In one sentence, a Bloomberg News report published Thursday morning summarizes why government needs to take immediate action on the economy.
Interest rates on three-month dollar loans rose to the highest since January, short-term corporate borrowing fell by the most ever and high-yield loans tumbled, exacerbating the credit freeze that's paralyzing business around the world.
Stock prices have been on a roller-coaster ride all week, but the credit crisis just keeps getting worse -- punishing individual Americans and massive corporations alike. AT&T is having trouble raising cash and car buyers are having trouble getting car loans. In a sobering New York Times piece also published this morning, Louis Uchitelle details how small businesses are suffering from the epidemic of tight credit.
Uchitelle observes that the problem has two sides -- credit is getting more expensive while businesses are also declining to seek new loans as they tighten their belts to prepare for what looks to be a serious downturn. Dean Baker, the co-director of the Center for Economic and Policy Research, chimes in with a similar point. While responding to Joe Nocera's must-read account of how the credit crisis metastasized over the last two weeks, Baker says the drastic drop in short-term loans made to businesses is in part a natural result of "the decision of many firms to delay borrowing until the costs are lower."
Many firms have excess cash right now (especially with the recession leading them to put investment plans on hold), so it would be perfectly reasonable for them to delay borrowing for a few weeks in the hopes that the markets will settle down and they would be able to borrow at a lower interest rate. In other words, much of the drop shown in the chart is likely just an issue of timing, and not reflecting a lack of availability of credit.
How "much of the drop" is just timing, and how much is due to the credit freeze? I cannot pretend to tell you. But I think the essential point here is not trying to determine which is more responsible for what is going on, but understanding that the reluctance to seek credit combined with the growing price of credit creates a negative feedback loop that is highly volatile. Conditions in the real economy are undeniably deteriorating.Manufacturing activity dropped in September twice as fast as economists were predicting, to the lowest level since 9/11. Unemployment claims spiked again this week, and unemployment figures for the month of September that will be released on Friday are likely to be bleak. The high cost, or utter unavailability, of credit will accelerate those trends, as will the decision by individuals and companies to stop spending. Just based on consumer spending figures for August and September, GDP growth for the third quarter of 2008 is likely to be negative.
If the current status quo continues without timely government action to address problems in the credit markets and the real-economy woes of consumers, a downturn could easily become much worse. Nobody knows this better than Federal Reserve chairman Ben Bernanke.
Ben Bernanke had spent his career studying financial crises. His first important work as an economist had been a study of the events that led to the Great Depression. Along with several economists, he came up with a phrase, "the financial accelerator," which described how deteriorating market conditions could speed until they became unmanageable.
To an alarming degree, the credit crisis had played out as his academic work predicted. But his research also led Mr. Bernanke to the view that "situations where crises have really spiraled out of control are where the central bank has been on the sideline," according to Mark Gertler, a New York University economist who has collaborated with Mr. Bernanke on some papers.
As credit tightens, as unemployment grows, as consumer spending slows and manufacturing activity declines -- all these factors reinforce and exacerbate each other. Throw in a rash of bank failures, imploding money market and hedge funds, the annihilation of the investment banking industry and, it seems to me, you have all the elements for a crash.
Which brings us, once again, to the politics of the bailout. Like many Salon readers and economists, I agree that the critical question is how best to stabilize the banking industry. Capital is in short supply -- financial institutions must be recapitalized. Several economists have suggested that the government should just step in and buy large chunks of failing institutions -- a strategy similar to that employed with AIG. We would still be talking about a rescue plan costing hundreds of billions of dollars, but it would not carry the same stigma of government handouts to malefactors that the current proposal on the table stinks of.
I can certainly see the attraction of such a plan, but like Paul Krugman, I question the political reality of it. I have no doubt that the House Republicans would rather commit mass hara-kiri than sign on to what would, without exaggeration, be a socialist semi-nationalization of the financial industry. So in the House, Democrats would have to muster up a party line vote. Not impossible. But is it realistic to think that such a measure could pass the Senate, where hard-line conservatives have demonstrated their ability and willingness time and again to torpedo much less drastic reforms? Would George Bush sign such legislation?
I kind of doubt it.
No one has been harder on George Bush over the last eight years than Paul Krugman, which is why I give heavy weight to his extremely qualified endorsement of the bailout. Here's a recent summary:
The Dodd-Frank changes make the plan less awful, mainly by creating an equity stake. Essentially, this makes it possible for the plan to do the right thing through the back door: use toxic-waste purchases to acquire equity, and hence inject capital after all. Also, the oversight means that Treasury can be prevented from making the plan a pure gift to financial evildoers. But it's still not a good plan.
On the other hand, there's no prospect of enacting an actually good plan any time soon. Bush is still sitting in the White House; and anyway, selling voters on large-scale stock purchases would be tough, especially given the cynical attacks sure to come from the right. And the financial crisis is all too real.
So right now we are left with the mess that is on the table, a mess that I would lay heavy odds on the House of Representatives passing on Friday. Not a pretty sight, for sure. But I think those who are arguing that doing nothing is better than accepting the bailout are walking on a pretty perilous tightrope. We've got about four months before a new president and a new Congress come into power, with the potential for a drastically different approach to economy policymaking. But an awful lot of bad things can happen in that span of time.
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