If Escher built a house of cards, then removing any would lead to 52 pick up. This seems to be a good model for the current economy as we see someone about to remove the Bear Stearns card — and some rare Fed (and JP Morgan) maneuvering to make sure it stays there.

The fundamental problem is that everyone who has lent money is worried about getting it back — and so they are asking for more back than usual. And if you owe money, it is more likely that you don’t have that money in the bank, but invested elsewhere. And getting that money back means that you are selling to cover positions. For example, if you have some stock and a big credit card bill — and the credit card needs their money paid back, you probably have to sell your stock even if the market is down. The amounts that banks, big equity funds, investment banks, etc have had to actually keep has been way too low (for example about 1/33 for the Carlyle Capital Group). Their, and many others, strategy of investment works wonders when the economy keeps growing. Imagine missing out on some of the mortgaged-backed security growth — the groups that have been making money hand over fist have taken large risks that have worked perfectly while there has been plenty of liquid for them to immediately borrow from someone else if they needed money.

Now, even with interest rates being quite low, people are nervous to borrow because of the fragile state of the economy and also because they are being forced to repay and having trouble borrowing to do so. The Fed has been making use of some tools not seen since the Great Depression to inject liquidity back into the market — basically allowing companies to borrow huge amounts of money for very short periods. But in many cases the Fed is starting to take more risks than it has. For Bear Stearns, they have allowed JP Morgan to borrow huge amounts for 28 days with much of the risk squarely on the Fed.

Usually in downturns, there are some industries that generally do well. Though there are some differences this time. The weak dollar and the demand from some growing giants (eg China) means that a number of very core commodities (eg copper, steel, oil, etc) have not dropped in price. Some have been doubling in price. Oil has hit $110 after being $35 in mid 2004 (note that the Iraq war did not bring the price down and Exxon-Mobil has been making record profits). Copper has gone from less than a dollar/pound in 2003 to almost $4/lb today. These raw material costs staying high will make some of the traditional downturn industry more difficult.

The need for real regulations that would have prevented much of this will ward off the future construction of houses of cards — but what about now? What is the solution now? How can we have our cake and eat it too? How can we keep spending with record deficits and have an economy that becomes more financially sound? How can we find the lenders to make this happen indefinitely? Can we find the next China and Saudia Arabia? The next Japan?

So how can we make no hard choices and maintain the high standard of living that we have enjoyed?