It's impolite, bordering on rude, but bears could be forgiven for rightly wearing the

"I told you so"

smirk today.

Friday's much-ballyhooed advance proved very much to be a one-day wonder as the

Dow Jones Industrial Average

fell 1.1% to 9274.90 after having traded as low as 9240.36. The

S&P 500

shed 1.2% to 976.98 vs. its early low of 972.91 and the

Nasdaq Composite

lost 3% to 1405.61 after trading as low as 1401.28.

Shares were depressed by the spectacle of the House's hearings on the



scandal and allegations of accounting chicanery at


(MRK) - Get Report

, which says it was in compliance with GAAP.

Weak earnings by


(AA) - Get Report

, a profit warning by

Allegheny Energy


, and a resumption of weakness in the dollar didn't help either. Additionally, there was a re-examination of Friday's lackluster employment report and the realization that day's gains were built on a tenuous foundation.

Oh, and there's also the fact we're in a bear market, which are commonly demarked by sharp rallies that get some participants excited, for a fleeting moment.

Sweat Down Your Body, a Chill Up Your Spine

Despite the stock market's struggles, the hunt for a bottom continues, as

reported earlier. Something many would-be bottom pickers are missing is the message from the bond market, which continues to suggest trouble afoot.

Last week I noted reports that collateralized debt-obligation managers (read "banks") could be on the hook for $500 million if WorldCom were to file for bankruptcy.

"Suffice to say it is worse than described," said a source in the CDO market, who requested anonymity, "as my career is tied to the distribution of precisely the product that is blowing up."

More troubling, Pimco managing director Paul McCulley argued on the firm's Web site today that the entire U.S. economy may be on the brink of a "meltdown" due to ongoing revelations of corporate malfeasance and resulting risk intolerance among banks.

"If we don't see a renewal in risk appetite in the corporate lending market in the next six to 12 months, then we are on a very greased banana peel toward a Japan-type syndrome," McCulley said, with typical flair, in a follow-up interview. (Concerns about Japan-style deflation were commonly heard

last year but have recently faded, as the economy improved and some signs of inflation re-emerged. McCulley certainly isn't alone in warning of the risk of a deflationary spiral here, but is the most notable market participant to publicly discuss it, certainly in recent memory.)

Being the conduit for the Fed's role as lender of last resort, banks "serve a unique place in the financial firmament," he continued. "The banking system has got to step up and take responsibility, as opposed to contracting banks' lines of credit," as is occurring now.

The most recent Fed

survey of senior loan officers found "further tightening of standards and terms for loans to both businesses and households."

McCulley recommended the Fed "order the banking system to quit withdrawing from 'liquidity lending,'" using the term "order" quite intentionally. The

quid pro quo

of the commercial banks' access to the Fed's discount window is they are "supposed to lend when the capital markets are caught in a paroxysm of rectitude," he wrote.

Of course, banks prefer to lend when times are flush and retreat in tougher environments, but "with inflation near the 'tipping point' into deflation, the pro-cyclicality of bank lending is noxious at the macroeconomic level," McCulley wrote.

Let's set aside for now the debate over whether a Japan-style deflationary scenario is more a risk than the re-emergence of inflationary or "stagflationary" pressures: McCulley clearly believes the former risk is greater and his second recommendation is that


Chairman Alan Greenspan should convey "the doctrine of pre-emptive tightening to be dead and buried." Point being it's easier for the Fed to deal with a re-emergence of inflation than the onset of deflationary pressures, as Japan's experience demonstrates.

In arguing "the Fed must be willing to use all its powers to save capitalism from itself," McCulley incorporated the macroeconomic theories of John Maynard Keynes, the essence of which he described as: "Attack private sector deflation with public sector reflation."

Secondly, McCulley cited the work of Hyman Minsky, an economics professor and author of (among others)

Stabilizing an Unstable Economy

, who in 1992 wrote about three types of corporate borrowers, which the professor labeled "hedge, speculative, and Ponzi finance."

The concern being that many speculative finance units -- which Minsky defined as those that "need to 'roll over' their liabilities -- issue new debt to meet commitments on maturing debt," i.e. most of Corporate America -- are "being exposed as Ponzi finance units in drag," McCulley wrote. "These developments are, as Minsky declared, a prescription for an 'unstable system' ... in which the purging of capitalist excesses is not a self-correcting therapeutic process, but a self-feeding contagion: debt deflation."

McCulley doesn't believe we reached that juncture yet, but fretted we're "far closer to the point than I thought we would get 18 months ago, or even three months ago."

Meanwhile, as I write this, President Bush is talking about the potential for investors to lose faith in the free enterprise system.

Hard times, indeed.


I did ask McCulley about the cynical view that his piece is curiously timed. Pimco has, with some fanfare, recently taken positions in high-yield corporate bonds and telecom debt, most notably of


(T) - Get Report




. Some saw today's missive as a backhanded request for a bailout.

He replied: "It doesn't surprise me that charge is on the tip of someone's tongue, and there's no question we are the beneficiaries, along with the economy at large, of enlightened monetary policy.

But we're big boys and are not saying 'bail us out.' This is more of a piece of policy advocacy, which benefits all investors."

For the record, McCulley was critical of the Fed in the late 1990s for not doing more to help quell the boom -- i.e. raising margin requirements -- but said "now is not the time

for the Fed to operate in a temperate fashion."

Finally, McCulley agreed the Treasury bond market would have a visceral reaction if the Fed were to take additional accommodative measures -- beyond keeping the fed funds rate at a 40-year low despite a 6.1% first-quarter GDP and widespread consensus the rebound continues.

But comparing Treasuries to "an insurance policy against Armageddon," he suggested, "the last thing you want is a screaming rally in Treasuries. You can barely measure interest rates in Japan and that's not a good thing."

Today, the price of the benchmark 10-year Treasury note rose 19/32 to 100 19/32, its yield falling to 4.79%.

More on this and the market at large in interviews tonight, on CNET Radio at 4:10 p.m. PDT (7:10 EDT) then on WABC Radio (Batchelor & Alexander show) tonight at 9:05 p.m. PDT/12:05 a.m. EDT.

Aaron L. Task writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.