"What would you have us do?" you ask. Frankly, Ythat question is simply too late.

I predicted last September that the Fed was going to be in a real bind this year. With the collapse of the housing bubble (brought on by Alan Greemspan's 17 months of interest rates, after he had lowered the interest rates to as low as 1.75% to get Bush reelected in 2004) mixed with his refusal to regulate mortgage lenders who were criminally lending to people who should never have had the loans (Liar loans, for example, which IndyMac Bancorp specialized in to assist CountryWide Mortgage Co get loan origination fees.)

But Greenspan knew that he had to raise interest rates after the 2004 Presidential election because it was killing the value of the dollar. It's not like he had to lower interest rates before the 2004 election for economic reasons - he had raised them in 2000 to defeat Al Gore. Don't believe me? I show in my post Economics and politics of the Fed fund rate he has raised the interest rate to 6.5% in 2000 presumably to slow the economy and defeat Al Gore. There was not a good economic reason for that timing.

But now, with the increased rates in 2005 and 2006, the housing bubble that Greenspan had encouraged collapsed. That, and the various gimmicks used by the investment banks to expand loans (assets, they are called - until they become non-paying) are now coming back to bite America in the ass. This is too early, of course. The conservatives wanted the inevitable economic collapse resulting from their economic mismanagement of the economy to occur after a Democrat was elected President.

Say what you want - this is a direct result of the free market Libertarian ideology anti-regulation ideology pushed by the conservative movement and the Reagan Revolution.

So what do we do now? The American economy is going to suffer through the next two or more years of nasty stagflation while (we can hope) sensible government officials start properly reregulating the financial sector so this doesn't happen again.Because this was exactly the kind of unregulated economy Boom and Bust cycle, with each Boom and Bust larger than the one previous, that the FDR government created the SEC, the FDIC, and the Glass-Steagall Act to prevent. Because the financial industry cannot exist in a stable configuration without extensive clear reporting and close regulation - things the off-the-books games are designed to avoid.

Remember Enron. The off-the-books games were what ultimately killed them. If those things had been on the books, Enron would never have been seen to be profitable. Now we see that all the major American banks have been playing the same game.

What do we do now? First we just flat suffer as a nation. We start living within our means - which will mean, by the way, at least a 50% cut in the pentagon and Intelligence Agency spending which we can no longer afford no matter how bad the apparent need. Priorities will matter.

Also, we will apply real regulations to the financial sector. That will start with real reform in financial reporting. The risks have to be identifiable. This is going to cause a real shriek from the banks because they won't be able to play fast and loose with the risks they are taking as they presently are doing. So while the military will shrink, the financial regulations will need to sharply expand.

Although not directly related to the collapse of our financial sector, we also need to start emphasizing the fact this is a middle class nation, not one designed for the benefit of the wealthy. Because the alternative is the Latin American model - a very wealthy class, a very large poor class, and an anemic middle class that doesn't matter much. That alternative is where we are headed. (Go Read David Cay Johnston's book Free Lunch.) American previously avoided this problem because the European diseases wiped out the Native Americans and the resulting free land allowed Americans to move West, resulting in no real power to wealth because the free land allowed everyone the opportunity to become wealthy. The closing of the frontier and the rising population has ended that dynamic. Now we are just like Europe, China and India. Wealth equals power, and democracy is dying here. Europe has shown that it doesn't have to be that way, but a totally unregulated free market will inevitably lead to a strong class system and the Latin American model.

But your question was what do we do now? First we suffer. It's too late to avoid that. But then we reregulate our financial sector and stop this silly idea that government is the enemy. Not that it's not dangerous. Fire is dangerous, but civilization is impossible without it. The same is true of government. We have to get it back in balance with private enterprise - something that should never be allowed free rein because unrestrained it is fully as dangerous as is unrestrained government.