The Greater Depression of 2008

What has happened over a span of just two weeks is that the engine of American economic growth has derailed and is slowly dragging the rest of the global financial markets and economies along.

The culprit is the American model of less government intrusion in the private sector in particular, less regulation of the financial sector while turning a blind eye to unbridled growth of greed and deception of the CEO's of large corporations and the Wall Street manipulators.

The demise is essentially a reflection of the absence of ethics and morality in Wall Street. People's sense of responsibility for their own actions - paying their bills or keeping their promises has plummeted. Greed and deception of executives of financial institutions have skyrocketed, because the Bush administration and the politicians in the Congress unleashed deregulations while partying with Wall Street millionaire CEO's.

To survive this crisis, the already debt-ridden America would need more borrowing from the rest of the world. This will indubitably hamstring the next president's ability to act unilaterally on anything other than critical national security issues. Foreign aid to developing economies is also bound to be tight-fisted. To slow the bleeding, a bailout package of $700 billion was proposed by the US Treasury, and a modified version of it was passed by the Congress on October 3 amid opposition from many lawmakers and public outcries. The ultimate cost will be less than $700 billion since the bailout is an asset swap government bonds for banks assets. The concern, though, is about burgeoning budget deficits resulting from financing the bailout by issuing government bonds to be held by investors, which will crowd out other, more productive, investments. One may plausibly argue that as long as the government buys banks assets such as mortgage-backed securities (MBS) with new issues of government bonds there is no crowding out effect.

The loss is inevitable, given that Wall Street bankers leveraged $1 trillion worth of MBS, which are valued at approximately 40 cents or less on the dollar. The potentially crippling problem now is the short-term credit markets, where banks are hoarding whatever cash they have in an effort to ride out the crisis and, thus, loans are few and far between. This hoarding is creating a larger credit crisis that could begin to squeeze every business that needs cash flow from department stores financing inventory to credit card companies juggling millions of purchases every day.

The concerns in the US are the migration of the crisis from Wall Street to Main Street, where the pain is only beginning to be felt. The government and the Federal Reserve are focusing on keeping money flowing in the credit system and thereby limiting layoffs, shutdowns and bankruptcies. Today's automatic macroeconomic stabilisers, such as unemployment insurance, Social Security blankets, the government backed insurance of bank deposits (by FDIC: Federal Depository Insurance Corporations), and circuit breakers to keep stocks from falling too fast, stand as safeguards.

The Great Depression can still revisit us but it is highly unlikely. A recession is inevitable if not already underway and the policy makers are striving to make it less painful and short lived, if that is at all possible.