PAUL KRUGMAN: Edge of the Abyss

NYT



As recently as three weeks ago it was still possible to argue that the state of the U.S. economy, while clearly not good, wasn’t disastrous — that the financial system, while under stress, wasn’t in full meltdown and that Wall Street’s troubles weren’t having that much impact on Main Street.

But that was then.

The financial and economic news since the middle of last month has been really, really bad. And what’s truly scary is that we’re entering a period of severe crisis with weak, confused leadership.

The wave of bad news began on Sept. 14. Henry Paulson, the Treasury secretary, thought he could get away with letting Lehman Brothers, the investment bank, fail; he was wrong. The plight of investors trapped by Lehman’s collapse — as an article in The Times put it, Lehman became “the Roach Motel of Wall Street: They checked in, but they can’t check out” — created panic in the financial markets, which has only grown worse as the days go by. Indicators of financial stress have soared to the equivalent of a 107-degree fever, and large parts of the financial system have simply shut down.

There’s growing evidence that the financial crunch is spreading to Main Street, with small businesses having trouble raising money and seeing their credit lines cut. And leading indicators for both employment and industrial production have turned sharply worse, suggesting that even before Lehman’s fall, the economy, which has been sagging since last year, was falling off a cliff.

How bad is it? Normally sober people are sounding apocalyptic. On Thursday, the bond trader and blogger John Jansen declared that current conditions are “the financial equivalent of the Reign of Terror during the French Revolution,” while Joel Prakken of Macroeconomic Advisers says that the economy seems to be on “the edge of the abyss.”

And the people who should be steering us away from that abyss are out to lunch.

The House will probably vote on Friday on the latest version of the $700 billion bailout plan — originally the Paulson plan, then the Paulson-Dodd-Frank plan, and now, I guess, the Paulson-Dodd-Frank-Pork plan (it’s been larded up since the House rejected it on Monday). I hope that it passes, simply because we’re in the middle of a financial panic, and another no vote would make the panic even worse. But that’s just another way of saying that the economy is now hostage to the Treasury Department’s blunders.

For the fact is that the plan on offer is a stinker — and inexcusably so. The financial system has been under severe stress for more than a year, and there should have been carefully thought-out contingency plans ready to roll out in case the markets melted down. Obviously, there weren’t: the Paulson plan was clearly drawn up in haste and confusion. And Treasury officials have yet to offer any clear explanation of how the plan is supposed to work, probably because they themselves have no idea what they’re doing.

Despite this, as I said, I hope the plan passes, because otherwise we’ll probably see even worse panic in the markets. But at best, the plan will buy some time to seek a real solution to the crisis.

And that raises the question: Do we have that time?

A solution to our economic woes will have to start with a much better-conceived rescue of the financial system — one that will almost surely involve the U.S. government taking partial, temporary ownership of that system, the way Sweden’s government did in the early 1990s. Yet it’s hard to imagine the Bush administration taking that step.

We also desperately need an economic stimulus plan to push back against the slump in spending and employment. And this time it had better be a serious plan that doesn’t rely on the magic of tax cuts, but instead spends money where it’s needed. (Aid to cash-strapped state and local governments, which are slashing spending at precisely the worst moment, is also a priority.) Yet it’s hard to imagine the Bush administration, in its final months, overseeing the creation of a new Works Progress Administration.

So we probably have to wait for the next administration, which should be much more inclined to do the right thing — although even that’s by no means a sure thing, given the uncertainty of the election outcome. (I’m not a fan of Mr. Paulson’s, but I’d rather have him at the Treasury than, say, Phil “nation of whiners” Gramm.)

And while the election is only 32 days away, it will be almost four months until the next administration takes office. A lot can — and probably will — go wrong in those four months.

One thing’s for sure: The next administration’s economic team had better be ready to hit the ground running, because from day one it will find itself dealing with the worst financial and economic crisis since the Great Depression.