Economy, banking locked in vicious cycle: James Saft

-- James Saft is a Reuters columnist. The opinions expressed are his own --

By James Saft

LONDON (Reuters) - Should we be more worried about the new crisis coming to a head in the financial system or that the United States is self-evidently in recession? Sadly, we don't have to choose.

Banks, starved of capital, are calling in their debts, turning clients, notably hedge funds, into forced sellers, as large swathes of the financial markets are caught in a vicious cycle of margin calls, fire sales and further price falls.

The Federal Reserve has tried to break the cycle, again, by offering another $200 billion to banks, on easier terms and for longer, but confidence in their ability to succeed has fallen.

Meanwhile, back in the real world, consumers and company managers have gotten the message and are firing each other as, respectively, providers of goods and services and wage earning employees.

Last week's U.S. payrolls data was grim indeed and the retail and consumption figures are little more encouraging. "The Fed's efforts to isolate the effects of the financial crunch from the real economy have clearly failed," said Lena Komileva, economist at brokerage Tullett Prebon in London.

"We are now seeing the materialization of this new relationship between the financial and real economy where both are now in crisis."

In essence, the negative feedback loop the Federal Reserve fears, with banking and the economy pushing one another downhill, is taking hold.