The Economy - a clear look

From The Wall Street Journal comes a bit of perspective:

We're Not Headed for a Depression
No, this isn't the crisis that kills global capitalism.

In order to promote a much smoother functioning of the financial system, it is paramount to distinguish between the immediate steps needed to cope with the present crisis and the long-run reforms needed to reduce the likelihood of future crises. Let's start with the short-run fixes.

First of all, the magnitude of this financial disturbance should be placed in perspective. Although it is the most severe financial crisis since the Great Depression of the 1930s, it is a far smaller crisis, especially in terms of the effects on output and employment. The United States had about 25% unemployment during most of the decade from 1931 until 1941, and sharp falls in GDP. Other countries experienced economic difficulties of a similar magnitude. So far, American GDP has not yet fallen, and unemployment has reached only a little over 6%. Both figures are likely to get quite a bit worse, but they will nowhere approach those of the 1930s.

The Treasury's announced insurance of all money-market funds, and the full insurance of bank deposits, carry considerable moral hazard risks, but they have not aroused much controversy. The main thrust of the new banking law allows the Treasury secretary to purchase bank assets up to $700 billion in order to increase the liquidity of the banking system. These assets are of uncertain worth since there is essentially no market for many of them, and hence they have no market price. The government hopes to create this market partly through using auctions, where banks would offer their assets at particular prices, and the government would decide whether to buy them. I would have preferred starting with a smaller dollar value of purchases, and up the amount if the situation deteriorates further.

Partly because many consumers are repelled by the intention to bail out companies and their executives who made decisions that got the companies into trouble, the new law includes income and severance pay limits for executives whose firms seek government help. Even though one cannot think much of executives who led their banks into such a mess, that is a bad precedent since it involves too much micromanagement of bank operations. Moreover, such salary controls can be evaded by very generous fringe benefits.

The moral-hazard consequences for banks receiving a bailout now is worrisome since they may expect to get rescued again by the government if their future investments turn sour. Yet while I find helping these banks highly distasteful, moral-hazard concerns should be temporarily relaxed when the whole short-term credit system is close to collapse. Still, the bank bill with its huge bailout does suggest that the $29 billion bailout of the bondholders of Bear Stearns in March was a mistake. It seemed to have a moral-hazard effect by encouraging Lehman Brothers and other investment banks to delay in raising more capital because they too might have expected the government to come to their rescue if times got much worse. Although the government was apparently concerned that foreign central banks were major holders of the bonds, it was unwise to give them and other bondholders such full protection.

This was written by Gary S. Becker who won the Nobel Prize for Economics in 1992 and is professor of Economics at the University of Chicago and Senior Fellow at the Hoover Institution. He might just know a little bit about this subject... His website is here: Gary S. Becker He shares a Blog with Richard Posner: The Becker-Posner Blog