But by keeping interest rates below the rate of inflation for three straight years starting in 2002, the Fed created a bubble in the housing market. That bubble has now popped, leaving in its wake a severe liquidity crisis.

The machinations of the US Federal Reserve are uppermost in the minds of investors — and the media. The Fed is in a jam. On the one side slowing growth and the specter of the credit crisis. Rising inflation on the other.

S&P’s/Case-Shiller’s index of housing prices in 20 major US cities fell by a record 15.3% year-on-year in April, the steepest drop since the began collecting data in 2001.

Bill Bonner in The Daily Reckoning takes on the Fed’s big dilemma. How can the it simultaneously fight inflation and deflation of asset prices?

“A very nasty period is soon to be upon us — be prepared,” reads the latest release from the Royal Bank of Scotland. Its hotshot credit analyst Bob Janjuah predicted a 22% crash for the S&P 500 by September… “The Fed is in panic mode.

Late payments on home-equity loans are at a record high, and delinquency rates on loans for cars, small businesses and construction are at levels not seen in a decade or more — all bad news for lenders, regardless of their subprime exposure.