Business comment, by Colin Donald

THERE is a scene in the nuclear accident film The China Syndrome when the plant manager's coffee quivers on his desk. The fact that he has been praising his plant's safety record up until then heightens the drama.

Last weekend was such a moment for American finance, and last Wednesday the shudder was transmitted to Edinburgh, where only a calm counter-offensive by HBOS's communications team prevented something unthinkably worse than even 17% slump in the share price.

Denial of the scale of the global financial crisis is becoming less and less possible by the day. President George W Bush made a characteristically goofy-but-cynical stab at it in a Pentagon speech last Tuesday, implying that economic salvation and the defeat of al-Qaeda in Iraq were intertwined.

In fact it is hard to see the latter having much effect on the former, and the closest connection between the bursting of the US property bubble and the Iraq war is the grim coincidence that each has cost the US economy $3 trillion ($3 million million).

The war figure comes from the Nobel Prize winner Joseph Stiglitz while the credit crisis figure is a three-fold revision of the one produced by Nouriel Roubini of New York University late last year. Despite his reputation as academic king of the bears, it has so far not been seriously challenged.

What is clear from the events of last week is that there is very little faith within the markets in the Federal Reserve Board's capacity to deal with this problem.

So far the Fed's interventions have enabled JPMorgan Chase to rescue Bear Stearns and have dispensed $200 billion of treasury bonds in exchange for suspiciously undervalued collateral. The Fed's intervention was intended to solve the liquidity problem, presuming that this is what the problem is, and counterparty risks should have contracted as a result. They haven't.

It is not that surprising that monetary policy tools are not sufficient to tackle the problem as nobody is quite clear what the problem is. Sub-prime is unwinding at the same time as a massive and accelerating compression in US property prices. Recent US polls show that three quarters of US citizens think they are entering a multi-year recession, a state of mind that will depress consumption even further.

Are there any lifelines out there for optimists to grab on to? Yes, there is the one about how this is going to be as bad as Japan, which has seen only fitful and anaemic emergence from recession since its bubble burst in 1991. The Japan scenario is held up as being beyond the worst-case scenario, and even if it gets that bad, Japan is still a functioning and in many ways comfortable economy, so how bad can it get?

There are some points of comparison between the US's problems and those of Japan, but in more significant respects the equation doesn't work. Japan's economy got into trouble at a time when conditions in the outside world were quite helpful. By the mid-1990s, the US economy was booming, sustaining Japan with a huge export market. There is also the fact that Japan's problem was concealed debt, whereas in this case it is debt that can't be assessed even by those responsible for it. So the Japan comparison is akin to those proverbial generals preparing to fight the last war, as Ben Bernanke, a scholar of the Japanese bubble experience as well as the Great Depression, knows well.

For now the Fed seems to have shot every bolt it can. The ball is in the court of fiscal intervention. Congress and the White House are agreed on tax rebates in an effort to pump up consumption, ignoring the fact that over-consumption was one of the chief causes of the mess. But how much will people spend if they are expecting a multi-year recession? The necessary fiscal intervention should be less a matter of giving people money to splurge on consumption and more on buying up bad debt from the banks. The trouble is, in an election year, no politician wants to be seen bailing out those fat cats, so there is a strong will to try the tax rebate route and see if works.

It seems unlikely. The stats may prick up momentarily but the effect will be flattened by the descending snowball of shrinking property values and the rest. People are likely to save their money or use it pay off outstanding loans. The old Keynesian magic is unlikely to work.

Right now we are at the stage of that film when the deep rumble has subsided and a hush descends in the nuclear station control room. Whichever outcome follows, the blame game is already under way, with "well-wishers" dredging up Alan Greenspan's hymns of praise to "increasingly complex financial instruments" and their contribution to "a far more flexible, efficient and resilient financial system".

In fact the blame must rest with those who got rich propagating the general belief that, as the housing-credit bubble machine ran out of creditworthy borrowers, sub-prime lending was OK as long as it was dispersed widely through the system.

This is akin to the chemical industry of 40 years ago believing "the solution to pollution is dilution". In fact the financial rot, like its chemical equivalent attacks the weakest first, as has happened with sub-prime. Decontamination is going to be a long and costly process.