bubble proponents argue that if demand for oil continues to ease and supplies hold up, the speculative fever driving up prices could quickly evaporate, and prices could fall sharply.

It wouldn’t be the first time prices have crashed. In 1986, oil prices began the year at $26 a barrel. By March, crude was selling for $10.25. In 1997, prices peaked in October at nearly $23 a barrel only to fall below $11 a little more than a year later.

But the forces that caused those oil “crashes” aren’t evident today. The 1986 slide was the result of heavy overproduction by OPEC, when Saudi Arabia opened the spigots after fellow cartel members cheated on their quotas. The 1998 pullback also resulted from a huge oversupply after the Asian economy unexpectedly slowed sharply as a currency crisis swept through the region.

Today, the world’s oil producers have little extra capacity, and the Asian economy is booming. Bubble skeptics say that while oil prices may be due for a pullback, the longer-term trend is clearly higher.

“When I hear bubble, I'm thinking of a technology bubble where we spike up and we just never come back to it again,” said Chris Jarvis, an energy analyst at Caprock Risk Management. “I don't think that’s the case. I think if anything you’re talking about more of a short-term pullback. What is short term? I don't know, nine months to a year. But the trend higher is still  intact. I would definitely not call it bubble.”

The reason for that kind of thinking is that the world’s “cheap" oil has been found and exploited. Even if producers continue to find new sources to keep up with growing demand, they’re going to have to drill deeper in more remote parts of the world. And the same inflationary pressure on oil prices is being felt on the increasingly tight resources needed to find and produce new oil — from drilling rigs to skilled workers.

“It's now twice as expensive to start a new oil field as it was three years ago,” said Cambridge Energy Research Associates Chairman Daniel Yergin. “All of these commodity prices are interacting with each other.”

It’s also less likely OPEC will slip up again and glut the world’s markets. Some members, including Venezuela and Nigeria, are having trouble producing at capacity. Political instability in big producers like Iraq pose an ongoing threat to supplies. Even Saudi Arabia has far less excess capacity than it did in the 1980s and 1990s. That makes it much easier for OPEC to keep prices high.

“OPEC is now up to a level that they're willing, frankly, to defend oil  prices at," said Diane Swonk, chief economist for Mesirow Financial. “A long time ago they were defending $25 per barrel. Now they're willing to defend over $80 a barrel.”

Since strong demand for oil has been a key factor in the run-up, a slowing economy should help reduce demand. But while the U.S. economy has slowed — and may have even slipped into recession — the rest of the global economy is still growing, especially in developing countries like India and China.

The growth of those developing economies also has sparked a longer-term trend of increasing wealth, which in turn increases demand for oil. As consumers buy more cars, for example, the overall base demand for gasoline rises — even if those economies slow down.

“In emerging markets, we're seeing a rise in real wages,” said John Brady, who follows the oil market at MF Global.  “In China alone, in 2007's first-quarter auto sales were up on a year-over-year basis 27 percent. And there’s little reason to see a trend like that come to an end, especially because China subsidizes the price of gasoline.”

China isn’t the only one. In Venezuela drivers can fill up for 19 cents a gallon, while in Iran drivers pay just 38 cents. Libya, Kuwait, Egypt, India, Nigeria, Malaysia, Indonesia and Iraq also subsidize gasoline to keep pump prices lower than the actual cost.

In those countries, higher gas prices have not discouraged consumption the way they have in Europe, Japan and, more recently, the United States, where consumption is declining slightly.

Longer term, the higher price of gasoline should encourage U.S. consumers to squeeze more miles out of each gallon. Despite big gains in efficiency after the surge in oil prices in the mid-1970s, the average fuel economy of cars and light trucks sold in the U.S. has remained pretty much flat since 1985. But overall mileage has fallen, as the share of lower-mileage light trucks and SUVs has risen from about 20 percent of the total fleet in 1980 to about half of all vehicles on the road today.

As suburbs have expanded, Americans are driving further to work, according to Federal Highway Administration surveys. In 1983, the average commute by car was 8.5 miles; by 2001 that had risen to 12.2 miles.

The good news is that those same surveys found that there’s room for some conservation if gasoline prices do go through the roof. About a third of the vehicle-miles traveled in 2001 were work related: the rest were for family and personal business (35.4 percent) and social and recreation (24.4 percent).

This week, readers are looking for a straight answer to what seems like a simple question. Is the U.S. in recession or not?

Okay, the answer is "Yes, it is simple question." After that, things get a little more complicated.

How can the economists disagree so greatly with each other? Is we is or is we ain't in a recession? It is a yes-or-no question.

— Mary W., Newport, N.C.3.

President Harry Truman shared your frustration.

“Give me a one-handed economist!” he is credited with saying. “All my economists say, 'On the one hand … on the other hand… '”

Which brings to mind an economist joke or two.

So these two economists were walking in town when they noticed two women yelling across the street at each other from their apartment windows.

“They’ll never come to agreement,” said one.

“Why not?” said the other.

“Because they’re arguing from different premises,” said the first.

(Badda-boom.)

And did you know that you could lay all the world’s economists end to end and they’d still never reach a conclusion?

Okay, maybe it’s unfair to pick on economists. There’s a reason they call it the Dismal Science. For all the disk drives full of economic data available to collect and analyze, there’s no speedometer on the U.S. economy. Each piece of data tells you only a piece of the story, and it’s not unusual for those pieces to contradict each other.

It also takes time to tally the books on the Gross Domestic Product of a $13 trillion economy: the final accounting of all the stuff we make and sell and the services we provide for each other. It takes months. In the meantime, you can look at individual pieces of data puzzle that can be added up more quickly.

Employment is a big one: if the economy is losing more jobs that it’s creating for more than a month or two, that’s a good sign the economy is headed in reverse — or about to. On the other hand (sorry about that), if all those jobs are lost because they went offshore, and U.S. companies keep selling more and more stuff made to order by workers in other countries, the U.S. economy keeps growing.

That seems to be one of the biggest sources of confusion among readers, based on last week’s email. A recession — by definition — doesn’t happen unless and until the overall level of economic activity begins shrinking instead of expanding. In other words, if U.S. companies all lay people off and then sell less stuff, that's a recession.

So far, the best indication we have that a recession is already underway in the U.S. is four straight months of job losses. The latest available reading on the broadest measure of the economy, the GDP, has slowed to nearly zero. But it has not yet signaled that we’re heading in reverse. (Usually, it takes two back-to-back quarters of negative GDP to confirm a recession.)

Okay, so why do so many people believe a recession is already upon us? The jobs data are compelling but not conclusive. Compared to past recessions, some of which were truly nasty, the numbers just aren’t that bad yet. Unemployment is half what it was in the worst of the 1982 recession. Inflation is rising at a very worrisome pace, but it’s still low by historical standards and nowhere near where it was in the 1970s. Why so much gloom and doom?

Many readers blame the media. There are certainly corners of the blog-infused, cable shoutfest that have made ridiculous assessments and dire forecasts not grounded in facts. But we suggest there’s another reason.

There’s no doubt million of families are suffering economically. Our Inbox is full of their stories, and they're not making them up. They’re having trouble buying groceries or paying for their health care. They can no longer afford to pay college tuition. Their wages aren’t keeping up with the cost of what they were able to buy last year. That hardly feels like prosperity.

There’s no doubt million of families are suffering economically. Our Inbox is full of their stories, and they're not making them up. They’re having trouble buying groceries or paying for their health care. They can no longer afford to pay college tuition. Their wages aren’t keeping up with the cost of what they were able to buy last year. That hardly feels like prosperity.

But, so far, that suffering is not the result of a recession. A recession is an economy that is contracting: that may yet happen. But since the last recession in 2001, the U.S. economy has been growing. So any talk about “the deep recession” we’re in just isn’t factually correct.

Unfortunately, for a variety of reasons in America today, personal prosperity and economic expansion aren’t the same thing. There are many serious problems with the way the rewards of the growing economy are being distributed. The gap between rich and poor continues to widen. As those at the bottom are hurting, the rewards of the expanding economy are going to the wealthiest: CEO's get bonuses for screwing up large corporations, lenders focus on profits without regard for the borrowers’ interests, tax cuts are funded with borrowed money. All of this is a real problem.

But it’s not a recession. It’s a problem with a broken tax system, increased concentration of wealth, misguided economic policies and financial deregulation run amok. Unless and until we understand what the real problems are, it’s hard to see how we’re going to find solutions.

Martin Feldstein intimated that if the depreciation of housing prices were to be anything like the appreciation of those same housing prices or greater than then the economy will be in a prolonged downturn. What is that depreciation rate of housing prices now?
— Dave, Newberg, Ore.

Real estate markets are very local, so the national averages may have little to do with what’s happening in your neighborhood. And there are different measures of house price trends; you can pretty much take your pick.

The National Association of Realtors focuses on sales of existing homes, one of the most widely watched measures. The price for an existing single-family home was $198,200 in March, down 8.3 percent from a year ago.

But keep in mind the data can be skewed by a change in the mix of properties. If sales of high-end homes stay strong, the median sale — the one in the middle of the list from top to bottom — may hold up well even though prices at the bottom are falling faster. 

New home sales are tracked by the Census Department. From a peak in March, 2007 the median price of a new home had fallen by 13.3 percent compared to a year ago.

The Office of Federal Housing Enterprise Oversight, the agency that oversees government housing finance giants Fannie Mae and Freddie Mae, publishes a House Price Index using data on on “repeat sales.” This index tracks prices of the same house over time, based on the mortgages on those houses moving through Fannie and Freddie’s books.

From a peak in April, 2007 to January, 2008, that index fell 3.7 percent. In February, the latest month available, the index bumped up by 6-tenths percent. Because OFHEO only tracks loans up to $417,000, those numbers may miss what’s going on at the high end of the market.

Then there’s the Case-Shiller Home Price Index (named for the economists who developed it) which is published monthly by Standard & Poor’s. The data tracks repeat sales of the same houses of over time but only in 20 of the biggest cities.

That index fell by 14.8 percent from a peak in July, 2006 to Feb., 2008, the latest data available. What’s most worrisome is that the price drop accelerated sharply between January and February, when the index fell 2.7 percent in one month. (The March index will be released on May 27.)

House prices are falling, food and energy prices are rising and consumers are gloomier than they’ve been in decades. But the latest data on the U.S. economy shows it still has a feeble pulse.

So which is it? Are we in the early stages of a full-blown recession? Or is this a brief downturn before the economy gets up another head of steam later in the year?

Though the start of a recession can only be seen in the rear-view mirror, many economists now believe the U.S. economy is close to recession or in one. That’s based largely on a string of monthly reports showing the economy has lost about 260,000 jobs so far this year.

“Since the 1950s we've never had a period of four months of job losses without that signaling that we were in a recession,” said Jared Bernstein, senior economist of the Economic Policy Institute. “If and when (a recession is confirmed), it will probably be dated based on these payroll numbers as starting sometime around December or January.”

But other economic signals are flashing yellow, not red. The government recently reported the gross domestic product grew slightly in the first quarter, while generally GDP shrinks in a recession. Last week's employment report for April showed the economy lost only 20,000 jobs, fewer than in previous months.

On Thursday, retailers reported better-than-expected sales for April. But most of those gains came from discounters and wholesale clubs, a sign that consumers are tightening their budgets.

Part of the puzzle may rest in the data itself. Monthly jobs data can be volatile, especially when hiring is slowing. The GDP data represents the economy's average performance in the quarter and is subject to revision in coming months.

“If you compare where the economy was at the end of March with where we were at the beginning of the year, there is no question the economy is down by just about every measure,” said Martin Feldstein, the former chief economic adviser to Ronald Reagan who now heads the National Bureau of Economic Research, which formally "declares" U.S. recessions.

Even without the confirmation of a down quarter, about half of the economists polled last month by the Blue Chip Economic Indicators survey said they believe the U.S. economy has already slipped into recession or will do so this year.

The majority said they don’t expect the downturn to be especially deep or last very long. The consensus forecast calls for the GDP to eke out a 0.1 percent advance in each of the first two quarters of this year before picking up speed in the second half and ending the year with modest 1.4 percent growth. That is down from earlier consensus forecasts of 1.5 percent in March and 2.6 percent last September, when the Federal Reserve first began to cut interest rates.

That’s not the view of Americans consumers, most of whom see the economic glass as less than half full, according to the latest survey of consumer sentiment. Americans are gloomier about the economy than at any time since the early 1980s, when the economy was emerging from a decade of weak economic growth and rampant inflation. Nearly nine in 10 consumers think the economy is in recession, according to the Reuters/University of Michigan survey.

Some economists are at a loss to explain that level of pessimism given that, so far, the data indicate the economy isn't in such bad shape.

“While there’s no question the economy is struggling, just how anyone could confuse the current environment with the worst economy since the Great Depression is baffling to say the least,” said Wachovia chief economist John Silvia.

The answer to that riddle may be that consumers see trouble ahead that the data isn’t picking up yet. The big worry is that falling house prices will continue to chew up the home equity that has become the main financial asset for many Americans.

Feldstein notes that home prices have fallen 13 percent in the past year and have been falling at a 25 percent rate over the past three months, leaving more than 8 million homeowners stuck with mortgages that are bigger than their house is worth. Many of them are tempted to simply walk away and mail the keys to their lenders.

“If we see a big increase in defaults, and ultimately in foreclosures, that's going to, I think, push us definitely into a significant recession," Feldstein said.

Even if the worst case doesn’t play out, consumer anxiety about home equity has a direct impact on the economic outlook because consumer spending accounts for about 70 cents of every dollar of GDP.

Some retailers reported Thursday that spending perked up in April after months of dismal sales. But the gains were concentrated among discounters like Wal-Mart and Costco. Consumers are still shying away from stores selling clothes and other non-necessities; most mall-based apparel stores struggled last month.

Spending has already been crimped by higher food and energy prices. And though job losses shrank in April, American workers saw their hours cut back and average hourly earnings pretty much flat. If you factor in the effects of inflation, wages have begun heading into negative territory. The last time that happened was in 2001, the start of the last U.S. recession.

“It’s clear that households have very little spending firepower at the moment through their inflation-adjusted paychecks,” said Credit Suisse chief economist Neil Soss.

Consumers are getting a boost from tax rebates that are being paid out to some 130 million households. But the sharp jump in gasoline prices already has taken a huge bite of that spending power.

All of which has some economists worried that the economy may not have hit bottom yet.

“There's good reason why confidence is as low as it’s been since 1982,” said Mark Zandi, chief economist for Moody's Economy.com. “It can go lower. Gasoline prices are going to continue to rise. House prices aren't going to stop falling. We haven't seen the end of the job losses. I don't see any reason why we should expect consumer spending to not weaken even further.”  

So far the surprising bright spot in the U.S. economy has been the manufacturing sector, especially companies that do strong business in exports. The weak dollar gets most of the credit, but the strength in exports has gone a long way toward offsetting the sharp decline in the housing market and the periodic freeze-up of the credit markets that provide the lifeblood for the economy.

Strong export demand has also kept inventories relatively lean, which means that even if the economy continues to slow, businesses are less likely to get stuck with a lot of unsold merchandise. Big inventory backlogs often prolong a recession even after the pace of sales begins to pick up again. If inventories stay lean, that could speed the economy’s rebound when business picks up again.

And just as they’ve kept inventories lean, businesses also have kept their payrolls fairly tight during the economic expansion that began in late 2001. That could help limit job losses during the current downturn.

A lot will also depend on whether homeowners stuck in mortgages due to reset to higher payments in the next few years can refinance into more affordable loans. While Congress has debated a number of solutions, the government has been relying on borrowers and lenders to work out new terms voluntarily.

“The trouble with the voluntary restructurings is there's nobody to talk to,” said Feldstein. “Sure, if your mortgage was taken out with a local bank that kept that mortgage, yes, you can sit down and talk. But if it has been securitized and (sold off to investors), there’s nobody there on the other side. That's why the Treasury's proposal in that direction has had so little impact.”

After a year of aggressively slashing interest rates, Federal Reserve policymakers signaled that their rate-cutting days may soon be over — for now.

As expected, the Fed's Open Market Committee served up just a quarter-point cut Wednesday, leaving the benchmark for overnight loans between banks at just 2 percent — down from 5.25 percent when the rate slashing began last summer.

Some Fed watchers say we may see one more cut before the Fed pauses to see if its easy-money policy has the desired effect of boosting a sagging economy — without setting off another upward price spiral. But the comments attached to Wednesday's decision lead some to believe the Fed is headed for
the sidelines.

"I think they're going to pause right now and that's the message we should be taking away," said former Fed Governor Susan Bies.

Fed Chairman Ben Bernanke and his colleagues may have little choice.

That's because soaring food and energy prices are beginning to spill over into the wider costs of other goods and services. And the quickest known antidote to higher inflation is to move interest rates back up again.

In explaining Wednesday's decision, the FOMC put less emphasis than in prior meetings on the risks of an economic downturn, and noted that " uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully."

Those developments include a continued surge in oil and gasoline prices. Oil recently came within a dime of $120 a barrel to set a record. Pump prices are up 55 cents a gallon in the past 10 weeks. Credit Suisse economist Jonathan Basile estimates that each penny at the pump costs American consumers roughly $1 billion in spending power.

So even as $150 billion in rebate checks begin showing up in taxpayer accounts, about a third of that stimulus money will already have been spent to pay for higher fuel costs.

Rate cuts have been the Fed’s main weapon against a slowdown, but each move usually takes at least six months to begin having the desired effect. While the economy has been flashing recession signals in the latest monthly data, Wednesday's report on growth in the fourth quarter of last year showed that the national Gross Domestic Product inched head at just 0.6 percent. Though very weak, the data have yet to confirm the economy is in outright recession. If, as many economists currently believe, the economy emerges from a shallow decline by year-end, the Fed is concerned that continued rate-cutting could make inflation worse when things begin to pick up again.

So far, the latest series of rate cuts seem to have had only mixed success with a more immediate goal — calming financial markets.

As the debt bombs created by lax mortgage lending standards began exploding last year —  blowing big holes in the value of hedge funds and the balance sheets of financial services companies — the credit markets all but shut down. Nine months later, confidence is just beginning to return on the belief that the worst of the losses have already been reported.

The stock market, encouraged by a recent round of relatively strong corporate profits, has been moving higher in the past six weeks. Investors are betting that while the economy likely is in a recession it will begin expanding again by the end of the year. Many of the companies recently reporting strong quarterly results, especially those with overseas operations that have benefited from a weaker dollar, seem to share that view.

But the multitrillion-dollar capital market that supplies the essential raw material for the world's economy remains badly damaged. It may be that further cuts in interest rates won’t help much.

In addition to its aggressive rate cuts, the Fed has showered the markets with cash. In November, the central bank pumped $48 billion in temporary reserves into the banking system in its biggest combined daily injection of cash funds since the 9/11 attacks. In March the Fed said it was adding another $200 billion into the banking system.

The Bank of England and European Central Bank have made similar cash infusions to shore up the global financial system.

Despite these moves, commercial and investment banks are still nervous about lending to their counterparts because of concerns that one of them may be the next Bear Stearns, the Wall Street brokerage that was forced into a shotgun marriage with JP Morgan after it nearly collapsed under the weight of its bad loans.

Lower rates also have done little to revive the housing market, which remains mired in one of the most severe downturns in history. Mortgage issuers have responded to their former easy-money ways by dramatically tightening lending standards.

A weakening job market — some 300,000 jobs have been lost in four months — has taken some buyers out of the market and given others second thoughts. Gloomy consumer sentiment —which fell last month to the lowest levels in 26 years — continues to dampen home sales in what is typically the industry's strongest season. For a second year, it looks like spring will have come and gone without any signs of life for housing market.

The Fed has another strong reason to signal that it wants to take a breather from cutting rates — it may soon have to start raising them again. Lower rates and easy money help drive inflation — at the very moment the Fed is also hoping to contain it.

The gamble is that a slowing economy will reduce demand, taking pressure off prices. But the forces driving up oil prices include strong demand from a still-growing global economy and tight supplies brought by limits in surplus production. The Fed is powerless to reverse those forces.

And the full impact of the recent run-up in food and energy prices may take months to work through the system. The longer the Fed waits before tightening credit and raising rates, the bigger the risk that inflation will become more deeply embedded in the U.S. economy —and more difficult to fight.

With all the gloomy economic news out there, from a nasty housing slump to a weakening job market, some readers are wondering: Why is the stock market going up?

For the past six months, (we’ve seen) a further imploding housing market, a financial market crumbling on several fronts and consumer sentiment/spending beginning a long, slow march south. The problem is that the stock market is not reflecting this reality.  Today the Dow is a mere 2 percent down from a year ago and less than 10 percent off its 12-month high. Isn't the ticker defying normal market psychology, or are the professional investors actually all idiots?
— Tim B., Fort Myers, Fla.

Well, not all of them.

It is a little hard to understand how the stock market is holding up so well these days. We’d add to your list of worries: a weakening job market, rising inflation, sky-high oil and food prices and a shrinking dollar. With all the bad news out there, anyone could be excused for wondering why stocks have been in rally mode for the past month or so.

Since the two magnetic poles that act on investor psychology — greed and fear — are apparently still in force, fear seems to have subsided for the moment and greed has the upper hand. That’s because stock investors are betting not on what’s happening today but on what they think will happen six months from now.

If the worst of the bad news is already known, the thinking goes, now is the time to buy. If all goes well, and the economy starts to recover by the end of the year, a bet on stocks today will pay off then.

If you wait for enough good news to confirm that the worst is over, stocks prices will have already moved higher and it will be too late to buy. As the folks down at the New York State Lottery like to remind us, “You’ve got to be in it to win it.”

So Wall Street’s bulls are hoping that the past year’s interest rate slashing by the Federal Reserve, along with $150 billion in government tax givebacks soon hitting taxpayers’ mailboxes, will give the economy a big enough lift to turn things around. Because those remedies take months to show up in the data, stock market bulls are buying now to get out in front of that hoped-for turnaround.

In past few weeks, stock buyers also have been encouraged by a batch of relatively strong corporate profit reports. Some of those companies, like IBM and Coca-Cola, have big international operations that have benefited from the weak dollar.

That works two ways. First, products priced in dollars are cheaper for customers abroad than competing products priced stronger currencies. And when U.S. companies earn profits overseas, those profits turn into more dollars per widget when they're converted from foreign currencies back into dollars.

Corporate profits are usually a pretty good guide to how well stocks are priced. Unlike a bond, which is backed by assets and a promise to repay your money, a stock is just a claim on a company’s profit stream. So one way to find out if stock prices are too high or low is to compare prices to the level of earnings.

By that measure, stock prices are a little high. The price-to-earnings ratio of all the stocks in the S&P 500 index stood at 22.2 at the end of last year, compared with the 50-year average of 17.5. But current prices are still less than half the bubble-induced high of 46.5 at the end of 2001.

Companies have also been fairly cautious in their forecasts of future profits: If the economy begins bottoming this summer, those profits could well turn out to be higher than expected by the end of the year. And that is exactly what Wall Street analysts are forecasting.

Of course, it’s entirely possible that this line of thinking is wrong and that the recent stock market gains are a "sucker’s rally." The recent upward move needs to continue before the bulls can claim a convincing victory.

In the meantime, a lot could go wrong: Another Bear Stearns or two could blow up, inflation could get out of control, housing prices could keep falling for the next few years, rising unemployment could cut into consumer spending and snuff out any recovery. We don’t presume to have any idea whether the bulls or bears are right on this one.

Regarding China's holdings in U.S. Treasury debt: Is it possible for China to call in all the debt at once? If so, what would the impact be to the U.S. government and the U.S. economy in general?  
— M.C., Stafford, Va.

Debt securities (bonds, bills and notes) sold by the U.S. Treasury are not “callable.” That means investors can’t ask for their money back before the security matures. The maturity date, anywhere from 3 months to 30 years, is set when the debt is auctioned off to investors.

But investors who want to unload their Treasuries can do so in a very active “secondary” market, where $1 trillion worth of outstanding debt is traded every day. China holds about $500 billion in Treasury securities.

So, as big as the market is, if China sold all its U.S. debt at once, the market would have a hard time absorbing it. Bond prices would likely fall and interest rates would soar. Such a vote of no confidence could also send the dollar falling further.

That, of course, is why China would never do such a thing. It would be virtually impossible to liquidate half a trillion in U.S. Treasuries at once — even if you could find buyers — without destroying the value of your own holdings. China also wants to keep its currency from getting too strong against the dollar; dumping its U.S. debt holdings all at once would hammer the dollar and make Chinese exports much more expensive to American buyers. So cashing out of Treasury debt in hurry would be financial suicide.

The more realistic concern is that China — and other large buyers of our debt — slow or stop their purchases. Demand for Treasuries keeps long-term interest rates under control. If that demand goes away, Uncle Sam has to raise rates to find fresh buyers.

The Fed, which controls short-term rates, has much less control over market-based long rates. The only thing it could do is drain money out of the system — which is exactly what you don’t want to do in a credit crunch (See: "Depression, Great.")

The solution, of course, is to balance the federal budget. But cutting spending and/or raising taxes is not a great idea when the economy is weak. Even if the world's appetite for U.S. debt remains strong, it’s long past time for Congress and the White House to get our financial house in order.

When the economy slows down, the resulting drop in demand normally takes some of the pressure off inflation. But these are not normal times: Even as the economy is slumping, oil prices are rising and food prices are jumping.

All of which could spell more trouble for consumers in the coming months. Tax filers this week can look forward to some relief from a massive government rebate program. But that one-time shot in the arm won’t help consumers — or the economy — if energy and food prices keep rising.

On Tuesday, oil prices surged to a new high, passing $113 a barrel, and the government reported that prices at the wholesale level jumped 1.1 percent in March.

“These are going up way too rapidly,” said economist Joel Naroff of Naroff Economic Advisors. “This is the money that the average person has to spend, and as a result they don’t have a lot of money left over for other things.”

Food and energy prices tend to move up and down more quickly than other goods, but lately they’ve only been moving in one direction. In the last three months, gasoline prices are up by a third and food prices are up 10 percent.

Analysts take some comfort in the fact that the so-called “core" inflation rate has — so far — remained in check. The hope is that higher food and energy prices haven’t yet spilled over into the prices of other goods.

But if you break down the list of those goods, the price increases have been mildest in so-called capital goods — business machinery and equipment. Price of consumer goods other than food and energy are up 5.5 percent in the past three months. Analysts are expecting that trend to show up in the Consumer Price Index due out Wednesday.

There are multiple causes to the current rise in prices. A falling dollar increases the cost of the steady stream of imported consumer goods made overseas. As the dollar falls, it takes more of them to buy goods priced in stronger currencies. Developing economies around the world are bringing increased demand for raw materials.  Rapid expansion of ethanol production in the U.S. has diverted supplies of corn from grocery stores to gasoline pumps.

Underlying all of these is the rising cost of energy, according to Stuart Hoffman, chief economist at PNC Financial Services Group.

“A lot of this gets right back to oil at $113 barrel and that, to me, is just reverberating through the inflation pipeline — and not just in the in the U.S.,” he said. “We’re seeing global problems on inflation, particularly on the food front in countries where their subsistence level (income) doesn’t give them any room for leeway.”

On Tuesday, Indonesia became the latest country to clamp down on food shipments out of the country to try to maintain supplies. Rising global prices prompted more farmers to sell their crops at export prices that are nearly double local rates.

The list of other countries that have placed restrictions on food exports in a bid to secure supplies and limit inflation includes Russia, Vietnam, India, Cambodia and Argentina — the latter is the world’s fourth largest wheat exporter. In Bangladesh, economists estimate 30 million of the country’s 150 million people could be going hungry. Haiti’s prime minister was ousted over the weekend following food riots there.

U.S. households spend a smaller part of their budgets on foods than any other country — some 7.2 percent in 2006, according to the USDA. But food costs in the U.S. are rising faster than they have in 17 years. Eggs cost 25 percent more in February than they did a year ago, according to the USDA. Milk and other dairy products jumped 13 percent, chicken and other poultry nearly 7 percent.

“It’s eating into a lot of peoples’ budgets,” said Naroff. “And we’re beginning to see it already in the retail sales numbers.”

All of which leaves policymakers at the Federal Reserve between a big rock and very hard place. After  the housing slump and mortgage mess threw sand in the gears of the credit markets last summer, the Fed began flooding the financial system with money to get things moving again. But it’s a risky move: too much money sloshing around the economy can also feed inflation.

Central bankers are betting that a slowing economy will help take the pressure off demand for goods — which ordinarily would help tame inflation. But if higher energy prices are the underlying cause of higher prices, the Fed has a lot less room to maneuver. Raising interest rates now to fight inflation runs the risk of further damaging to the financial system and global economy.

“There a lot of bad things that are coming together when it comes to inflation but not a lot of them can be effected by Fed policy,” said Naroff. “What’s the Fed going to do — drive the world into recession so the world stops eating?”

For the time being, the best central bankers can do is signal that their rate-cutting days are numbered.  After slashing short-term rates in half over the past nine months, many economists expect the next move to be a relatively modest quarter-point cut when the Federal Open Market Committee meets at the end of the month.

As Congress moves ahead with efforts to fix the mortgage mess — and head off another million or more foreclosures — a lot of readers are wondering: Why should homeowners who got in over their heads get help from the government?

My question is this. It seems to me that too many people in this country are getting a free pass with this mortgage mess. I, for one, got a 30-year fixed loan, paid the fees, pay my mortgage on time and so on. But all these people who took the easy way, low payments for two years, zero down etc., are basically getting bailed out in some form or another, whether it be mortgage companies rewriting their loans, or doing a short sale. Where is my free money for doing it the right way in the first place and paying my bills like I agreed to?
— Dave B., Sultan, Wash.

It’s absolutely a fair question.

There’s no doubt that some of the people who are now losing properties to foreclosure entered the market at the height of the boom, put little or no money into the transaction, planned to make a quick buck, and then got burned when the music stopped. They made a bet and lost. The government shouldn’t be expected to help them any more than it should be helping out losers at the craps table in Las Vegas.

The problem is that the lending boom — and in its latter stages it was a lending bubble, not a real estate bubble — swept up a lot of people whose only mistake was trusting a mortgage broker or lender who promised to get them started on the path to homeownership and then wrote them a loan that they knew was unsustainable. Is it really plausible that a novice homeowner could somehow dupe a chain of financially sophisticated players that included mortgage brokers, lenders, Wall Street firms packaging these loans into securities and the investors who bought them?

Unlike those of us who may be on our second or third mortgages, or who learned the hard way that some “trusted professionals” are neither, many first-timers got suckered. I’ve heard from hundreds of readers and talked to dozens who fall into this category. The issue of “personal responsibility” seems irrelevant when the transaction was so complicated it flummoxed even the Wall Street investors who bought these loans and are now writing off hundreds of billions of dollars.

It turns out that, so far, very few mortgages have been rewritten with more favorable terms. True, there are short sales going on, in which the homeowner sells the house before foreclosure begins and the lender agrees to take less than the loan’s full value. But many of the appraisals on which those loans were based were fraudulently inflated — to benefit the lender and mortgage broker, not the buyer. In any case, I’m not sure how a short sale qualifies as a bailout: The homeowner loses everything.

It’s also worth considering the “bailout” that’s been extended to the lenders who made these bad loans in the first place. Even before the $30 billion taxpayer-backed rescue of Bear Stearns, the Fed had been flooding the banking system with cheap money to help lenders recover from the bad decisions they made. And in many cases, these loans were so highly "leveraged" — made with borrowed money — that the investment bankers churning them out had essentially no money down either.

At some point, you also have to consider the issue of protecting the value of your home. If another 1 million to 2 million homes are foreclosed in the next 12 months, it’s hard to see how the housing market will be able to recover. That means the value of all of our houses will continue to fall and the economy likely will slide along with them.

Think of it this way: If your house was in the path of a wildfire, would you object to the fire department putting out the fire on your neighbor’s house to protect yours?

I've put most of my retirement money in silver and gold. Everyone tells me this is a folly, for those precious metals have had their run in high prices. However, because of global inflation, I just don't trust currencies anymore and feel that true value is in the good old precious metals. Am I being totally reckless?
— Allysa H., Fords, N.J.

Well, not totally.

It’s true that if inflation gets out of control again, precious metals should hold their value as the buying power of paper currency erodes. It’s also true that after an unusually long quiet spell, inflation seems to have perked up a bit. Precious metals are also seen as a refuge when the economy hits the skids. In countries where political instability or financial market meltdowns threaten to erode wealth, precious metals can be an effective place to hide.

The result has been a stampede to gold and a resulting surge in gold prices. Since the beginning of 2006, gold prices doubled to more than $1,000 an ounce before pulling back to $900 in the past few weeks. “Gold bugs” — the folks who seem to believe there’s never a bad time to buy gold — would like see that pullback as a good time to buy.

But the conditions that send gold prices higher can also reverse course and send them back down again. We’ve seen this movie before, and for many “buy and hold” gold investors, it ended pretty badly.

The last time gold prices went through the roof was at the tail end of the 1970s, a decade that produced one of the worst inflationary spirals in modern history. Heavy government spending on social programs and the Vietnam War, along with an easy-money Fed in the in early 1970s, touched off a decade of inflation that defied repeated government efforts to thwart it.  Soaring oil prices compounded the problem.

Gold prices responded accordingly. At the beginning of 1979, an ounce sold for $200 and then rose more than fourfold in a little over a year.

But it turned out that the direst predictions about inflation and the economy didn’t pan out. After the Volcker Federal Reserve slammed on the brakes, pushing interest rates as high as 20 percent, inflation began to subside. Oil consumption began falling after cash-strapped homeowners weather-stripped their windows and drivers sick of lining up for gasoline traded in their cars for more fuel-efficient vehicles. As oil consumption fell, so did prices.

It didn’t take long for gold prices to come crashing down as well. By the middle of 1982, the economic storm clouds began lifting, the stock market began one of the biggest bull runs in its history, and those $850 ounces of gold were soon worth $300 apiece. Two decades later, after some ups and downs along the way, gold was still selling for $300 an ounce.

There’s nothing inherently foolhardy about any individual investment category, whether it’s stocks, bonds, real estate or art. Even rare Beanie Babies had their day on eBay. What’s risky is putting all your investment chips into the pot on a single bet. All of these investment categories have their ups and downs, and no one can predict with any accuracy when they will come.

It’s impossible to know how this surge in gold prices will end. (Keep in mind that the people who speak with the greatest confidence about an investment are often the ones selling the very investments for which they claim great forecasting ability.)

So as long as you understand that gold prices could come down as fast as they’ve gone up, go for it. If inflation spirals out of control and the global financial system collapses, you’ll be sitting pretty.

Then again, if that happens, you’ll probably have more to worry about than the price of your gold.

The events of the past few weeks — from the collapse of the investment house Bear Stearns to reassurances from the White House about the economy — have rattled readers. Some are wondering: Just how bad is the economy going to get?

Given the fact that we are already running a huge budget deficit, with China and Russia funding these deficits while our interest rates continue to drop making Treasury bonds much less attractive for foreign investors. And of course, let's not forget in the meantime we're sending hundreds of billions to the Middle East. All in all, I really don't see how this turns out with a happy ending for the USA. Do you?
— Richard M., Provo, Utah

You’re probably not going to like our answer on this one.

First off, we have yet to see confirmation that the economy has entered even a mild recession, let alone a severe downturn. The U.S. economy grew very weakly in the fourth quarter of last year, but it still moved ahead. Since then, we’ve seen overall losses in employment — the freshest monthly government data you can look at. The exact definition varies a bit, but generally speaking you need two quarters of negative growth to call it a recession. By definition, then, we won’t be able to confirm a recession until July at the earliest.

The recent upending of the housing and financial markets, however, is not a good sign. When lenders get spooked — and hoard their cash as they’re now doing — the flow of money through the system slows down. Eventually, the economy does, too. The Fed has been doing what it can to get money flowing again, but it remains to be seen whether it has enough plumbing tools to clear the clog of bad mortgage paper choking the financial markets. So the script is still being written. Still, we’ve had "credit crunches” before, and eventually they come to an end.

The drop in home prices may be even more worrisome. Hundreds of billions of dollars worth of home equity have evaporated, leaving some homeowners with a bigger mortgage than their house is worth. That's a big reason why consumers are gloomier than they've been in years. Something like 70 percent of our economy relies on consumer spending: if it stops, so does economic growth.

That's the bad news. But it may help to take a longer-term view. The worst economic period in my lifetime was the 1970s. When I finished college and went job hunting, unemployment was double what it is today. When my wife and I first went looking at houses, interest rates were on their way to 20 percent. Every time you got a raise, inflation ate it up – and then some. Gasoline wasn’t just expensive: it wasn’t available on some days at any price.

Since that period, the headlines have included: the run on Continental Illinois bank in 1984, the $400 billion collapse of the savings and loan industry, the Crash of '87, the housing crash and credit crunch of 90-91, the Asian currency meltdown of '98, and the dot-com crash of '01 — along with additional meltdowns in Russia, Argentina, Mexico, and Orange County, Calif. At each juncture, the papers (and later the cable channels and later still the Internet) offered up a steady supply of experts warning of the “coming collapse.” Some of them wrote books about the resulting social upheaval and the need to learn how to can your own crops and shoot a rifle.

Warning of such a collapse is a great way to generate reader traffic. But in each of the past “catastrophes,” the pessimists got it wrong — they overstated the downside risks. This is human nature. What we’re seeing is the flip side of the insanity that pushed house prices to unsustainable levels. Fear is at least as strong an emotion as greed, and that’s where we are in the cycle.

It may be that we’re headed for an economic cataclysm the likes of which I’ve never seen. I certainly hope not, but again, I could be wrong. Still, it’s impossible to say now that an economic downturn on the order of the 1970s is inevitable. There are plenty of people who will make that prediction and if, God forbid, it comes about they’ll claim they were prescient.

I disagree. Even a broken clock is right twice a day.

If the sale of treasury bonds produces the money required to cover over spending and old debt, how will the national debt every decrease when the only way to cover the maturing debt is to create more bonds/debt to cover them?
— Scott, Michigan

It’s not the only way. The other way would be to take in more in taxes than we spend. At the end of the 1990s, the budget was balanced and there was even a little extra to pay down the debt. That prompted many people to say “Wait a minute, the government is taxing too much.”  So we got tax cuts, and now we’re back to running up the debt.

At the very least, the first step would be to have the federal government go back to the “pay as you go” spending rules used in the 1990s. The idea was pretty simple: don’t spend more than you take in. That means if you cut taxes, you have to cut spending by the same amount. And if you want to spend new money – whether on a war or a Medicare program to pay for prescription drugs — you have to raise taxes to pay for it.

Raising taxes to pay off the debt isn’t necessarily a great idea. In any case, with the economy faltering, now is not the time to raise taxes. In fact, if Congress and the White House could just balance the budget indefinitely, the debt as a percentage of Gross Domestic Product would gradually decline.

This would be roughly equivalent to a young person starting out with a big, interest-only student loan. As their income goes up over time, the debt shrinks relative to that income. As long as they don’t borrow more, the interest payments on the loan make up a smaller and smaller part of their budget.

The same thing is possible with the national debt. If you balanced the budget forever — and froze the debt at current levels — the debt becomes less of a problem over time as the economy grows.

The real long-term problem is the multi-trillion-dollars worth of promises made by the Social Security and Medicare programs. As us Baby Boomers retire and start consuming more government-funded health care, the burden on the budget will get bigger. As it stands now, those plans are financially unsustainable over time - unless they’re fixed.

That’s not to say they can’t be fixed, just the way the Reagan administration, with the help of a commission lead by former Fed Chairman Alan Greenspan, did in the 1980s. Just like any retirement plan, you need to make mid-course corrections along the way. With a relatively modest increase in taxes or cut in benefits – or both – those plans could be put back on a sound financial footing.

But so far, no one has been able to get Congress and the White House to agree on a fix.

The broad regulatory changes proposed by the White House Monday add to an ongoing debate in Washington about what is needed to clean up the mess created by Wall Street’s failure to manage its own risky investments — and keep it from happening again.

With millions of homeowners at risk of losing their homes, Democrats have focused on heading off an expected rise in mortgage defaults — and the resulting losses to investors who bought bonds backed by those now-shaky mortgages. Republicans tend to favor a series of regulatory reforms to streamline the current alphabet soup of agencies created during the Great Depression to rebuild the American dream of homeownership.

Regardless of which approach the government ultimately takes, the most important question is: Can the government can act quickly enough to keep the current credit crunch from spreading?  That part of the story is still being written.

The proposal formally spelled out Monday by Treasury Secretary Hank Paulson was widely reported over the weekend. The goals of the reform would be to improve consumer protections, tighten regulation of some business practices and improve stability of the financial markets. To do that, Paulson proposed giving the Federal Reserve broader powers and more information about investments held by Wall Street brokerages and investment firms.

The hope is that by providing the Fed with more authority to step in and limit investment activity that poses a threat to the financial system, the central bank can act to head off bigger problems down the road.

“That authority at current is limited only to where the Fed identifies a potential systemic, downside risk if they do not act," said Richard Baker, CEO of the Managed Funds Association and former member of the House Finance Services Committee. “It's merely saying, 'We see the train coming.' Today, I have to wait for the train to run over me before I can act. Now we’re going to say, ‘I hear the whistle, I see the steam, I smell the smoke: let's do something before it gets here.’ ”

Though many praised the plan as a step in the right direction, critics argued that it fails to address the more immediate problem of a widening credit crunch that began last summer as the pace of mortgage foreclosures began to rise.

Senate Banking Committee Chairman Christopher Dodd said Monday that the administration blueprint "would do little if anything to alleviate the current crisis."

Dodd and House Financial Service Chairman Barney Frank are working on a bill that would expand the government’s role in helping to refinance mortgages written at the height of the lending boom that have now become unsustainable as house prices have fallen. The White House has opposed measures that would “bail out” borrowers losing their home or the investors who bought securities backed by their mortgages.

But supporters of a government role in refinancing bad mortgages say that approach risks causing wider damage to the economy.

“A million more foreclosures are going to continue to exacerbate this problem," said John Taylor, executive director of the National Community Reinvestment Coalition. "The deterioration of the economy driven by this foreclosure crisis is going to force the hand of something pro active. We can’t go to January of '09 before someone comes into office that’s willing to do something about this.”

Since the financial markets began to come unwound last summer, the government’s primary response has come from the Federal Reserve. After a series of fairly tepid interest rate cuts failed to stem the turmoil, policy makers responded with increasing urgency, culminating in a $30 billion pledge to shore up Bear Stearns after a flight of investor capital pushed the firms to the brink of collapse. 

The proposals unveiled Monday will likely re-open a debate over whether the Federal Reserve was too slow to use its existing powers to cut interest rates and too lax at regulating the business practices that contributed to the problem in the first place.

“They missed the subprime crisis in August,” said Greg Valliere, chief political strategist at Stanford Financial Group in Washington. "They were the regulators who were supposed to stop all of this predatory lending. This is like putting Eliot Spitzer in charge of the Morals Division."

The plan would also consolidate dozens of state and federal regulators that currently oversee pieces of the banking and investment industries. With so many powerful constituents behind those agencies, the odds are long that Congress will enact a comprehensive reform package this year. Just few months before summer adjournment, a third of the members of the Senate and all of those in the House have already begun to focus on getting re-elected in November.

“There's a need for comprehensive legislation to change the regulatory system in my view, and Congress will have to get down to it," said former SEC Chairman Harvey Pitt. "But that probably won't come until after the election.”

Progress on various legislative solutions has also been slowed by a broad philosophical divide over how to respond to the surge in foreclosures and the resulting market turmoil. Democrats have generally favored government intervention to rework mortgages that are set to jump to unsustainable levels — either as a buyer or insurer of new loans to help homeowners avoid foreclosures. Republicans have generally favored a “hands off” approach and support the idea that, no matter how painful the consequences, people who took on more risk than they could handle — whether home buyers or investors — should have to accept the resulting losses.

Philosophical differences aside, the reforms outline by Paulson Monday would be a daunting task; each of the agencies involved has its own powerful constituency in business and on Capitol Hill.

Paulson's plan is not the first, for example, to propose merging the regulatory role of the Securities and Exchange Commission and the Commodities Futures Trading Commission. As derivatives, like options, have morphed into ever-more complex securities, the regulation of these risky bets has not kept up with expansion of trading volume. But past efforts to combine the two key agencies — each of which regulates different pieces of the market — has been stymied by turf wars. Oversight of the CFTC is the domain of the House and Senate agriculture committees, while the SEC falls under the finance committees of those houses.

"That comes up constantly," said Kenneth Scott, professor of law and business at Stanford University, referring to a SEC/CFTC merger. "I don't see any likelihood of that."

Bank regulation is similarly split among agencies that were created decades ago, and in some cases haven’t evolved as quickly as the industries they’re supposed to regulate.  Long after the collapse of the savings and loan industry in the early 1990s and the removal of Depression-era restrictions on interstate banking, regulation is scattered among a patchwork of state and federal agencies. Past efforts to streamline that structure have come up short; it remains to be seen whether the White House will be able to overcome opposition to consolidate or abolish these agencies.

Office of Thrift Supervision Director John Reich has already vowed to oppose Paulson’s proposed changes, calling is just the latest in a series of failed efforts at restructuring over the last 60 years, and one that would meet the same fate. The American Bankers Association has also come out against some Paulson’s proposed changes.

"Dismantling the thrift charter and crippling state banking charters will weaken banking in America," said ABA president and chief executive officer Edward Yingling.

Regardless of the philosophical divide, a further deterioration of the economy will likely put continued pressure on members of Congress on both sides of the aisle. But Monday’s White House proposal may help defect criticism that the government failed to act to contain the financial crisis.

“It gives them some cover politically and globally and shows that, ‘We realize there's a problem. There is a plan out there,’” said Valliere. “We all know Barney Frank and others will change it. But at least Paulson is giving the impression that he's on top of things.”

A pick-up in sales of existing home earlier this week had some homeowners wondering if the steep housing slump may be coming to an end. But the latest data on new homes sales reported Wednesday indiciate that such optimism is premature and that this spring will likely be another washout for the residential real estate market.

“There is no clear bottom yet,” said David Blitzer, chief economist for Standard and Poor’s, which tracks home prices. “We hope it comes soon. But right now it's a hope.”

Homebuilders got fresh reminder of that on Wednesday, when the latest monthly numbers showed that sales of new homes fell in February for the fourth straight month, a 13-year low.

The Commerce Department reported that new home sales dropped 1.8 percent last month to a seasonally adjusted annual rate of 590,000 units, the slowest sales pace since February 1995, a little worse than expected. The median home prices dropped to $244,100, down 2.7 percent from the level of a year ago.

Another widely watched measure of home prices fell 10.7 percent in January compared to a year ago, according to the latest reading of S&P’s Case-Shiller index. Prices were hardest hit in Miami and Las Vegas, where the index fell nearly 20 percent. Of the 20 cities tracked by the index, 13 posted their biggest drops in two decades.

Falling prices were clearly a factor in the 2.9 percent gain in existing home sales for February in a separate report on Tuesday. That uptick had been taken by some analysts and industry officials as a sign that the housing market may be nearing a bottom.

“I think we're finally beginning to work our way through the seller’s denial segment of the market  where the sellers are holding up their prices, expecting to get numbers that were unreasonable,” said Joel Naroff, chief economist at Commerce Bancorp. “Now they're dropping. And in some places very, very sharply. That's triggering more sales.”

But falling prices are also putting a drag on the broader economy. On top of higher prices for food and gasoline, further home price declines will weigh more heavily on household finances, according to New York University economist Nouriel Roubini.

“(Falling home prices) are pushing down the value of homes and putting millions of  people underwater,” he said. “Already today, 8 million houses have negative equity. If home prices fall another 10 percent as expected, we're going to see 16 million people with negative equity. It's a big problem."

Homeowners with negative equity — with loans bigger than their house is worth — are more likely to face a foreclosure or bankruptcy that gets them out from under those loans.

That could quicken the already steep pace of foreclosures as mortgages written during the height of the lending boom reset to higher levels. More than a million of the loans are expected to reset this year, putting added pressure on homeowners and worsening the foreclosure outlook.

Those foreclosures will put more homes on the market at distressed prices and add to the glut of supply. Last month, there were some 10 months supply of unsold homes available — more than double 2005 levels. That overhang of unsold homes will further delay a sustainable housing recovery.

Tuesday also brought fresh data showing that consumers are getting more anxious about the economy. The Conference Board’s consumer confidence index “fell out of bed with a loud thud,” dropping to its lowest level since 1973, according to Brain Bethune, an economist with Global Insight, an economist forecasting firm.

Most worrisome is that consumers are getting gloomier about their job prospects.

“We’ve had no job growth in the last three months, and March could be the fourth straight month,” said Ken Goldstein, a Conference Board economist. “That's exactly what consumers were worried about. That's why these numbers are down and have come down so much, and it also why it’s going to take a good while before we start to see these numbers  improve.”

The housing industry has also been encouraged by a recent easing in mortgage interest rates, but analysts say ongoing turmoil in the financial market could keep those rates from falling much further.

“I think we are at least two or three months from a sense of (the housing market) going up, and longer than that, maybe six months, for real confirmation at best,” said Blitzer. “There are plenty of people out there, including S&P’s economists, who think we are probably looking at another year before there's a real bottom.”

There’s also concern among some analysts that the recession in residential housing could spread to the commercial real estate market, which has held up relatively well so far.

With prices falling, some condo owners have turned them into rental units. Condo sales perked up a bit last month, but the level of unsold inventory rose to a 13 month’s supply. As those condos hit the rental market, owners of commercial apartment buildings are feeling the impact, according to Sam Chandan, chief economist at Ries, Inc., a real estate research firm.

“It’s undermined occupancy levels in a lot of the southern U.S. markets to a significant degree,” he said. “Even though we're seeing stronger demand for apartments, people are nervous about buying homes when there is the potential for prices to fall further."

Chandan said there are other troubling signs that the commercial real estate market could be in trouble. High levels of consumer debt — along with a drop in consumer confidence — could spell trouble ahead for retailers, forcing them to close some of their stores.

“We also have more retail development in the pipeline than we've seen in over a decade,” he said. “And there’s some concern about whether or not consumers can grow their spending in the next couple of years in the way we’ve experienced in the housing boom.”

With the economy slowing and the housing market stuck in reverse, Tuesday’s report of a surge in wholesale inflation last month was not good news for the Federal Reserve.

The problem: Central bankers now find themselves between a rock and a hard place in trying to meet their dual goal of setting interest rates low enough to get the economy moving again while also keeping them high enough to keep prices in check.

The Fed can’t do both. But given the ongoing turmoil in the capital markets — and the risk of a credit crunch that could do even more damage to the fragile economy
— Fed watchers say inflation-fighting is taking a back seat.

"Right now they feel the greater risk to the economy spills over from the housing slump," said Joshua Feinman, chief economist at Deutsche Bank Asset Management. "They are still going to err on the side of providing more insurance against downside risk to the economy."

The Fed's latest inflation forecast, issued last week, projects "core" inflation of up to 2.2 percent this year, dropping down into the Fed's preferred range of below 2 percent next year.

A slowing economy is supposed to help keep inflation in check, as weaker demand takes some pressure off prices. Some economists note that, with the economic downturn still in its early innings, it may simply take awhile longer for the slowdown to begin easing inflation pressures.

But there are forces at work driving prices higher that may persist even once the impact of the slowdown is fully felt. Oil prices are being driven higher, in part, because oil producers are having trouble finding new reserves fast enough to keep up with the growth in global demand and the depletion of older oilfields.

Food prices have also been moving higher, in part, because of those higher energy costs and the need to find alternatives to oil, according to Stephen Stanley, chief economist at RBS Greenwich Capital.

"The whole ethanol craze is behind a lot of the food inflation in the sense that it's driven up corn prices and increased the demand for crop space because people want to grow crops to make ethanol," he said.

Food and energy prices have been tracking higher for some time, but the data for January showed a more worrisome trend: Those higher costs seem to be working their way through the economy faster than expected. The prices increases were broad-based, a sign that companies can no longer absorb the higher costs of producing goods and services, economists say.

There are also signs that the Fed’s shift to an easy-money policy last year — designed to revive the economy and calm the credit markets
— may be adding fuel to the inflation fire. By pumping more dollars into the economy to spur growth, the Fed has been weakening the dollar, according to Conrad DeQuadros, a senior economist at Bear Stearns.

"As result of that (easing) the value of the dollar has fallen," he said. "And that’s making the cost of goods that we get from abroad more expensive."

Consumers are already feeling pinched and tell pollsters they’re hunkering down as the economy slows. A majority told a recent Reuters/Zogby poll that they expect a recession in the next 12 months. That was the first time since the poll began asking the question last September that a majority said they expect recession.

Those recession fears may take some of the wind out of the sails of the government’s fiscal stimulus plan — which will begin mailing tax rebates in a few months to try to get the economy moving again.

Nearly half of those surveyed in the Reuters/Zogby poll said they plan to use the money to pay down debt or build up their savings — neither of which will provide the spending boost that Congress and the White House are hoping for. Just 16 percent said they would spend their entire rebate; about as many said they plan to save it all. Nearly one in three said they would pay down debt, while 27 percent said they would spend some and save some.

The uptick in inflation also complicates the Fed’s job for another reason. Though it has a powerful influence on short-term lending rates, it has much less control over the pricing of long-term loans. If investors and savers who park their money in long-term bonds begin to fear that rising inflation will erode the buying power of those investments, they'll begin demanding higher rates in the bond market.

"For the first time in a long time people are starting to question the Fed’s will to fight inflation," said Stanley. "And that kind of leaves the Fed in a tough spot."

Traders bid up interest rates on long-term Treasury bonds after Tuesday’s inflation data were released. Rates had already begun rising after last week’s news that consumer prices also jumped in January. If inflation worries become more widespread, rates could move higher still.

"The market is pricing in a fairly benign inflation environment," said DeQuadros. "And I think it's underestimating the likelihood of high inflation over the next several years as the Fed has moved to this inflationary momentary policy."

If inflation remains strong, and long-term rates move higher, that could undercut the Fed’s efforts to head off an economic slowdown.

"That’s very important in the real economy because most fixed-rate mortgages are set off of longer-term interest rates," said Stanley. "And a lot of the borrowing rates for real people in the economy — be they consumers or businesses
— are based as much or more on long-term rates as on short-term rates."

Still, until the housing market recovers and the financial markets calm down, higher inflation probably won’t prompt the central bankers to change course. For the time being, the Fed is in "full risk management mode," according to Diane Swonk, chief economist at Mesirow Financial.

"They are willing to discount these (inflation) numbers — put them on the side and deal with them later
— and say the moderation in growth should help moderate inflation," she said. "Whether it does or not, history will tell."

With economic forecasts calling for bad weather ahead, Congress and the White House have turned attention to proposals to offer Americans some shelter from the storm.

There’s no shortage of ideas in an election year. But it remains to be seen just how much the government can do to halt the continued slide in an economy battered by falling housing prices, rising energy costs and a lending slowdown caused by worries about how many more loans will go bad.

There’s little doubt the U.S. economy is slowing sharply. Economists are divided on whether the U.S. is headed for recession or already in one. But in just the past few weeks, the latest economic data have gotten worse.

The debate over a potential stiumuls package centers on what measures — if any — will have an impact.

Lawmakers have been giving the issue a high profile this week on Capitol Hill. On Tuesday, House Speaker Nancy Pelosi, D-Calif. Met with Fed Chairman Ben Bernanke talk about various legislative proposals to help bolster the Fed’s rate-cutting moves to get the economy moving again. On Wednesday, former Treasury Secretary Lawrence Summers told a hearing of the Joint Economic Committee that Congress should pass an economic stimulus bill of up to $150 billion.

"The risks here of 'too little, too late' are far, far, far greater than the risk of 'too much too soon,"' Summers told the panel.

Pelosi and Minority Leader John Boehner, R-Ohio, are scheduled to meet later Wednesday to try and lay the groundwork for a consensus on what measures should be enacted. Bernanke testifies before the House Budget Committee Thursday.

But Congress has a mixed track record when it comes to passing legislation to prop up a sagging economy, according to former Federal Reserve Gov. Lyle Gramley.

“The main reason is that it takes so long to get something passed through Congress that once it kicks in, the recession is over,” he said.

Economic stimulus generally comes from two government sources. The Federal Reserve can lower interest rates — as it has been doing since September — to promote borrowing and spending. And Congress and the White House can lower taxes or boost spending to provide an added jolt.

There’s widespread agreement that the Fed will have to do the heavy lifting to reverse the current downturn, and more rate cuts are all but certain. But those rate cuts can take months to work their way through the system and get the economy growing again.

Tax cuts or spending increases could work more quickly, said Chad Stone, chief economist at the Center on Budget and Policy Priorities, a think tank that focuses on low- and moderate-income families. But Congress and the White House are only now getting around to such fiscal measures, even though the housing recession and credit crunch have been under way for months.

Now, the political pressure to act is rising. With economic data increasingly pointing to a downturn, voters are getting more worried about a recession. Some 47.5 percent of those surveyed think a recession is likely in the next year, up from 43.4 percent in the previous month's surveyaccording to a Reuters/Zogby poll released on Wednesday.

And with the election season is in full swing, there is no dearth of proposals about what the government could do.

Republicans generally favor tax cuts and are trying to steer the discussion to the renewal of Bush administration tax cuts that are set to expire in 2010. Democrats have proposed a variety of measures to put money in consumers’ hands, including extended jobless benefits, higher food stamp payments, and aid to cash-strapped states to offset budget cuts. Another possibility is a one-time tax rebate.

On Tuesday, the Congressional Budget Office weighed in with a report saying that tax rebates like those paid out to soften the recession of 2001 are among the more cost-effective measures Congress could enact. The report also said rebates are more effective when given to middle- and lower-income taxpayers who are more likely to spend it, rather than wealthier taxpayers.

"When the economy is weak, the key impediment to economic growth is how much demand there is," said CBO director Peter Orszag. "And from that perspective what you want to do is get money to people who are going to spend it really fast."

While the ailing economy might need help right now, it is not clear how quickly a fiercely divided Congress can act. Any bill would have to work through both the House and Senate and then go through a conference committee before approval by the White House, which means nothing is likely to take effect until spring.

And when the dust settles, it’s not clear these measures will do much to prop up a faltering economy.

“For some individuals this could be important,” said Greg Valliere, chief political strategist at Stanford Group. “This could help the out them out of a very tight spot. But when you look at the economy as a whole, it’s awfully hard to see in the statistics how this type of stimulus has ever really made much difference."

The politics behind these proposals may be clearer than their potential impact. Democrats are eager to highlight the economy’s current problems and blame the Bush administration for the downturn. But Democrats who have vowed to contain federal budget deficits are wondering how increased spending or tax cuts would be paid for. Republicans seems to be taking a more wait-and-see attitude on spending. Some are warning about the negative impact of letting the tax cuts expire in 2010.

Politics aside, the economics of the current proposals are problematic in part because they don’t directly address the source of the slowdown: a housing market that shows no signs of hitting bottom.

The White House last month announced a plan to help head off a coming wave of mortgage foreclosures this year and next but conceded that only about a third of homeowners at risk would be helped. Fed Chairman Ben Bernanke said last week that lenders need to do a better job of speeding up the process of working with borrowers to head off loan defaults.

“You can lower taxes all you want and cut interest rates to zero," said Howard Glaser, a mortgage industry consultant and former HUD official during the Clinton administration. “But it’s not going to fundamentally affect the housing problems we have and bring investor confidence back unless we stop the death spiral of the housing market."

Lenders this week reported another round of losses from bad mortgages in the final quarter of 2007. Banking giant Citigroup said bad debts led to a $10 billion loss for the quarter, the largest in its 196-year history.

As more borrowers default, their foreclosed homes are being added to a glut of unsold properties, further depressing prices. Higher defaults also continue to weigh on the market for new home loans, especially large ones.

“The housing market generally is depressing the economy,” said Gramley. “We have a significant part of the credit markets that are simply dysfunctional. That’s potentially a very large problem.”

So far, consumers have held up relatively well. But there are signs that the housing recession may have begun to weigh on consumer spending, which accounts for roughly 70 percent of  economic activity. Job growth slowed to a trickle in December and more recent data show retail sales have weakened.

With house prices falling, the home equity that helped fuel spending during the housing boom has evaporated. Merrill Lynch economist David Rosenberg estimates that lost wealth could result in "a $360 billion hit to consumer spending over the next two years, which would be the equivalent of a 2 percent wage cut."

Supporters of a targeted stimulus package argue that putting money back in consumers’ wallets will help blunt the impact of that loss in wealth.

“What the anti-recession measures do is restore purchasing power that can reduce the secondary spillover effects — no matter where the recession starts,” said Stone.

If such measures are temporary, and come quickly enough, they could have some positive impact. But there’s also a risk that a “stimulus” package includes longer-term tax cuts or spending programs that don’t bear directly on boosting the economy — and only worsen the government's ongoing budget deficits.

“The question is: Is it the right medicine?” said Stuart Hoffman, chief economist at PNC Financial. “And what are the side effects if it makes the markets get more nervous about the hole you open up in deficit?”

With economic indicators signaling trouble ahead, Answer Desk readers are bracing for a downturn. Many, in fact, are convinced the sky has already fallen. But some readers are taking a more optimistic approach — like Sheila in Utah who is wondering which businesses do well when the economy heads south.

Can you tell me what type of business does well in a recession?
— Sheila, Layton, Utah

Though a recession describes an economy in reverse (it shrinks instead of grows) that refers to the overall level of activity across the country. Some businesses (like housing) and regions (like parts of the industrial Midwest) are already in recession. Others may feel little or no impact from the current economic downturn, which may or may not turn out to have been a recession when all the economic data are collected in a few months.

Some businesses are more vulnerable to recession than others. Carmakers, for example, often suffer badly because buying a car is usually a longer-term decision. When times get bad, people tend to put off buying a new car as long as they can.

Other businesses are said to be “recession-proof” (though few really are.) Funeral home directors and accountants, for example, can safely assume a recession won’t have much impact on death and taxes.

But the list of reliably recession-proof businesses is pretty short. Since 70 percent of the U.S. economy relies on consumer spending — and consumers typically cut back when a recession hits — there are few consistently safe shelters from the storm of a serious downturn.

One way to think about which businesses face the greatest risk is to ask: What products and services are people going to continue to buy even if there’s a recession? Health care companies generally do well because people get sick just as much in a recession (sometimes more) as they do when times are good. Even in a recession, you can't dry clean your clothes at home, and people still need to buy car insurance. 

There's more to surviving a recession just being in the right business. Some businesses don’t act quickly enough to cut prices as demand dries up. Others may find themselves too heavily in debt and unable to borrow more money to get them through the downturn. Some businesses “scale” better than others; those with high fixed costs may be more vulnerable than businesses that can survive for a time on a shoestring.

Surviving a recession as a business is not all that different than surviving as an individual. If you think you’re a possible layoff candidate, you fire up your social and professional networks and find out who might be hiring. Business owners who see a downturn coming often turn to their customers for guidance. The sooner they find out which customers plan to cut back, the sooner they can plan to make the changes they need to cope with those cuts.

I heard the U.S. is about $9 trillion in debt long-term. Are we at a point in history that it is impossible to balance the budget?
— Anthony L., Palatine Ill.

Never say never. But while the deterioration in the U.S. economy is beginning to get some traction on the presidential campaign trail, balancing the federal budget doesn’t get much  attention. One reason is that none of the candidates wants to explain what federal programs they would cut or who they’d ask to pay more taxes.

As of this writing, the outstanding public debt amounted to $9,202,650,551,336.71 — or about $9.2 trillion. Of that, about $5.1 trillion is held by the public and another $4 trillion or so is held by government accounts (like Medicare and Social Security.)  For the past year or so, the national debt has been growing at about $1.5 billion every day. (In theory, there’s a legal limit to the national debt, but every time Congress needs more it just votes to raise the limit when no one’s looking.)

Ironically, higher inflation and/or a weaker dollar could offer some relief from the debt bomb.  Simply put, both forces allow the U.S. Treasury to pay back borrowed money with cheaper dollars. Since the value of the dollar has fallen steadily since the recession of 2001, so has the value of the debt we owe to foreigners. If domestic inflation returns, tomorrow’s $100 debt payment will be a lot easier to make because those dollars will represent less real (inflation-adjusted) value than the dollars that were originally borrowed.

But a weaker dollar or higher inflation also comes with nasty side effects for American consumers. Inflation destroys domestic savings just as surely as it makes debts easier to pay. Your $1,000 Treasury bond is no longer worth what you paid for it. And if the dollar continues to fall, it eventually loses its place as the world’s reserve currency. If that happens, the impact on anyone paid in dollars becomes even more pronounced.

In spite of the Treasury’s stated support of a strong dollar, and the Federal Reserve’s longstanding mandate to treat inflation as Economic Enemy No. 1, the huge overhang of federal debt is making those goals increasingly difficult to achieve. Heavy borrowing by Uncle Sam has contributed to the dollar's slide as investors who pay with other currencies worry that they may not get all their money back. When that happens, investors usually demand higher interest rates to offset the loss in value from the weakening currency.

But these are not normal times. The latest round of economic data has some forecasters wondering out loud if the U.S might not already be in a recession. That’s hardly a good time to raise interest rates. Add to that the backdrop of a presidential campaign — when the Fed has historically done its part to keep the economy humming by encouraging more borrowing and spending. As Fed chairman Ben Bernanke made clear last week, the central bank is focused on cutting rates — the only question is how far and how fast.

In the end, the problem is really outside the Fed’s control, even though it is usually called upon to clean up the mess. The solution is for Americans to get back to saving and investing —both individually and collectively. That means saving up for a big screen TV before you buy it — instead of just putting it on your credit card. It could also mean raising more taxes —or shifting the burden. If higher taxes are no longer politically feasible that means giving up more government services.

The reason this hasn’t happened is that giving up the trip to Disney World or supporting higher taxes to repair crumbling bridges requires sacrifice. At the moment, our political leaders have not been able to package the problem well enough to sell real solutions. We all share responsibility: Congress and the White House have failed to take on the tough work of balancing the budget, in large part because voters insist on getting something for nothing in the form of tax cuts without corresponding cuts in services. 

As long as Americans rely on others to subsidize their personal and public spending, it’s going to be tough to slay the debt monster. It’s hard to predict when it will bite back. But until the U.S. gets its financial house in order, we’re living on both borrowed money and borrowed time.

Our story on Friday’s worse-than-expected December jobs report — and the increasing odds of a recession — drew heavier-than-usual reader mail. Many wonder why we don’t just come out and say the U.S. is already in a recession. But others take issue with our “negative” focus on the economic data that are now flashing warning signs — arguing that these stories just spook consumers and make matters worse.

I do not know why the people that think they know how the economy is doing are just now realizing how bad things really are in this country. Do you all wear rose-colored glasses or what? It would seem that the fact that most middle-class workers' wages have been on the decline along with the loss of a lot of jobs would have given them a clue a long time ago.  Almost everyone but the supposedly experts already knew what was happening.
— James J., Okla.

I see a lot of positive things going on in business, yet I don’t think that that makes headlines.  It is the doom and gloom stuff that journalists keep hammering out to the general public that do not actively get much involved in business. (The public) then sense that things are really bad, and they aren’t. I think that if we get enough journalists together we can talk ourselves into a recession. … Talk to those that have a pulse in the marketplace and you will find that we are doing relatively OK. 
— Vaughn R. Waterloo, Iowa

It’s certainly true that consumer psychology plays an important role in health of the U.S. economy. With consumer spending generating roughly 70 cents of every dollar of economic output, the public’s fear of recession can easily turn into one of its causes. But even if the press had the power to change consumer psychology (which it does not — the facts create the impact, not the reporting), it’s not our job to try to head off a downturn by cheerleading about how great things are. Nor is it our job to try to convince people the sky is falling.

At the moment, based on the mail, more readers are frustrated with the media for what they see as an underreporting of their personal financial burdens and the current problems facing the economy. We’ve recently been accused by some of glossing over “the fact that we are already in a recession.”

We pick our words carefully, and the word recession has a very specific meaning. Though popular definitions vary, the term generally refers to a period of more than a few months of declining gross domestic product. Economic conditions in some regions of the U.S. (especially in the industrial Midwest) and some industries (like housing) already appear to be headed in reverse. But a national recession can't be confirmed until the economic data show that the overall economy is in decline. (Further, economists, academics and investment analysts have, since World War II, relied on the National Bureau of Economic Research, a private research group, to provide the "official" timing and severity of recessions.)

That’s not to say that current economic conditions don’t feel like a recession to many readers. You might walk out the door, when the wind is blowing and the temperature is 33 degrees, and observe to a friend: “Wow: it’s freezing out here today.” And we wouldn’t say you’re wrong. But the weatherman won’t use the word "freezing" until the temperature is 32 degrees or lower.
Unfortunately, measuring the health of the economy takes a little longer than looking at a thermometer. Because of the time involved in collecting and analyzing economic data, it’s very possible to be well into a recession before the numbers confirm it.

Until the data make it clear, no one can confirm that a recession is under way. Until then, it would be inaccurate (not to mention irresponsible)  to report that the “U.S. economy is in a recession now.”

You provided a response as to how to "back out" sales tax. You used an example of a $20,000 car purchase and backing out 7 percent. Thank you for that, it was a great help. But if that tax was comprised of 4 percent state tax and 3 percent county tax, and I need to back out each to send separate checks, if I use your example, why doesn't it equate to the same as the 7 percent?

Any help?
— Martin B., Address withheld

Oh. Sorry. We were daydreaming about eating apple pie and watching a building collapse. (Maybe that’s what got you off track.)

Rather than trying to look up a formula on some Web site — with no way of knowing if it’s accurate — let’s just run through the problem and come up with our own.

We’re going to start by assuming that the state and county are taxing the same original (pre-tax) purchase price — and that you’re not given credit by one tax man for taxes paid to another. (In some cases, you can get credit from one jurisdiction for taxes paid to another one. But we’ll leave the question of preparing your tax return for another day.)

Setting that issue aside, the solution goes something like this.

The total amount of money you shelled out included three separate expenses: 1) the pre-tax cost of the item, 2) the tax paid to the state and 3) the tax paid to the county. At this point, we have to switch over to math.

Total Amount Paid = 1 X Pre-tax Purchase Price + .04 X Pre-tax Purchase Price (state tax) + .03 X Pre-tax Purchase Price (county tax)

Then solve for PPP (or find a math teacher and have them do it). You’ll get:

TAP = (1 x PPP) + (.04 x PPP) + (.03 x PPP)
TAP = (1 + .04 + .03) X  PPP
TAP = 1.07 X PPP
PPP = TAP / 1.07

To find out the pre-tax purchase price of the car, divide the total amount paid ($20,000) by 1.07 and you get $18,691.59. That leaves $1,308.41 in taxes.

Since the total tax is 7 percent of $18,691.59, the county tax is 3 percent of $18,691.59 (or $560.75) and the state tax is 4 percent of $18,691.59 (or $747.66.)

To check your work (just like your math teacher told you to), you add back up the pre-tax purchase price ($18,691.59) + the county tax ($560.75) + the state tax ($747.66) and come up with = the total you shelled out ($20,000.)

OK: That's enough math. (Hey, you in the back — you can wake up now.)

Readers with similar accounting puzzles should give them a shot before forwarding along for solutions. We’re really not set up to prepare tax returns at the Answer Desk.

With the latest numbers on jobs growth showing the U.S. economy deteriorating more rapidly than expected, the threat of a recession - and the measures needed to revive growth - has taken on a larger political profile.

Friday's jobs report for December, showing a much weaker than expected net gain of 18,000 jobs, added to growing fears that the U.S. economy may be headed for — or already in — a recession. Forecasters were generally looking for growth of about 70,000 jobs. The unemployment rate jumped from 4.7 to 5.0 percent, which was also higher than expected.

With evidence mounting that the economy weakened further than expected in December, Friday's report added to the political debate over how to address the impact of a declining housing market, rising energy prices and a tax policy that has the government spending more money than it takes in. And as higher energy prices pose a threat of rising inflation, the Federal Reserve has less room to maneuver as it tries to cut interest rates to keep the economy humming in an election year.

The White House sought to downplay Friday's jobs report, and warned that raising taxes could harm the economy further.

"This economy of ours is on a solid foundation, but we can't take economic growth for granted," President George Bush told reporters after meeting with his so-called Working Group on Financial Markets.

The White House and the Democratic-controlled Congress have blamed each other for not doing enough to stem the fallout related to the housing and credit debacles.

"If there were ever a shot across the bow to this administration to get off its laissez-faire boat and start helping the economy, this is it," said Charles Schumer, D-N.Y. Other Democrats, including presidential contender Sen. Hillary Clinton, called the employment figures troubling and criticized Bush's economic stewardship.

After six years of uninterrupted growth, the outlook for the U.S. economy in 2008 has darkened considerably in just the past month. While many economists say it’s too soon to know whether a recession is coming, forecasters say the latest economic figures don’t look promising.

“If there’s going to be a recession, it’s entirely possible that we are in it — or just beginning it now,” said Nigel Gault, an economist at Global Insight. “We won’t know for a while. In two or three months, looking back from there to the December, January, February numbers, I think it will be evident by then whether or not we’ve entered a recession.”

Given the rapid pace of slowing since the sizzling 4.9 percent annual growth rate logged in last year’s third quarter, there is some speculation that the economy may already be slipping into a period of negative growth. Given the lag in the collection and analysis of economic data, it’s not unusual for a recession to be underway before statistics confirm it.

"The rise in the unemployment rate is very disturbing," John Ryding, chief U.S. economist for Bear Stearns, told clients in a note Friday morning. "January's data will be very important in informing on the state of the business cycle," he added.

Saying he was now on "recession watch," Ryding noted that the unemployment rate has now risen 6-tenths percent in the last year, a jump that hasn't happened since 1949 without a recession following.

With the presidential campaign heating up, and the economy sure to be an issue, some voters are convinced the economy is already in recession.
Though popular definitions vary, the term generally refers to a period of declining Gross Domestic Product. Some regions of the country, such as the industrial midwest, and some industries, such as housing, are apparently already headed in reverse. But a national recession can't be confirmed until the economic data show the overall economy is indecline. Since World War II, economists, academics and investment analysts have relied on the National Bureau of Economic Research, a private research group, to provide the "official" timing and severity of recessions.

Rising foreclosures and falling home prices have also put something of a damper on consumers, many who have funded a large portion of their spending in recent years with gains on the value of their homes. Coupled with the recent resurgence in energy prices, many consumers are feeling squeezed; any resulting slowdown in spending could also present the economy with a substantial headwind.

The December jobs data follows bad news earlier this week from a monthly report on U.S. manufacturing activity from a private research group; the numbers showed a surprise slowdown to the lowest level in almost five years. Though it takes more than a single month’s data to confirm a trend, the report from the Institute of Supply Management suggests that the economy may be in worse shape than many economists had believed.

That report follows more bad news from the housing market — which continues to collapse after a prolonged boom that came to an abrupt close last year after years of easy-money lending left lenders coping with big losses and millions of borrowers facing foreclosure.

New home sales in November — the latest data available — sank to their lowest level in more than 12 years. After months of declining sales and rising inventories of unsold homes, the drop was worse than most analysts had expected.

“At the moment housing activity is just plunging, and it is a huge drag every quarter on growth,” said Gault.

Forecasters who see the glass half full are hoping that the sharp drop in new home starts is actually a good sign because it reduces the inventory of unsold homes. Eliminating that backlog is a key ingredient to any recovery in the housing market. And the sooner that recovery comes, the sooner the overall economy can regain strength.

A pickup in exports by U.S. companies – due in large part to the weakness in the dollar - has also provided an important buffer to the economic damage done by the turmoil in the housing and lending markets. A weaker dollar makes U.S. goods more competitive when sold in overseas markets: it’s the equivalent of putting all U.S. goods on sale for foreigners.

“While there is plenty to be negative about with respect to housing, credit and the consumer, at the same time we believe we are in the early stages of a manufacturing renaissance,” Merrill Lynch economist David Rosenberg wrote in a note to clients Wednesday.

But, as Wednesday's ISM data indicated, it’s not clear that that surge in exports will continue. A lot depends on how well the economies of major U.S. trading partners hold up this year. If growth abroad remains strong, continued demand for Made in America products could offset the meltdown of the housing market and help the U.S. economy get through the current weakness without heading into reverse. If the housing market remains weak, consumers tighten their belts and the export sector falters, there would be little left to head off recession.

The question of whether the economy dodges a recession won’t be answered until several trends become clearer — starting with signs of life in the housing market. Another key ingredient is the impact of recent moves by the Federal Reserve to lower interest rates as it tries to clear the sand out of the gears of the global credit markets. After all but shutting down in August, the debt markets perked up in the fall — only to slow again in December. Multi-billion-dollar losses posted by major banks and investment houses have spooked lenders and investors and tightened credit — even as the Fed is trying ease.

The Fed’s latest rate-cutting moves — and its promise to pump billions of dollars into the global credit markets — are designed to ease those lending fears and get the financial markets back on an even keel. But in minutes of the Fed's Dec. 11 meeting released Wednesday, policy makers acknowledged the trouble it faces in setting the right course.

“Although members agreed that the stance of policy should be eased, they also recognized that the situation was quite fluid and the economic outlook unusually uncertain,” the minutes said.

Higher oil prices could also limit the Fed’s rate-cutting options if higher energy prices begin to work their way into the cost of other goods and services and stoke inflation above current levels. The antidote for an outbreak of inflation is usually to raise — not lower — rates.

That could force the Fed to choose between raising rates to contain inflation and lowering them to promoting growth — a choice made more difficult by the political pressures of the presidential campaign season.

With the housing market still in decline and consumers tightening their belts, the economy is likely to slow substantially in the coming year but will skirt an all-out recession. That, at least, is the consensus view of economists polled for msnbc.com’s sixth year-end economic roundtable.

While the 10 forecasters on our panel believe the economy will avoid a recession, much depends on how the Federal Reserve responds, how many more homeowners get swamped by higher mortgage payments and whether oil prices stay below $100 a barrel.

After shrugging off the housing recession over the summer, the economy has showed clear signs of slowing over the past three months. On average the panelists on our roundtable expect the economy to show growth of just 0.6 percent in the current quarter and 1.2 percent in the first quarter.

That feels like slamming on the brakes after surprisingly strong growth of 4.9 percent in the third quarter, a figure that may have reflected an inventory buildup that is unlikely to be completed.

Employers continued to add jobs at a healthy pace in November but are getting more cautious about their hiring plans. Fewer than a quarter of employers say they plan to add jobs in the first quarter of 2008, according to a survey of 14,000 companies by Milwaukee-based global staffing firm Manpower Inc. released earlier this month.

The relatively strong labor market, including continued wage overall gains, has helped blunt the impact of the painful housing downturn. A weaker dollar has helped boost exports. And manufacturers haven’t staffed up as much since the last recession, in 2001, as they have in the past, according to Ed Leamer, forecast director at the UCLA Anderson School of Business.

“We just don’t see the manufacturing sector losing enough jobs for it to be a real recession,” he said.

Because consumer spending makes up some 70 percent of U.S. economic activity, a lot depends on how well household budgets hold up. With home prices stagnant or falling in some areas, many homeowners are no longer able to tap rising equity to fund their spending.

“People are beginning to recognize the wealth gains in the housing market are disappearing,” said Ethan Harris, chief U.S. economist at Lehman Bros. “And with a lag they tend to adjust their spending habits.”

There are signs consumers are already pulling back. Auto sales slumped in November, and some automakers and analysts predict sales in 2008 could drop to their lowest level in a decade. though retail sales were relatively strong in Novermber, it's not clear whether holiday shopping will hold up through December and January.

And with some 2 million homeowners facing higher mortgage payments in the next few years, it remains to be seen how big an impact those higher costs will have on overall consumer spending. The White House this month unveiled a plan to try to head off a rising wave of defaults and foreclosures. Bur critics say it doesn’t go far enough to stem a looming consumer credit crunch.

By freezing adjustable rates for five years, the plan simply postpones the problem that will hit the economy when mortgage rates “reset" to levels that borrowers can’t handle, according to Merrill Lynch chief North American economist David Rosenberg.

“We are far from confident this plan is going to be (an) effective cure for a credit crisis that has now spread far beyond the subprime loan market,” Rosenberg wrote shortly after the plan was announced. “It is now spreading to prime mortgages, commercial real estate, auto finance and credit cards.”

Much of the outlook for slow — but still positive — growth is based on the widely held belief that the Federal Reserve will continue to cut interest rates. All but one of the msnbc.com panelists expect the Fed to lower short-term rates further next year, with the consensus calling for a year-end overnight lending rate of 3.5 percent, down from the current 4.25 percent.

As the problems in the mortgage market have spread to other forms of commercial lending, the  credit tightening has put a damper on business expansion.

“A lot more easing is coming,” said Jan Hatzius, Goldman Sachs chief U.S. economist. “We expect a fed funds rate of 3 percent by midyear.”

The other major wild card in the forecast for 2008 is the price of oil. After approaching $100 a barrel in November, prices have fallen back as signs of a U.S. economic slowdown have become more apparent. Slower growth tends to cut into demand, taking some of the pressure off prices. But economic growth outside the U.S. remains relatively strong, supporting continued strong demand for oil.

Any major supply interruption could send oil prices soaring again. That could bring inflation pressure that would leave the Fed in a tough spot. Heading off recession means lowering rates, but fighting inflation requires raising them.

Inflation could also pose a problem if the value of the dollar keeps falling in 2008. A weaker dollar makes imported goods, including oil, more expensive.

So far, the weak dollar and strong growth overseas have helped offset the weakness from the housing recession and the turmoil in the credit markets. With strong demand from rapidly growing economies, U.S. exports have held up well. If global growth remains relatively strong, that could help prop up a weak U.S. economy.

That would be something of a role reversal for what is still the world's largest economy, said  Harris.

“We’ve gone from the being the engine of growth to the caboose on the global growth train,” he said. “The U.S. is in some ways the most troubled major economy. The rest of the world is going to take its turn helping us along for a change.”

Last week's reports on a strong uptick in prices has readers wondering how worried they should be about inflation. And why do policy makers at the Federal Reserve insist on looking at so-called "core" inflation — which eliminates the cost of rapidly rising food and energy prices?

Core inflation is at 2 percent, excluding food and fuel. Nobody can choose to not buy food and fuel. What is the core number based on? And why does it matter if most of my budget is not counted and groceries are way more than 2 percent above last year?
— Elizabeth K., Ellsworth, Maine

These data aren’t designed to reflect the individual experiences of each consumer. They’re designed to track broad changes in prices across all product categories.

So the prices you pay — your own personal inflation rate – will likely have little to do with the monthly national average statistic. Yes, food and gasoline costs are going up. But the cost of a big screen TV is going down. (That makes up for a lot of eggs.)

So why are food and energy prices excluded from the “core” number economists and the Fed watch closely? Yes, the trend in energy prices today is upward — but the price of crude has fallen by more than $10 a barrel in the past month. The same thing happens with food prices: A drought in a farm region can force up short-term prices dramatically. But when the next crop comes, they fall back again.

The idea is to filter out the price of commodities that are subject to big moves over short periods. If you don’t, inflation numbers can bounce around quite a bit from month to month. The Fed can’t have an impact month-to-month; changing interest rates is more like turning a supertanker. A cut in rates today can take months to flow through the system. So the Fed looks at longer trends. Eliminating food and energy "smooths" out the short-term ups and downs of the price of these commodities.

There are other ways economists try to smooth the data. Factory orders, for example, can get thrown off by a single aircraft order moved from one month to the next. So if Boeing lands a big contract, that order skews the overall number way up one month and down the next.

Another widely used “smoothing” method is what’s called a “moving average.” What you do is take the last three months and average those for a monthly number. When the new month comes along, you add the new data point, drop off the one that’s four months old, and average again. So any one-month blip — up or down — gets filtered out.

The Fed also looks at more than the price of goods. Another major component, so-called wage inflation, creeps into the economy when growth is so strong that employers have a hard time finding and keeping qualified workers. When that happens, they have to raise wages to keep their operations staffed and employees have an easier time getting a raise because they can get a better offer elsewhere. So far, both wages and productivity are rising – which means the cost of labor is not adding a lot of pressure to the inflation outlook.

All of which is not to say the Fed isn’t worried about inflation. At the moment, they’re focused on cutting rates to head off a recession and calm the financial markets. But runaway inflation can be worse than recession, which often clears the way for a new period of growth. The only way to stop inflation is to keep raising rates until it stops. And the medicine can be worse than the disease.

Why haven’t gas prices reached $7 in the U.S.? What’s keeping oil companies from doing that? Are they afraid that gas will stop being purchased?
— Robert G., Denton, Tex.

If the market price of gasoline is, say, $3 a gallon and you charged $7 for it, no one would buy it. At least not as long as they could buy it somewhere else for the market price.

The reason gasoline prices haven’t jumped is that the gasoline markets are well supplied. That usually happens this time of year: Refiners have had a chance to catch up with demand after it surges in summer, and demand goes down in the fall when the summer driving season is over. It’s been like this for at least 25 years.

But you don’t see headlines saying "Pump Prices Remain Stable" because that’s not news. Higher oil costs will eventually flow through to the pump price because refiners aren’t going to make gasoline at a loss. But gasoline is a separate market; until the current supply is worked off, prices should remain stable. Refiners can only charge what the market will allow.

In the meantime, profit margins for oil companies and refiners have fallen. But you won’t see headlines saying Oil Company Profits Collapse because, again, that’s not news.

And as soon as pump prices start rising again, you’ll hear people complaining about price gouging. Since the gas lines of the 1970s, many drivers have been convinced that oil companies set pump prices, not the market. If there were ever a better time to prove otherwise, this is it.

What happens when the U.S. government doesn't have enough tax revenue to pay the interest on the federal debt?
— Tom, Aurora, Colo.

It has two choices, neither of which is pleasant.

The government can raise taxes. Or it can borrow more money, which pushes more debt into the financial system, which devalues the purchasing power of each dollar.

In the meantime, the rising interest payment puts pressure on Congress to cut all other government services. Unless the rising debt can be contained, the interest bill will slowly consume the rest of the federal budget.

I am 31 years old and I have saved up $100,000 dollars. I do not know where to invest. I own a house and I owe $180,000 on my house. Any ideas?
Kishen, Granite City Ill.

It’s hard to say without knowing a lot more about you: how reliable your income is, what kind of family responsibilities you have, what other financial goals you have, including retirement. There’s also no one-size-fits-all answer for investing. A lot depends on the investor: How much risk are you comfortable with? How much time do you want to spend managing your investments? How skillful are you — or do you want to become — in following your investments and learning about new ones?

These are all good questions to discuss with a good, fee-for-service financial advisor or planner. The reason you want a planner who charges you a fixed fee is that you’re less likely to be sold an investment based on how much it pays the “advisor” rather than how much it pays you.

With the credit market still reeling from an ongoing housing recession, the Federal Reserve is widely expect to cut interest rates again when it meets on Tuesday. Despite strong economic growth in the third quarter, the economy is already showing signs that the housing bust is dragging overall growth lower.

With the economy slowing and inflation apparently still under control, most Fed watchers are looking for another quarter point cut in rates. The stock market has also interpreted recent public comments by Fed officials as a signal that a cut is likely.

Two weeks ago, both Fed Chairman Ben Bernanke and Vice Chairman Donald Kohn noted that conditions in the financial markets had deteriorated since improving in September and October. Bernanke said policy makers needed to be "exceptionally alert and flexible" while Kohn called for "flexible and pragmatic policymaking."

A quarter-point cut in short-term rates won’t be enough to offset the ongoing housing bust, especially in hard-hit areas like California, Arizona, Nevada, Florida and parts of the industrial Midwest.  But cutting rates could help ease the impact on consumer spending, which accounts for roughly 70 percent of economic activity.

Job growth remains relatively strong — some 94,000 jobs were added in November, according to the Labor Department. But with some one in eight jobs dependent directly or indirectly on the housing industry, a prolonged slump could whittle away at future job gains.

Consumer spending may also take a hit from the falling value of the roughly $25 trillion worth in U.S. residential real estate, according to Sung Won Sohn, president of Hamni Bank.

“For every $100 decrease in the price of house, that effects consumption by about 3 to 5   percent,” he said. “You can see the housing recession does affect consumer spending, but over time. So we really haven’t seen the brunt of it yet.”

Though many economists believe the odds of a recession have increased, it’s far from inevitable. A lot depends on how homeowners react to the wave of higher mortgage payments set to hit next year. Further rate cuts by the Fed could help blunt that impact, according to Greg McBride, an analyst with Bankrate.com

“The fact is the Fed easing will have a much more significant impact for more people that the much ballyhooed (White House) foreclosure relief plan,” said Greg McBride.

While housing remains a major headwind, other forces have been offsetting that weakness. A cheaper dollar has helped boost exports, as American products look cheaper to foreign buyers.

And while housing has been mired in a slump, commercial construction has held up well. Business are building new plants, warehouses, hotels and office buildings. State and local governments are busy putting up schools, expanding airports, rebuilding roads and bridges.

“What’s happening there is the mirror image of what’s happening in housing,” said Stuart Hoffman, chief economist at PNC. “There’s a lot of strength there and it’s been a partial offset of housing and the overall drag of housing on the economy.”

If oil prices return their march to $100 a barrel and beyond, the Fed may need to reconsider its current rate-cutting stance. Rising prices give the Fed less maneuvering room to cut rates, because the best known antidote to higher inflation is higher rates.

“Inflation is going to be a word on everyone lips in 2008,” said McBride. “Another rate cut isn’t exactly a boost for the dollar. And a declining dollar also feeds into those inflation concerns.”

That’s because a falling dollar doesn’t go as far when consumers buy imported goods; that tends to raise the price of those goods in dollar terms.

The outlook for the dollar depends in part on how central banks around the world respond to signs of slowing economic growth. The Bank of England cut rates on Friday in response to forecasts of slowdown there. Growth in Europe is also expected to slow; if European banks begin cutting that could ease some of the pressure on the falling U.S. currency. (With rates currently lower in the U.S. than in Europe, the dollar is less attractive to foreign investors because they get a lower retunr on dollar-based investments. That reduces demand for the dollar and hurts its value relative to other currencies.)

“When we get the point where (the Europeans) are cutting rates and the Fed stops, some of that swoon in the dollar may come back a bit,” said McBride.

Most Fed watchers believe the central bank still has a ways to go before it stops cutting the cost of money — possibly until short-term rates reach 3.5 percent. Some argue that the central bank has been moving too slowly — or that it has failed to give a clear message about its thinking to the financial markets about what comes next.

That may be, in part, the traditional reluctance of central bankers to show their hand, hoping to some extent that the element of surprise can add weight to its policy moves.

If may also reflect a change in the culture of the Fed under its new chairman Ben Bernanke, according to Mark Zandi, chief economist at Moody’s.com.

“Chairman Bernanke is more collegial (than former Fed Chairman Alan Greenspan) and is a allowing for more voices, giving more weight and input to the Fed bank presidents and the rest of the board. And therefore it’s more difficult to respond and send a strong message to the marketplace. It’s always more diluted when you put together a statement where you have 10 people involved as opposed to one or two.”