Federal Reserve Bank of San Francisco president Janet Yellen suggested on Tuesday evening that the U.S. economy has fallen into a broad recession, and said that prospects for recovery rest on restoring some semblance of normal functioning to the nation’s financial markets. “Indeed, the U.S. economy appears to be in a recession,” she said in a speech to tech executives in Palo Alto, Calif. “This is not a controversial view, since the latest Blue Chip consensus projects that there will be three consecutive quarters of contraction in real GDP starting last quarter.” “By now, virtually every major sector of the economy has been hit by the financial shock,” she said, alluding to the widespread economic downturn that now appears to be emerging. It’s a view clearly buttressed by the Fed’s latest beige book data, released Wednesday afternoon, which found that economic activity weakened in September across all twelve Federal Reserve districts. The Fed data found that increasing foreclosures, credit dislocations, and tighter credit availability to consumers all led to a decidedly negative effect on both real estate and mortgage lending sector activities. Yellen said that resolving the current economic woes required a focus on fixing dislocations in the financial market — dislocations that began with mortgages but have now become widespread. “A precondition, in my view, for the economy to recover is that the financial system must get back on its feet,” she said. “This freezing up of credit flows reflects a breakdown of the trust and confidence needed for potential lenders to extend credit beyond overnight to counterparties and widespread flight to the very safest assets, to the point where Treasury bill yields have fallen to close to zero at various times in recent weeks.” Much of the confidence issues now facing the market are tied to the rise of the private-party mortgage market, Yellen claimed — pointing to mortgage-backed securities and CDOs in particular. “[T]he pricing of the risk in these instruments has now become not a marvel of financial engineering, but a fog of confusion,” she said. “Such complex instruments make it incredibly difficult now to know where the risk actually resides or how to price it.” Of course, Yellen may be overstating the complexity of these instruments; the truth is closer to the idea that uncertainty over future collateral performance — whether via market correction or government intervention — is making it difficult to value any security with something resembling confidence. Regardless of the reasons why, Yellen pointed to resolving the current “vicious cycle” as critical to any future recovery effort, and acknowledged for the first time that the U.S. financial markets are stuck in an “adverse feedback loop” that regulators have long said they feared. “[T]he efforts of the private sector to fix itself through deleveraging and other means are only making matters worse,” she said. “This is why government action was urgently needed.” Despite the government intervention, however, it’s not clear that things are getting better. The so-called TED spread, 2-year swap spread, yield on 3-month Treasuries — all have been getting worse thus far, not better. And it’s worth remembering that the government has been “taking action” since before the first economic stimulus package was passed by Congress.