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The flap over bonus payments to executives and traders at the American International Group continues in full force, and looks set to dominate at least another news cycle or perhaps more. The focus of mainstream press reporting on the story has shifted to "how much did Obama and Geithner know about the bonuses, and when did they know it?" But while journalists are obsessing over the reactions of the Administration and Congress, the real import of the story lies in how it vented a deep current of almost violent anger among the people, who have been seething over taxpayer bailouts since Bear Stearns collapsed a year ago.

As I'll show you, that anger has opened the way for Congress and the Administration to take actions that will severely threaten the free exercise of contracts and agreements. And yet with all this, the actual impact of the AIG bonuses in financial terms is almost insignificant.

Every financial firm pays bonuses to its employees. In the former Wall Street investment banks, the annual bonuses (which are usually determined in November and paid out in January) can in fact comprise the majority of each individual's compensation. This goes beyond the holiday bonuses or sales commissions that are common in other industries. For firms whose only real business is handling money, the bonus system is a way of inducing cutthroat competition among their own people.

It would actually be refreshing if someone big and important stood up to say that policymakers really haven't a clue how to improve the economic and banking crises. But no one in a position of political authority is willing to do so, least of all the New Masters of the Universe in Washington. So therefore, the task falls to me.

In the US, there's a growing sense that the Obama Administration just doesn't know what to do about the worsening economic and financial picture. Consumer demand continues to fall, jobs continue to be lost at a rate of more than half a million a month, the credit crisis is still as bad as ever, and housing is still far overpriced.

The bright spot, if it is one, is that Fed Chairman Bernanke has been doing more than anyone else in the world to get ahead of the deepening problems in the capital markets. The leaders of the world's other central banks are mostly watching him and waiting to see if anything works. So far, a lot has worked, but the economic problems that are of greatest concern haven't been touched.

Bernanke's academic specialty has been his studies of the Great Depression, particularly of the dynamics through which a long chain of bank runs and capital-market stresses turned into the worst episode of sustained high unemployment in our history. He also watched closely as Japanese authorities mismanaged their deflationary situation in the early Nineties.

What he concluded is that at a time like this, monetary authorities have to act as fast as possible, and in as much size as possible.

However, he concluded this not because he knows it will work, but rather because nothing else has been known to work. We're in totally uncharted territory, and so far nothing in the broad economy is looking any better.

I must admit to you that I was very surprised by the budget that Barack Obama announced on Thursday.

In the short time he's been President, we've seen a pattern of a man who talks big but passes the buck. Everything he wants to do is someone else's job -- responsibility is passed on to Congress, his own subordinates, or the future (as in, "today we're announcing a major initiative that will accomplish X, Y, and Z. You'll have the details in a few weeks").

Not so with the budget. This budget is something different. Whether anything like it actually becomes law is impossible to say at this point. But it does represent a radical change in its basic philosophy about the relationship between the American people and their government.

I'm one of the many people who have been throwing the phrase "New New Deal" around, although I claim some measure of paternity because I've been using it (and the companion phrase "Great Depression II") since late 2007, which is longer than anyone else I'm aware of.

The government is floating the idea of taking up to a 40% share in the common equity of Citigroup, which is about as close as you come to admitting the bank is insolvent.

How are the markets reacting? Government coupon-debt is sharply lower on the news. It's being taken as a positive, reducing the need to hold Treasury paper as a safe haven. Stock markets will climb on the open.

Here's a canary in the coal mine: Canada's CPI has fallen four months in a row, which hasn't happened since the early Thirties. Our CPI is under pressure (it's being held up by slightly higher gasoline prices, as supply ratchets down to meet lower demand), but producer and wholesale prices so far are holding steady. That news is mixed and unconclusive.

There's a remarkable story being reported in the New York Times. It's remarkable in itself, and also because as far as I can tell, it's only being reported in the Times.

It's a proposal by the Treasury for a radical way of restarting private participation in credit markets. I'm only going to give you the barest outlines of this with minimal analysis, because I can't be sure the Treasury really means it.

For many months now, "securitizations" have come to a near-standstill. That's the much-maligned process through which whole mortgages get "sliced and diced" into mortgage-backed securities and sold to the world's investors.

Through a different but analogous process, other kinds of consumer loans are also securitized: car loans, credit cards, and student loans. (The goal is always to give an investor a piece of paper with a credit rating, a semi-annual coupon payment, and a maturity date. Mortgage analytics and risk management are more complicated, but beyond that, the process is the same.)

Securitization matters because banks can't provide credit now that most of them are so far undercapitalized. Securitization is an alternate process through which investor funds are channeled into the consumer credit markets.

I'm trying to interpret all the stories floating around about foreign investors starting to demand that US agency paper be converted to an explicit full-faith-and-credit guarantee.

Between Fannie and Freddie, we're talking about $5 trillion in assets. Since the nationalization of the GSEs in September, their periodic debt auctions haven't gone all that badly, all things considered. The spread between agency paper and Treasuries is now in the 70-basis point range across parts of the curve. Far more than what it was pre-crisis, but far tighter than a few months ago.

And yet, foreigners are noting US officials' pointedly stopping short of calling the Federal guarantee of agency debt "explicit." (FHFA Administrator James Lockhart calls the guarantee an "effective" one.)

That's turning out not to be good enough for seriously risk-averse foreign investors, who appear to have shifted at least $100 billion from agencies to straight Treasury paper in the second half of 2008.

In effect, what they're trying to do is to exit their exposure to US housing finance, and change it to exposure to the US dollar itself. In a way, this converts credit risk to market risk.

But is it really that simple?

It's too early to figure out what Obama actually proposed yesterday, by way of mortgage reforms. It's not even right to call it a proposal, since we're not getting full details for another couple of weeks. It seems like Obama is trying to lead by press release.

There are two aspects to the "plan" that are intended to generate headlines: it will supposedly make mortgage payments "more affordable" for a total of 9 million people; and it will seek to drive everyone's mortgage payment to 31% of their monthly pre-tax income, or less.

Let's quickly dispose of the Fannie Mae/Freddie Mac aspect of the press release. There is a provision of $200 billion to be supplied to the GSEs, for purposes of covering losses in their mortgage portfolios. This would actually be an expansion of the $100 billion that was already provided when the GSEs were nationalized back in September. They haven't yet come near to consuming the $100 billion, so this is less than it appears to be. Still, it's a nice headline.

It's the $75 billion in direct aid to distressed homeowners that's more of interest. So far there are no details on how this will work. Obviously, the taxpayers will be transferring $75 billion to someone. But to whom, exactly?

It seems to me that Obama would like you to think that he's planning to put more money in your pocket. But judging from the uniformly-enthusiastic reactions of banking-industry executives and spokesmen, I think the money trail leads to them rather than to you.

Ok, so the Teacher And Firefighter Job-Preservation Act of 2009 is now law. Last week, President Obama told us that starting today, the stimulus would immediately speed saving succor to the US economy, using metaphors that suggested the stanching of an open wound. Are you feeling stimulated?

A more true metaphor is that the stimulus will be like a fart in a windstorm. Why? Three reasons: A) It's small relative to the size of the problem; B) It won't be spent all at once; and C) It's programmatic rather than broad-based. The real practical effect of the stimulus bill will be to enable 50 state governors to raise taxes less than they would have been forced to.

Why didn't Congress take the direct approach and simply enact a payroll-tax cut, which would have ultimately had the same effect, but much more immediate and more salutary? Well, I think the answer to that is more political than economic so I'll leave it to others.

And coming up fast in the rear-view mirror are the Detroit automakers, who as I've relentlessly predicted since December, will soon ask Washington for tens of billions of dollars more. Unless the autoworkers union agrees to far deeper cuts (not likely), the taxpayers will be supporting GM and perhaps Ford Motor, more or less permanently.

But we need to look ahead to the continuing banking crisis. Here we have to make hard choices between who lives and who dies.

Something very important has been missing from the debate about fiscal stimulus. There are two really good reasons to oppose the Obama stimulus bill.

First, it's got be to just about the most hasty and poorly thought-out piece of legislation ever to come out of the US Congress. (Isn't it ironic that it also happens to be the biggest expansion of government spending ever?) This bill is so full of waste, earmarks and pork-barrel spending that Obama will have to use all his charm and deception to blow it past the American people.

Second, and this is what you hear from a lot of Congressional Republicans, the bill expands the Federal deficit tremendously.

It's being suggested by many sharp observers that global investors (like the Chinese) will be unwilling to fund this stimulus package, and will demand much higher interest rates on US debt.

Not quite. This deficit will be a lot easier to fund than many people think. It's what comes later on that we have to worry about.