The US economy is in a mess ”“ even if growth has resumed, and bankers are once again receiving huge bonuses. More than one out of six Americans who would like a full-time job cannot get one; and 40% of the unemployed have been out of a job for more than six months.

As Europe learned long ago, hardship increases with the length of unemployment, as job skills and prospects deteriorate and savings gets wiped out. The 2.5-3.5 million foreclosures expected this year will exceed those of 2009, and the year began with what is expected to be the first of many large commercial real-estate bankruptcies. Even the Congressional Budget Office is predicting that it will be the middle of the decade before unemployment returns to more normal levels, as America experiences its own version of “Japanese malaise….”

Three things can make a difference: a second stimulus, stemming the tide of housing foreclosures by addressing the roughly 25% of mortgages that are worth more than the value the house, and reshaping our financial system to rein in the banks.

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A professor at Columbia University, Mr. Stiglitz uses his experience teaching to give the lay reader a lucid account of how overleveraged banks, a shoddy mortgage industry, predatory lending and unregulated trading contributed to the meltdown, and how, in his opinion, ill-conceived rescue efforts may have halted the freefall but have failed to grapple with more fundamental problems.

He is eloquent on how the American economy was sustained before the crisis by “a debt-financed consumption binge supported by a housing bubble” and impassioned in describing what he sees as the government’s failure to make substantial reforms to the economic system: though “excesses of leverage will be curbed,” he writes, “the too-big-to-fail banks will be allowed to continue much as before, over-the-counter derivatives that cost taxpayers so much will continue almost unabated, and finance executives will continue to receive outsized bonuses.” In each case, he writes, “something cosmetic will be done, but it will fall far short of what is needed.”

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The effect of free money is remarkable. A year ago investors were panicking and there was talk of another Depression. Now the MSCI world index of global share prices is more than 70% higher than its low in March 2009. That’s largely thanks to interest rates of 1% or less in America, Japan, Britain and the euro zone, which have persuaded investors to take their money out of cash and to buy risky assets.

For all the panic last year, asset values never quite reached the lows that marked other bear-market bottoms, and now the rally has made several markets look pricey again. In the American housing market, where the crisis started, homes are priced at around fair value on the basis of rental yields, but they are overvalued by almost 30% in Britain and by 50% in Australia, Hong Kong and Spain.

Stockmarkets are still shy of their record peaks in most countries. The American market is around 25% below the level it reached in 2007. But it is still nearly 50% overvalued on the best long-term measure, which adjusts profits to allow for the economic cycle, and is on a par with two of the four great valuation peaks in the 20th century, in 1901 and 1966.

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Banks and other lenders are still foreclosing on Americans’ homes at a rate that’s outpacing the Obama administration’s main effort to stem the crisis.

In fact, while the Treasury Department’s Home Affordable Modification Program, or HAMP, has started the mortgage modification process on almost 760,000 homeowners who are at risk of losing their homes, less than 5 percent of those workouts have become permanent, government data show.

“HAMP has made only limited progress for nine months now, and the residential foreclosure crisis continues to mount,” said Richard Neiman, the superintendent of banks in New York state and a member of the Congressional Oversight Panel that was formed to monitor the Treasury bank bailout funds that support the mortgage program. He was appointed to the post by the Democratic leadership in the House of Representatives.

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The second important lesson involves understanding why markets often do not work the way they are meant to. There are many reasons for market failures. In this case, too-big-to-fail financial institutions had perverse incentives: if they gambled and succeeded, they walked off with the profits; if they lost, the taxpayer would pay. Moreover, when information is imperfect, markets often do not work well – and information imperfections are central in finance. Externalities are pervasive: the failure of one bank imposed costs on others, and failures in the financial system imposed costs on taxpayers and workers all over the world.

The third lesson is that Keynesian policies do work. Countries, like Australia, that implemented large, well-designed stimulus programs early emerged from the crisis faster. Other countries succumbed to the old orthodoxy pushed by the financial wizards who got us into this mess in the first place.

Whenever an economy goes into recession, deficits appear, as tax revenues fall faster than expenditures. The old orthodoxy held that one had to cut the deficit – raise taxes or cut expenditures – to “restore confidence.” But those policies almost always reduced aggregate demand, pushed the economy into a deeper slump, and further undermined confidence – most recently when the International Monetary Fund insisted on them in East Asia in the 1990’s.

The fourth lesson is that there is more to monetary policy than just fighting inflation….

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The last two quarters were even more extreme: Productivity in the nonfarm business sector grew at a shocking 8.1% annual rate. There are two possible explanations. One: The last two quarters were among the most technologically innovative and entrepreneurial in the history of the United States. Two: Fearful businesses pared payrolls to the bone. If the second is closer to the truth, payrolls are extraordinarily lean right now. Which means that firms will need to hire more workers as their sales and production grow. Which means that employment may start growing sooner than the pessimists think.

I have been pointing this out for months, but until the last employment report, it was a hypothesis supported by no evidence. Not anymore. While payrolls continued to decline in November, it was by only a scant 11,000 jobs; and the job counts for September and October were revised upward. The data now show a clear trend that suggests that net job creation may be only a month or two away. We’ll see.

There is more to the case for optimism. For one thing, less than 30% of February’s $787 billion fiscal stimulus has been spent to date; over 70% is still in the pipeline. Pessimists dote on the fact that the rate of increase of stimulus spending has probably peaked and will be lower in 2010. True. But the level of GDP will continue to get support from fiscal policy, and a second job-creation package (“Please don’t call it a stimulus!”) looks to be in the works.

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For the country [ofAmerica] as a whole…homebuyers have paid no more than the old-fashioned standard of 25% of their incomes for housing in any year since 1985. Renters have in recent years paid a somewhat higher percentage of their smaller incomes but not more than 30% in any year over the past several decades.

Neither by comparison with the recent past nor by comparison with other countries today is most housing in the United States unaffordable. The median-priced home in the United States as a whole is 3.6 times the median income of Americans. For Great Britain, the median-priced home is 5.5 times the median income and, in Australia and New Zealand, the ratio of home prices to income is 6.3.

Acknowledging this reality would cause a widely accepted vision, and the national crusades and policies built upon it, to collapse like a house of cards. Instead, facts that would undermine this vision and this political crusade have been largely ignored.

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Yet the urgent problem now isn’t TBTF [too big to fail], or even banker bonuses. These are distractions. The urgent problem is the giant riverboat gamble that Washington can save the economy by doing what comes naturally””spending money carelessly, creating massive new entitlements without funding them, dishing out cheap credit to politically favored sectors, telling business people where and how to invest.

Mr. Feinberg is an apt symbol indeed, for this gamble is built on the conceit that Washington can hector the recipients, whether auto companies, banks or homeowners, into behaving in ways that are “responsible.” So far, however, human nature is proving a disappointment: Take the outbreak of tax fraud related to the government’s emergency home-buyer’s credit.

Nor is the larger gamble looking so good either. Banks continue to fail at an alarming rate, the dollar is under assault, and Washington is looking at a future of trillion-dollar deficits. One might have guessed it would take a decade of Obamanomics to produce European welfare state levels of youth unemployment, but at 18.5% we’re there.

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Jeff Nielsen called the couple’s lender, Wells Fargo, and said he’d like to apply for a home loan modification.

“The bank didn’t quite know what to do with that,” he says. He remembers them telling him, “We don’t know anything more than you know. Just send in all kinds of documents and we’ll get to it as soon as we get the details from corporate.”

The Nielsens tried to guess what kinds of documents Wells Fargo might want and sent them in. Two months passed with no response, aside from a form letter saying the lender received the application. Jeff Nielsen began calling the bank twice a week. After another month, he heard that his file was on someone’s desk, but no one could tell him who that person was or whether anyone had looked at his file.

“Do you remember that scene in Kill Bill where Uma Thurman is trying to fight Lucy Liu,” he says, “but Lucy Liu has all these henchmen, so she has to fight all the henchmen and then Lucy Liu has like 50 more henchmen? But I feel that instead of being this samurai warrior, I’m like Jonathan Lipnicki with all these henchmen. So I have no chance to get to Lucy Liu.”

Read or listen to it all, a great examiniation of a government program from the inside.

Many of Mr. Obama’s supporters surely thought this young, dynamic generation of public leaders would elevate the hip, cutting edge of the U.S. economy — nanotechnology, genomics, robotics, even health and medicine technology. Instead, we’ve gotten the Old Economy on dialysis. General Motors has been commanded to restart aging UAW factories to output product on behalf of the administration’s hybrid-car obsession. Where’s the New Economy in any of this?

Or ObamaCare. How will a build-out of Medicare (b. 1965) to cover everyone and costing $1.2 trillion over 10 years not kill innovation in medical and health technology by siphoning away growth capital and its potential financial rewards?
All of this seems so out of sync with the persona and promise Barack Obama conveyed in the campaign. A lot of his Web-based supporters probably thought Mr. Obama was going to be about promoting young guns with new ideas seeking risk capital for the next big thing. Instead, it looks as if the Obama years will be about managing soft landings for mature industries and old unions in the American autumn.

Congress is talking about a “bad behavior” tax on beer and soda pop to reduce obesity and fund mega-Medicare. How about a bad-behavior tax on government? Slim as the president looks, Uncle Sam is looking like quite the fat boy.

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Such government micromanagement of the economy is everywhere. The Post recently reported that Richard Wagoner, the former CEO of General Motors who was removed by the government, remains on GM’s payroll “because senior Treasury officials have yet to decide whether he should get the $20 million severance package that the company had promised him.” His 2009 compensation — $1 — is payable Dec. 31. The $20 million promised to him includes contractual awards, deferred compensation and pension benefits accrued over 32 years with the company. Promise-keeping, including honoring contracts, is the default position of a lawful society. But suddenly, many citizens’ legal claims are merely starting points for negotiations with an overbearing government.

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There will be no recovery until there is a halt in the relentless rise in foreclosures. Foreclosures threaten millions of families with financial ruin. By driving prices down, they sap the wealth of all homeowners. They exacerbate bank losses, putting pressure on the still fragile financial system. Lower monthly payments are a balm, but they are no substitute for home equity. And until more Americans can find a good job and a steady paycheck, the number of foreclosures will continue to rise.

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Two weeks ago, the U.S. Treasury released additional details (link opens .pdf) about the homeowner bailout, or in Washington-speak the “Making Home Affordable” program. Part of those details included some new ways for homeowners to avoid foreclosure. I thought the far more fascinating part, however, was the so-called “Home Price Decline Protection Incentives” (HPDP). It’s the most interesting part of the homeowner bailout that you probably haven’t heard about. I have been fascinated with the HPDP since the bailout was announced in February, and now we finally have some detail to dig into.

For some strange reason, virtually no one is talking about the HPDP. I haven’t seen a single article on it. Here’s how the new fact sheet describes it:

This initiative provides lenders additional incentives for modifications where home price declines have been most severe and lenders fear these declines may persist. These incentives will encourage servicers to undertake more modifications by assuring that incremental investor losses will be partially offset.

All of the initiatives within the homeowner bailout have attempted to stabilize the housing market. But this is the only one that provides a sort of insurance to investors if home prices continue to decline. In February I remarked that it seemed like the housing bailout included everything but the kitchen sink. I was wrong: this is the kitchen sink.

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They’re back. We refer to the global investors once known as the bond vigilantes, who demanded higher Treasury bond yields from the late 1970s through the 1990s whenever inflation fears popped up, and as a result disciplined U.S. policy makers. The vigilantes vanished earlier this decade amid the credit mania, but they appear to be returning with a vengeance now that Congress and the Federal Reserve have flooded the world with dollars to beat the recession.

Treasury yields leapt again yesterday at the long end, with the 10-year note climbing above 3.7%, its highest close since November. Treasury yields had stayed low, and the dollar had remained strong, as long as investors were looking for the safest financial port amid the post-September panic. But as risk aversion subsides, and investors return to corporate bonds and other assets, investors are now calculating the risks of renewed dollar inflation.

They have cause to be worried, given Washington’s astonishing bet on fiscal and monetary reflation. The Obama Administration’s epic spending spree means the Treasury will have to float trillions of dollars in new debt in the next two or three years alone….

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[BARRY] RITHOLTZ: Most of Wall Street is furious at what happened. Most of Wall Street aren’t involved in mortgage securitization or derivatives or any of the other bad assets that have been blowing up. The average guy — you know Wall Street is a meritocracy, eat what you kill, as much as you can earn in profits you get to take as a bonus — and I know a lot of guys, everywhere from Merrill Lynch to Bear Stearns to Lehman, that actually were really profitable. But because this one division was run by rogue pirate traders and reckless derivatives salesmen, they wiped up the entire bonus pool for the entire firm, and then some, all the while engaging in really reckless behavior.

[Kai] Ryssdal: Do you figure we’re stuck now as a bailout nation? We’re going to be subsidizing banks and car companies and insurance companies for some time to come.

RITHOLTZ: You know we’ve already seen the trucking industry make hints they want stuff. And we’ve seen the homebuilders who are key players in this, who just overbuilt everything. They’ve been asking for a bailout. That’s the slippery slope. Once you reward people for their worst behavior, for speculative, irresponsible investing and punish the prudent and the people who are careful with that money. Everybody seems to think it’s a free for all. Hey, you’ve got yours. How do I get mine?

Ryssdal: What’s the alternative to these bailouts? I mean should we have just done nothing?

RITHOLTZ: What you do is what the FDIC does when a bank is found to be insolvent. Look what happened with Washington Mutual….

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The U.S. Treasury auction of long-term bonds on Thursday was “terrible”, in the words of one Wall Street economist, with the rate on the 30 year bond jumping from 4.1 to 4.3 percent. This is just the first sign that the debt-based Obama economic stimulus plan is about to become a major drag on the recovery, just as expected.

The economic news is not all bad. We are seeing signs the rate of contraction is abating quickly, promising a bottom to the recession sometime this summer as many forecasters have expected. But therein lies another piece of the interest rate puzzle, and the trouble ahead.

There are two critical consequences to the economy stabilizing. The first is that the massive liquidity injected into credit markets by the Federal Reserve and central banks around the world transforms from economic medicine to inflationary heroin. Central banks are going to face a difficult task of extracting the excess liquidity before inflation soars and without causing another recession. Doubt about the fight against soaring inflation means higher inflation premiums in interest rates.

The second dangerous consequence is that President Obama is on course to double the national debt in just four years….

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Still, the tea parties are not based on the cold wonkery of budget data. They are based on an “ethical populism.” The protesters are homeowners who didn’t walk away from their mortgages, small business owners who don’t want corporate welfare and bankers who kept their heads during the frenzy and don’t need bailouts. They were the people who were doing the important things right — and who are now watching elected politicians reward those who did the important things wrong.

Voices in the media, academia, and the government will dismiss this ethical populism as a fringe movement — maybe even dangerous extremism. In truth, free markets, limited government, and entrepreneurship are still a majoritarian taste. In March 2009, the Pew Research Center asked people if we are better off “in a free market economy even though there may be severe ups and downs from time to time.” Fully 70% agreed, versus 20% who disagreed.

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. Asked about the tea parties, President Barack Obama responded that he was not aware of them. As Marie Antoinette said, “Let them drink Lapsang Souchong.” His Imperial Majesty at Barackingham Palace having declined to acknowledge the tea parties, his courtiers at the Globe and elsewhere fell into line. Talk-show host Michael Graham spoke to one attendee at the 2009 Boston Tea Party who remarked of the press embargo: “If Obama had been the king of England, the Globe wouldn’t have covered the American Revolution.”

The American media, having run their own business into the ground, are certainly qualified to run everybody else’s into the same abyss. Which is why they’ve decided that hundreds of thousands of citizens protesting taxes and out-of-control spending and government vaporization of Americans’ wealth and their children’s future is no story. Nothing to see here. As Nancy Pelosi says, it’s AstroTurf ”“ fake grass-roots, not the real thing.

Besides, what are these whiners so uptight about? CNN’s Susan Roesgen interviewed a guy in the crowd and asked why he was here:

“Because,” said the Tea Partier, “I hear a president say that he believed in what Lincoln stood for. Lincoln’s primary thing was he believed that people had the right to liberty, and had the right ”¦”

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Mr. Obama is betting that the totality of economic policies his team and the Federal Reserve have put in place will act, like radiation therapy, to halt the spread and reduce the size of the cancerous tumors eating away at our financial system ”” and stimulate enough new growth and optimism so that Phase II will be small enough to get past Congress and the public.

As Treasury Secretary Timothy Geithner told ABC News, “If we get to that point” ”” where more funds are needed ”” “we’ll go to the Congress and make the strongest case possible and help them understand why this will be cheaper over the long run to move aggressively.”

Have no doubt, Phase II is coming. At best, it will require hundreds of billions of dollars more, at worst more than a trillion, to deal with more bad loans and toxic assets weakening the economy ”” problems that Phase I can’t fully absorb. Because unemployment is still rising ”” ensuring that the initial spate of mortgage defaults, which came from loans to people who could never repay, will be followed by another spate of defaults from those who could repay but now can’t because the deteriorating economy has stripped them of their jobs, their businesses or their credit lines.

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The good news from our historical study of eight centuries of international financial crises is that, so far, they have all ended. And we confidently predict this one will end, too. We are just not quite so sure it will be nearly as soon as the chirpy forecasts coming from policymakers around the globe. The U.S. administration, for example, is now predicting that growth will renew in the latter part of this year and continue at a brisk pace of 4 percent for several years thereafter. Is this a fact-based forecast or wishful thinking?

A careful look at the international evidence on severe banking crises suggests a far more cautious assessment. The recessions that follow in the wake of big financial crises tend to last far longer than normal downturns, and to cause considerably more damage. If the United States follows the norm of recent crises, as it has until now, output may take four years to return to its pre-crisis level. Unemployment will continue to rise for three more years, reaching 11”“12 percent in 2011.

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An infographic that flowcharts the nearly $12 Trillion allocated in government progams affecting the financial services industry.

When President-elect Barack Obama picked Timothy F. Geithner to be his Treasury secretary four months ago, numerous analysts praised the choice because of Geithner’s expertise in the financial industry. He was president of the Federal Reserve Bank of New York at the time, and had helped craft the response to the troubles roiling global credit markets. But as the debacle over the American International Group bonuses has made clear, Geithner’s knowledge about Wall Street is matched by his ignorance about the political culture of Washington. And the blunders committed by Geithner (and others, including the Federal Reserve and previous Treasury Secretary Henry M. Paulson) could undermine key elements of President Obama’s economic recovery plan.

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What has happened – not only in America but also in Britain – to this promise of a calm, pragmatic response to the world’s economic problems? This week Mr Obama expressed outrage at the $165 million bonuses paid by AIG, the stricken insurance group, to executives in its financial products division who are responsible for most of its tens of billions of dollars in losses.

In Britain the row over Sir Fred Goodwin’s pension continues to grow. And in both countries, hatred of bankers is making it difficult for governments to take further action to stabilise the banks and support economic growth.

The behaviour of the bankers who first blew up the world financial system and then proceeded to loot it, is genuinely outrageous and deserves political retribution. But that should take the form of recovering the booty by the normal processes of law.

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President Barack Obama’s approval rating has slipped, as a growing number of Americans see him listening more to his party’s liberals than to its moderates and many voice opposition to some of his key economic proposals. Obama’s job approval rating has slipped from 64% in February to 59% currently, while disapproval has jumped from 17% to 26% over this period.

Although most people think the new president is doing as much as he can to fix the economy and relatively few say Obama’s policies have made the economy worse, the public expresses mixed views of his many major proposals to fix the economy.

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Zach is feeling the icy fingers of the recession gripping his throat. He’s a small-business man with a retail store in New York and an investment in a small apartment renovation that hasn’t gotten a buyer. Suddenly, his income is down by 25 percent or so. He has a mortgage on the house in Brooklyn where he lives that he used to be able to afford, but now he’s dipping into his savings to the tune of $2,000 or $3,000 a month to cover his costs, and he’s worried.

So he called his mortgage bank to see what might be done. The answer was: not much, certainly nothing from any government plans to help homeowners get through the crisis. And for Zach, who’s never gone to the government for anything before, there’s a larger point in that fact.

To wit: If you’ve behaved responsibly and prudently all these years, you’re on your own. But if you’ve made colossal mistakes of greed and misjudgment ”” either by selling billions in mortgages to people who couldn’t afford to pay you back or by being one of the people whose eyes were bigger than their wallets”” you might just get rescued, at the expense of taxpayers like Zach.

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The misguided policy response from Washington has focused almost exclusively on squandering public money and burdening our children with indebtedness in order to defend the bondholders of mismanaged financial institutions (blame Paulson and Geithner ”“ I’ve got a lot of respect for our President, but he’s been sold a load of garbage by banking insiders). Meanwhile, I suspect that the little tapes in Bernanke’s head playing “we let the banks fail in the Great Depression” and “we let Lehman fail and look what happened” are so loud that he is making no distinction about the form of those failures. Simply letting an institution unravel is quite different from taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date. This is what it would mean for these banks to “fail.” Nobody is advocating an uncontrolled unraveling of major financial institutions or permanent nationalization as if we’ve suddenly become Venezuela.

Make no mistake. Buying up “troubled assets” will not materially ease this crisis, nor will it even improve the capital position of financial institutions (see You Can’t Rescue the Financial System if You Can’t Read a Balance Sheet). Homeowners will continue to default because their payment obligations have not been restructured to any meaningful extent. We are simply protecting the bondholders of mismanaged financial institutions, even though that bondholder capital is more than sufficient to cover the losses without harm to customers. Institutions that cannot survive without continual provision of public funds should be taken into receivership, their assets should be restructured to better ensure repayment, their stockholders should be wiped out, bondholders should take a major haircut, customer assets should (and will) be fully protected, and these institutions should be re-issued to the markets when the economy stabilizes.

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The day after the report I heard from a young Naval aviator in predeployment training north of San Diego. He flies a Super Hornet, sister ship to the plane that went down. He said the Marine investigation “kept me up last night” because of how it contrasted with “the buck-passing we see” in the government and on Wall Street. He and his squadron were in range of San Diego television stations when they carried the report’s conclusions live. He’d never seen “our entire wardroom crowded around a television” before. They watched “with bated breath.” At the end they were impressed with the public nature of the criticism, and its candor: “There are still elements within the government that take personal responsibility seriously.” He found himself wondering if the Marines had been “too hard on themselves.” “But they are, after all, Marines.”

By contrast, he says, when the economy came crashing down, “nowhere did we see a board come out and say: ‘This is what happened, these are the decisions these particular people made, and this was the result. They are no longer a part of our organization.’ There was no timeline of events or laymen’s explanation of how a credit derivative was actually derived. We did not see congressmen get on television with charts and eviscerate their organization and say, ‘These were the men who in 2003 allowed Freddie and Fannie unlimited rein over mortgage securities.’ Instead we saw . . . everybody against everybody else with no one stepping forth and saying, ‘We screwed up.'” There is no one in national leadership who could convincingly “assign blame,” and no one “who could or would accept it.”

Read it all or you may also find it here.

Supporters regard the threat of a mortgage modification in bankruptcy as a crucial tool to prod banks to negotiate with homeowners for more affordable terms. Critics argue the measure will create a flood of bankruptcy filings that ultimately will drive up mortgage rates and further destabilize the battered housing market.

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How to rescue housing? The Obama administration doesn’t have a plan — or, more accurately, it has only half a plan. It presupposes that preventing or minimizing home foreclosures is a formula for revival. It isn’t.

Almost everyone agrees that a housing recovery is essential for a broader economic upswing, in part because housing’s collapse brought on the recession. Mortgage delinquencies triggered the financial crisis. Tumbling home prices (down 26 percent from their peak) ravaged consumer confidence, borrowing and spending. Since late 2007, housing-related jobs — carpenters, real estate agents, appraisers — have dropped by 1 million, a quarter of all lost jobs.

Housing’s distress is too much supply chasing too little demand. Huge inventories of unsold homes have depressed prices and construction. Given that prices rose too high in the “bubble” — homes were affordable only because credit was dispensed so recklessly — much of this painful adjustment was unavoidable. But that process should be mostly complete….

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Bill Clinton declared more than a decade ago “the era of big government is over.” With his new budget, President Barack Obama has brought it back.

Obama’s $3.55 trillion budget proposal represents a gamble that Americans are ready for the sort of change they embraced by electing him in November, including a tax increase on Americans making more than $250,000 a year.

He proposes expansion of spending on the U.S. healthcare system, on greater energy independence and on education, hoping Americans weary of paying for a raft of expensive bailouts for banks and the car industry will go along.

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