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                 BEST OF DOUG NOLAND

Aug. 15 – Bloomberg (Anthony Massucci and Kathleen Hays): "William Poole, president of the St. Louis Federal Reserve Bank, said the subprime mortgage rout doesn’t threaten U.S. economic growth, and only a ‘calamity’ would justify an interest-rate cut now… ‘It’s premature to say this upset in the market is changing the course of the economy in any fundamental way,’ Poole, 70, said in the interview… ‘If the Federal Reserve were to act when it turns out there is no impact, then clearly the market would say these guys really don’t have the intelligence they need to have a policy actually based on solid evidence.’" August 17 – Financial Times (Eoin Callan): "The Federal Reserve took emergency steps to limit the damage to the US economy from the crisis in global credit markets on Friday by cutting the discount rate at which it makes loans to banks. The central bank cut the rate by half a percentage point to 5.75%, while keeping the main federal funds rate on hold at 5.25%. The surprise move, which was agreed during an emergency conference call on Thursday night, makes it more likely the Fed will cut its main rate next month and may help ease liquidity in financial markets and limit the blow to financial institutions from the deterioration in assets exposed to the meltdown in the US subprime mortgage sector."

I was as mystified as anyone with Dr. Poole’s Wednesday evening comments. U.S. and global Credit systems were succumbing to extraordinary stress, with overt negative ramifications for economic activity – especially for the U.S. Bubble Economy. Poole, "who confers regularly with regional business contacts," must not have many friends on Wall Street. The Board of Governors in Washington, the Federal Reserve Bank of New York, the Treasury and Administration do.

Today’s 50 bps reduction in the discount rate vaunted Dr. Bernanke, as a CNBC commentator put it, "to rock star status." Others referred ecstatically to "the new maestro." Whether it was merely coincidence that the surprise cut came one hour before trading opened for a key option-expiration session in U.S. equity markets (many index options settling based on opening prices), we can only speculate. But the relieved bulls took today’s move as a signal that the Bernanke Fed would maintain a "sophisticated" approach to market support operations. For an increasingly desperate Wall Street, it was pure genius.

It is Wall Street’s hope that Fed rate cuts will, once again, work their magic to restore confidence and incite a renewed appetite for risk. I have little doubt that Fed comments and cuts will have dramatic and immediate effects on a terribly distorted stock market, along with highly unstable financial markets generally. Yet this week’s wild gyrations will do little to remedy the faltering "quant" funds. And this week’s currency and emerging market tumult created only further stress in the leveraged speculating community and derivatives marketplace.

Bear market rallies are notoriously the most ferocious. And with the massive shorting that features prominently in today’s marketplace - most related to the problematic proliferation of various hedging programs and leveraged "market neutral" strategies - the Fed maintains extraordinary power to incite stock market panic buying - on demand.

The more paramount issue is whether the Fed and global central bankers have the capacity to maintain the necessary Credit creation to sustain inflated asset markets and Bubble Economies over the intermediate term. More specifically and immediately, will Fed rate cuts halt a rapidly unfolding mortgage Credit collapse? I actually believe the acute crisis unfolding throughout the commercial paper market can likely be ameliorated through aggressive lending at the Fed’s discount window. But the tattered MBS marketplace is a whole different story.

With a liquidity crisis forcing even national lending powerhouse Countrywide to dramatically tighten lending standards, the dearth of Credit Availability for subprime, Alt-A, and jumbo mortgage finance – virtually everything outside of GSE-related "conventional" mortgages - has reached crisis proportions. Today, holders of MBS – especially the "private-label" varieties – face a confluence of extraordinary uncertainty regarding MBS illiquidity, the further direction of interest rates, general economic prospects, and prospective Credit losses – along with systemic liquidity uncertainties. There will be evolving fears of a California bust and the viability of the mortgage insurance industry. It will be long before the marketplace recognizes the devastating ramifications of the jumbo mortgage freeze – especially for home prices throughout California and elsewhere across the country.

Commenting on Amgen’s announcement of layoffs (2,600) and capital spending cutbacks, a CNBC reporter highlighted the heightened risk to local (Woodland Hills, CA) real estate prices from major layoffs announced by two of the areas largest employers (Amgen and Countrywide). The average Amgen employee is said to make $160,000, with many scientists and skilled workers now having little alternative but to relocate for gainful employment. Throughout Southern California, thousands of previously well compensated mortgage brokers, real estate agents, related service providers, automobile salesmen, etc. will be forced to change their lifestyles.

Late-cycle Credit Bubble excesses were having a major – yet unappreciated – stimulating impact on upper-end incomes. From California real estate to Wall Street securities markets, unprecedented Credit-induced asset inflation has been feeding both directly and indirectly into the paychecks of a wide-ranging number of industries and ("service") sectors – from biotech, to alternative energy, to Hollywood, to professional sports and the media/advertising, and to finance. With the bursting of the Credit Bubble and the accompanied dramatic downturn in Credit Availability and Marketplace Liquidity, expect a snowball-like surge in the number of layoffs of highly-compensated employees and spending cutbacks (marketing and capital investment).

It is also my view that the Bubble-related boom at the "upper end" has played an instrumental role in the U.S. economy’s vaunted "resiliency." This is actually a typical Bubble Economy attribute, one that creates unrecognized susceptibility to what eventually becomes an abrupt and radical change in monetary conditions (the bursting of the Credit Bubble). Mr. Poole’s contacts in business may report that everything appears just fine today, but apparently little do they appreciate that Financial Sphere Tumult is in the Process of Pulling the Rug Out from Beneath the Economic Sphere.

Doug Noland is a market strategist at Prudent Bear Funds. Their website is www.prudentbear.com.