Stock prices last week fell more than 5% because of specific economic events and policy responses from Congress and the president.

Stocks may recover, but recent events demonstrate how nervous investors are becoming about what they see in primary economic indicators, and President Obama's populist and ill-directed responses.

Troubling Events

Since Jan. 1, signs that the economic recovery may be faltering have emerged -- job losses and new unemployment claims are up again and remain at recession levels; retail sales appear to be flailing; housing prices show signs of falling again; and demand for new homes is declining (fewer visits to new-home showrooms and disappointing sales data); and non-residential construction and jobs in that sector continue to fall.

China's fixed exchange rate policy has destabilized the U.S. and Chinese economies, sending tremors around the globe.

In the United States, China's policy floods markets with products priced at less than their cost of production and throws Americans out of work without creating new jobs in export industries. Falling employment results in poor retail sales and more job losses; it's what economists call the multiplier effect.

In China, the fixed exchange rate for the yuan against the dollar requires Beijing to print lots of yuan to sweep dollars off foreign exchange markets and return to China as payment for exports. This causes inflation, too easy credit and an asset bubble. Instead of fixing the problem by steady and significant revaluation of the yuan dollar peg, the Chinese government is pulling back on credit and that could cause a second crisis on both sides of the Pacific. A Chinese asset crash could be the next big thing, and that won't be a good thing.

Banks are paying out $150 billion in bonuses indicating profits at healthy banks jumped more than the economy grew in the second half of 2009. A lot of that is paper growth -- swapping money borrowed from the Federal Reserve at cheap rates for other securities -- and only creates sales jobs mostly for realtors in the Hamptons, clerks at high purveyors of luxury goods in Manhattan and starched waiters at high-end eateries.

Average compensation at the banks is five and 10 times the typical American, after bankers nearly threw the economy into a second "Great Recession," and each week about 450,000 Americans apply for their first unemployment check .

All of these things scare investors and are driving the markets down.

Ill-Conceived Policy Responses

In the wake of the public backlash that caused a political setback in Massachusetts for Democrats, the president is proposing ineffective solutions that scare investors further and push down the stock market as much as objective economic conditions.

Obama's tax on bank capital -- $10 billion a year -- would drive banks out of New York and offshore without correcting the dysfunctions in domestic lending practices, the sale of mortgages and other loans for conversion into securities, derivatives trading, and bank investments in dodgy residential and mortgage-backed securities which caused the failure of many regional banks.

Obama's proposal to prohibit proprietary trading by banks on their own accounts would do nothing to reform these practices either. The crisis was caused by poorly considered loans, the packaging of those loans into opaque securities, and swaps written on those securities by non-bank entities, which would escape Obama's proposed cures. The president is playing populist politics with the banks, and investors see it and are frightened.

Now Democrats in Congress are threatening to pillory Ben Bernanke when the banks and Obama are the problem. Neither will be subject to real constraints by Congress. The banks will continue trading and not lending, and Obama will continue pushing programs that divide a shrinking pie instead of focusing on growing the pie again.
Professor Peter Morici is a recognized expert on economic policy and international economics. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission. He is the author of 18 books and monographs and has published widely in leading public policy and business journals, including the Harvard Business Review and Foreign Policy. Morici has lectured and offered executive programs at more than 100 institutions, including Columbia University, the Harvard Business School and Oxford University. His views are frequently featured on CNN, CBS, BBC, FOX, ABC, CNBC, NPR, NPB and national broadcast networks around the world.