As Executive Vice President of the Federal Reserve Bank of New York, Dudley is now manager of the Fed's "open market account," responsible for implementing the Fed's interest-rate decisions through operations in the bond and money markets. He also oversees foreign-exchange intervention for the Treasury as well as the Fed.

Dudley will also be the point person when the Fed needs to intervene during periods of market turmoil as it went to Dino Kos in 1998 for help in brokering the private-sector bailout of the huge hedge fund Long Term Capital Management.

Dudley is well-known on Wall Street. He has been ranked Number 1 by Institutional Investor magazine and in various Wall Street Journal surveys for several years.

But as the Chief Trading Officer for America, we don't know whether this Dudley is going to be a Bo Derek 10. At the NBER Conference on Asset Prices and Monetary Policy (May 5-6 2006), in reference to the management of asset bubbles he gave us reason to question his trading abilities when he said:

"I can identify at least five bubbles that one could reasonably have identified in real time:

1. Dollar appreciation in 1984-85.
2. Stock market overvaluation in 1987.
3. Credit market spread widening in 1998 associated with the failure of LTCM.
4. Dotcom and NASDAQ bubble of 1999-2000.
5. Regional US housing bubbles that are currently in the process of unwinding.

I say this with some confidence because I tried to speculate against 3 of the 5 bubbles listed above myself (with limited success I might add, indicating why I remain an economist rather than have transitioned to being a trader)."

His words, taken in context.

But Dudley is going to be a favorite in the Cara household because he's a believer of the Cara Trading system (note his comments on the Distribution Zone). Besides, he actually calls a bubble a bubble.

Again, here are his words to the NBER Conference:

"For the US housing market of the past 5 years, the initial impulse to the housing price rise was the fall in long-term interest rates. Only beginning in 2004 did the housing market become a bubble. In some regions, prices continued to rise much faster than income even though mortgage rates were no longer declining.

Second, the rise in valuation leads to a change in perception about the riskiness of investing in the asset class. Rather than the asset being perceived as more risky as the price rises, it is perceived to be less risky because it has not gone down in price. There is a corollary to this. Investors tend to raise their expectations of the prospects for future price appreciation after the asset has gone up in price, when, in fact, rapid price appreciation should lead investors to lower their expectations."

Dudley, indirectly, also says about capex: "The rise in (capex) investment puts downward pressure on profit margins and upward pressure on real interest rates."

This is precisely the situation that has happened over recent years " in reverse. Capex has been dropped by management in their drive to increase profits and (with less industrial loan demand) cause downward pressure on interest rates.

The problem here is that the cycle must reverse at some point, and Dudley knows that will hurt profits and also serve to push interest rates higher.

At least America has somebody at the helm who understands and talks about these things. Recognizing the problem is the first step to finding solutions.

Therein lies the issue as Dudley sees it (in his own words):

"Supervision and regulation of depository institutions, the "bully pulpit", and margin requirements—together they do not make a very full or effective tool-kit. This suggests that Fed officials and others should explore developing additional instruments to add to the Fed's arsenal.

In addition to broader margin rules, this might include capital adequacy rules and or counter-party risk rules designed to limit leverage and risk. Increased disclosure requirements of portfolio positions by lightly regulated institutions such as hedge funds might also prove useful. Consider the LTCM debacle. LTCM was much more highly leveraged than market participants and its major counter-parties appreciated. Also, many major market participants had market positions similar to LTCM's. Better disclosure might have limited the ability of LTCM to expand its risk positions and it could also have discouraged market participants from taking similar types of positions.

The disclosure of portfolio positions would enable investors to find out when the "hot money" is all positioned the same way. Such a revelation would change investors' perceptions of risk and could help dampen speculation and incipient asset bubbles.

I clearly don't have the answer with respect to designing new tools for central bankers to use to address asset bubbles. But I think a more fruitful line of inquiry is to move in this direction. In my mind, the issue of whether short-term interest rates should be adjusted to lean against asset bubbles is mostly settled. It is time to move on and explore how central bankers can develop better tools to respond to asset bubbles."

If Dudley would kindly disclose the FOMC actions in real-time, for the same reasons, these just might be the most important words out of Washington and New York I have heard in over two years.

Yes, it could very well be that Paulson, Dudley et Cie have moved to Washington to clean up the quagmire created by politicians. I'm sure the Democrats would like to take credit, but I also feel they will assist in helping the Treasury and Fed managers do the right thing.

Without taking medicine today, America is not going to get out of sick bay. In fact, the U.S. equity market is going to soon recognize that Dudley and Paulson are there to do a job, ie, turn that ship around " like it or not.

I like it.

For your reading pleasure, here are two files that will enlighten you to the likely Dudley presence at the Fed.

Download Dudley May 2006 Presentation to NBER Conference.
Download Dudley June 2001 Testimony to the U.S. Senate Banking Committee.