Fed's intervention a roaring success, as long as you define success modestly enough

With markets now closed for the day, you'd have to say the Fed's frantic actions of the weekend--engineering the fire sale of Bear Stearns, cutting the discount rate and creating yet another "lending facility"--were successful. Stock markets didn't collapse (Dow up slightly, S&P 500 and Nasdaq down), and, much more importantly, credit markets didn't either. The all important TED spread--the gap between the T-bill interest rate and the London Interbank Offered Rate, which rises on financial distress--dropped slightly on the day. It's still much higher than before everybody started wigging out last summer, but substantially lower than in August or December.

This is what the Fed can do--keep the financial system from completely locking up. Fed Chairman Ben Bernanke has argued that the breakdown of financial intermediation in the early 1930s was what made the Great Depression great (as in horrible); he's made pretty clear that he's going to do everything in his power to keep that from happening on his watch.

What Bernanke can't do, though, is make bad mortgages good or prevent the credit crisis from causing a deep recession. Congress might be able to make the Great Mortgage Shakeout (hmm, I guess I could add that to the list of possible names for this mess, although it's not that catchy) a little more orderly with something like the Dodd-Frank plan to get the Federal Housing Administration to insure refinanced mortgages. But a shakeout there must be. Lots of loans were extended to buy things (houses, mostly) that are turning out to be worth less than the amount of the loans. That's bad debt, hundreds of billions (maybe trillions) of dollars of it, and it can't just be wished away by the Fed.

I've been gushing about what a great job the Swedes did in cleaning up their financial mess in the early 1990s. But Swedish GDP still shrank 5% between 1990 and 1993. If that happened here it would be by far the worst economic downturn since the Great Depression (I'm not counting the 11% GDP drop in 1946, which simply reflected sharp cuts in defense spending after the war). It wouldn't be nearly as bad as the Great Depression itself, when real GDP fell 26% between 1929 and 1933. But it would be far worse than anything I've ever experienced, that's for sure.

That's not a prediction of what lies in store for the U.S. It's just a suggestion of the possibilities, and maybe a yardstick by which the Fed's success or failure in managing this crisis should be judged.