After a two-week selloff, fueled in part by concerns that the seven-month old rally had gotten ahead of any economic recovery, stocks got a boost last week following better-than-estimated economic numbers and Alcoa’s (NYSE:AA) surprise quarterly profit.  That helped investors set aside worries and extend the rally.  Meanwhile, White House economic adviser Lawrence Summers reiterated the Obama administration’s commitment to a strong dollar, citing recent comments by U.S. Treasury Secretary Timothy Geithner.

This morning’s stock futures show markets are headed for a higher opening as the busy week of earnings commences. Ahead of the market's open, Dow Jones industrial average futures are up 59 points, or 0.6%, to 9,866.  Standard & Poor's 500 index futures gained 7.30 points, or 0.7%, to 1,075.40, while Nasdaq 100 index futures rose 11 points, or 0.6%, to 1,736.50.

On Friday, the Dow Jones industrial average rose 78 points, or 0.8%, to 9,864.94 -- its highest closing level in a year.  The S&P 500 index gained 6 points, or 0.6%, to 1,071.49 and the Nasdaq climbed 15 points, or 0.7%, to 2,139.28.  On the New York Stock Exchange, advancing issues beat those that declined in price by a three-to-two margin.  For the week, the DJIA rose 4% and the S&P 500 index gained 4.5% - their best performance since July.  The Nasdaq advanced 4.5% during the week.

Last week's rally saw all but one of the S&P500 industry sector recording gains.  Only telecommunications shares failed to advance, and fell 5.9%, following AT&T's (NYSE:T) announcement that it plans to allow internet-based phone calls on phones including Apple's (NASDAQ:AAPL) iPhones.  The gains last week were led by basic materials (+8.4%), oil and gas (+7.6%), financials (+6.3%), industrials (+5.0%), tech (+4.9%), consumer services (+4.5%), consumer goods as well as utilities (+2.9%), and health care (+2.7%).  Financials rose after a Goldman Sachs (NYSE:GS) report recommended large-cap banks. Gains in industrial shares were helped by last week’s fall in dollar and Caterpillar's (NYSE:CAT) announcement that it plans to hike prices globally in 2010.  Retail shares rose after firms reported better-than-expected comparable monthly sales numbers.

This week sees the release of the first big batch of third-quarter earnings.  Companies reporting their numbers include Johnson & Johnson (NYSE:JNJ), Intel (NASDAQ:INTC), JP Morgan (NYSE:JPM), Citigroup (NYSE:C), Goldman Sachs (NYSE:GS), Nokia (NYSE:NOK), Google (NASDAQ:GOOG), IBM (NYSE:IBM), Bank of America (NYSE:BAC), and General Electric (NYSE:GE).

The administration has focused on five key areas:

• Raising capital and liquidity requirements for all institutions, consolidated supervision by the Federal Reserve for "too big to fail" firms and establishing a council of regulators for better coordination
• Robust reporting requirements on the issuers of asset-backed securities, reducing reliance on credit-rating agencies, harmonizing the regulation of futures and securities, and strong oversight of "over-the-counter" derivatives
• Stronger framework for consumer and investor protection
• Resolution mechanism for the orderly resolution of "too big to fail" financial holding companies
• Improving regulation and supervision around the world

As a result, the financial institutions were able to shift risky products to less-regulated entities or entities having favorable accounting treatment. This calls for consolidated supervision of parent companies and all related entities as well as better coordination among all regulators.

The OTC derivatives include credit default swaps that caused the near-collapse of AIG (AIG). In view of the enormous size of the market and the threats these instruments pose to the financial system, their regulation is long overdue.

Also required is stronger coordination with regulators of other countries so as to effectively regulate financial giants like Citigroup (C), Bank of America (BAC) and JP Morgan Chase (JPM), which have operations all over the world.

Asian stocks recorded hefty gains on Thursday, including a 4% rally in Tokyo's Nikkei as Japan unveiled a big stimulus package aimed toward stimulating economic growth.  The Nikkei 225 stock average jumped 321.05 points or 3.74% to 8,916.06, after the government announced a $154 billion economic stimulus package and data showed an unexpected increase in the country's machinery orders. The Bank of Korea, which kept the rates unchanged at 2%, said it was keeping the option of cutting rates open. The comments sent benchmark Kospi up 4.3% to 1316.35, a six-month closing peak.  Hong Kong's Hang Seng index gained 2.3%.

U.S. stocks showed resilience yesterday as investors took heart from reports the Treasury will allow some troubled insurers access to remaining funds under the TARP program.  Today's post of retailers' March same-store-sales figures will also be closely watched for indications of consumer spending trends.

Premarket futures improved on the early release of Wells Fargo's (NYSE:WFC) quarterly numbers, coming in at a better-than-expected $3 billion, or 55 cents per share, versus consensus estimates of 26 cents.

On Wednesday's 18 of the DJIA components closed higher and 406 of the S&P 500 sectors ended in the green along with 93 of the NASDAQ 100. Volume stayed a low 1.3 billion on the NYSE, with advancing shares outrunning decliners by nearly three to one.  The CBOE fear factor index, the Vix, held below 40, off 3.8% at 38.85. Among sector action, only telecom shares closed lower, down 0.6%, with a 2.3% advance among consumer sector stocks leading the S&P industry groups, helped by increases among retailers and airline shares, followed by 1.9% increases in tech, 1.5% in basic materials, 1.3% in oil and gas and 1.1% in consumer goods sectors.

Release of Fed minutes from its March 17-18 FOMC meeting struck a note of caution among investors hopeful that the economy was showing signs of a recovery in housing and consumer spending. The report weighed in on the side of "downside risks" remaining to the economy, fearing an adverse feedback loop of unemployment and production would curtail any increases in spending, thereby threatening the economy and raising prospects of additional losses among financials, generating another round of credit tightening.  The Fed now expects a delay in the recovery until 2010, instead of 2009's second half, with unemployment rising at a steeper rate heading into 2010. However, traders chose to take the Fed's bitter concerns in stride, and instead focused on potential aid to insurers, and news that all nineteen banks undergoing stress tests currently will receive passing marks at month's end.

The Treasury is expected to extend remaining TARP funds to several insurers meeting program requirements of bank holding company status, including Hartford Financial (NYSE:HIG), Genworth Financial (NYSE:GNW) and Lincoln National (NYSE:LNC). News reports quote regulators as saying the stress tests show banks are recovering, although the reports do not rule out further losses are likely as economic weakness results in losses from real estate and corporate loans and credit card losses. Bank of America (NYSE:BAC) fell 4.1% Wednesday on an Oppenheimer report stating the company will need $36.6 billion further in equity-raising to increase its capital ratio to that of its peers. A WSJ report said Morgan Stanley (NYSE:MS) will take a $1.2-$1.7 billion hit on bonds when it reports first quarter results. American Express (NYSE:AXP) shares gained 4.7%, leading the DJIA, on a Citigroup (NYSE:C) upgrade to "hold" from "sell," as the expected news, though likely to stay negative, has already been priced into the shares.

Yesterday's economic reports indicated US wholesale inventories fell 1.5% in February, more than twice economists' expectations, and declining for the sixth straight month, as firms lowered stocks amid weak demand. The decline was the sharpest since record-keeping began in 1992, and brought the inventory/sales ratio to 1.31 from 1.34, although still up from 1.14 a year earlier. Today's economic posts include international trade, import/export prices, weekly jobless claims as well as monthly retail sales results. Investors hope that better-than- expected March sales numbers will point to improving consumer spending, although fearful of the impact from continuing gains in jobless rates. A closer look at Costco's (NASDAQ:COST) reported comparable sales decline of 5%, more than the projected 1.7% drop, shows the numbers in line with expectations when currency adjustments are excluded, according to one analyst. Weekly initial claims are projected at 660,000 versus 669,000 a week ago, but continuing claims may have increased to 5.8 million from 5.728 million prior. Comments from Lawrence Summers to the Economic Club of Washington are slated, as well as remarks from Minnesota Fed President Stern at 12:15 PM ET, and Kansas City Fed President Hoenig at 1:00 pm ET.

...basically, it seems to me, we're all flying blind. The markets are spiraling down, and our leading experts don't have much of a clue as to what to do.

Given that, one has to welcome the expected appointment to senior positions in the Obama administration of economists like Lawrence Summers, Timothy Geithner, Jason Furman, Peter Orszag, and Goolsbee himself. They're sober and competent people who know we face a real crisis -- and who, importantly, may be more willing than many of their colleagues to adjust their thinking early and often.

Indeed, one hopes they're not too invested in the findings of the economics profession of which they're such distinguished products -- because one suspects many of the conventional answers of that profession aren’t much applicable to the current situation. After all, wasn't it excessive confidence in complex economic models and sophisticated financial instruments on the part of people well educated in modern economics that helped get us into the current mess?

So I hope the best and the brightest who will be joining the new president will at least entertain the possibility that a lot of what they think they know is wrong. I trust they'll remember that successful economic policies in the past have pulled together elements from unlikely sources, and that they're as likely to find wisdom from reading political economists like Friedrich Hayek or Joseph Schumpeter, or Keynes himself, as from poring over the latest academic paper in a peer-refereed economics journal.

My puzzlement is driven by several assertions.

• Are our economic leaders flying blind?
• Were the economists overly enamored of complex economic models?
• Were the economists overly confident in sophisticated financial instruments?
• Is it as likely to find wisdom from Hayek or Schumpeter as in the latest academic paper?

On the first point, I think Kristol is on the most solid ground. So much of what has happened has been unprecedent in terms of institutions, although as Markus Brunnermeier has pointed out, the general outlines are remarkably similar to banking crises of the past. So, here I think reasonable people can certainly disagree whether it's ignorance, or failure to agree between Fed and the Bush Administration and components thereof.

What about complex models? First ask what exactly constitutes a complex model? Is Kristol alluding to models involving algebra? Or calculus? Or lots of equations? I think one could make the argument that the models weren't complex enough to capture important effects (asymmetric information, agency costs, etc.) despite the complexity along other dimensions.

Were economists overly confident in sophisticated financial instruments? Here I think it might be useful to discriminate between economists that work in the financial world, and those that work in academia. From the former group, I always heard a lot about "risk management" and sophisticated statistical models to price derivatives. From the latter, I heard a lot more skepticism, perhaps borne of ignorance. So, Kristol might be right, but I suspect his views are deeply influenced by the sample of economists he talked to.

By the way, I won't say I saw the full enormity of the leveraging problem, but at least I can truthfully say I was suspicious of the free lunch aspects of the net borrowing binge of the past decade. From my August 2005 Council on Foreign Relations report:

Although the likelihood of a "disorderly adjustment," is small,37 the potential consequences are so troubling that the possibility of economic disruption cannot be ignored. In addition to the threat of rising unemployment and declining income, sharp movements in asset prices and interest rates could also threaten the stability of the financial system. In the past, policymakers have been able to contain the threats of systemic crises, such as the crisis of Long Term Capital Management in 1998. That event was at least partly attributable to bets on interest rates movements that did not meet expectations. Markets for making bets are much larger and diverse than they were seven years ago. Some are very new and remain untested. The question is whether they are up to the task of distributing risks when low probability events occur.38 This open question should in itself give some additional weight to the case for action now, to avoid putting the world economy in the position of finding out the answer.

I'm confident it's quite easy to dig up plenty of quotes from other economists who were nervous.

Finally, the assertion that really caught my attention: That the likelihood of finding useful nuggets of economic wisdom in Schumpeter and Hayek is equal to that of finding it in the latest article in peer reviewed journals (I get the feeling he's making a perjorative remark about peer reviewed journals, but I'll let that slide).

Why do I think this is odd? Well, because the statement identifies modern economics as distinct from the great thinkers of the past. But in fact many of the works in the "peer reviewed journals" are not orthogonal to the works of the past, but like many other intellectual endeavors, based upon them. Open up the JPE or the QJE (or better yet, the NBER Working Paper series, and there are plenty allusions to "the greats", and ideas like "creative destruction". That being said, just like there has been plenty of thinking in political science since Machiavelli and The Prince (you'll get the allusion if you've read Dani Rodrik's take on Kristol's economics acumen), there's been a lot of insight developed in economics over the past hundred years. In this respect, the admonition to look backward sound good, but is less profound that it appears at first glance.

6.5% unemployment in October — worst since early Clintontime.  Worse still were the revisions of the August and September numbers.  And as Karl Denninger noticed, the number of unemployed plus the number of people working part-time who’d like to work full-time now tops 11%.  (And who knows what the real figure would turn out to be once John Williams applies Carter-era standards to the numbers.)

As I write, the president-elect is meeting with his “Transition Economic Advisory Board,” his temporary brain trust as it…

MSNBC reported last night that Obama is already getting advice from Ben Bernanke.  That ought to make you feel warm and fuzzy right there.

But wait, there’s more!  As of this writing it appears Lawrence Summers is the leading candidate for Treasury Secretary.  As in, the guy who was Clinton’s last Treasury Secretary.  So much for the promise of “no retreads” in an Obama administration.

I mean, Larry Summers?!  That’s really in-your-face, on any number…