This article first appeared in the St. Louis Beacon: September 21, 2008 - The economic storm that blew in like a hurricane last week has been years in making.
The full effects of the crisis are still unknown. While Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke insist that the bail-out's cost to taxpayers will be in the hundreds of billions of dollars, some economists think the likely price tag will be in the $1 trillion to $2 trillion range. Furthermore, the fallout from the crisis is likely to include a massive accumulation of debt, which would result in a serious drag on economic growth.
Another likely consequence of the financial meltdown is an increase in the rate of the cost-of-living because the Fed will probably allow inflationary pressures to go unaddressed. High inflation means that the value of debt will go down, which provides an opportunity to rein in the cost of growing levels of private and public debt.
The federal government moved with uncommon swiftness to prop up the teetering credit market and prevent the whole U.S. economy from collapse.
In the space of a few months, policy-makers in Washington, took control of investment firm Bear Stearns, mortgage lenders Fannie Mae and Freddie Mac and then American International Group, the world's largest insurer. It only drew the line at acquiring the failing Lehman Brothers, which surprised many on Wall Street.
Last Friday night, the Bush administration gave Congress its request for broad authority to purchase assets from U.S. financial institutions. The brief document outlines, among other things, giving the Treasury secretary power to oversee the purchase of assets by hiring asset managers and granting the government vast new powers to buy, sell and hold residential and commercial mortgages.
It is likely that Congress will seek to add a provision that will help struggling homeowners to pull themselves out of deep debt.
The proposal before Congress is the largest government intervention into the private capital market since the Great Depression. Underlining the the direness of the situation, Treasury Secretary Paulson is reported to have said, "If it doesn't pass, heaven help us all."
The federal bailout plan marks a comprehensive and systematic approach to manage the crisis in contrast to the incremental effots of the past few months.
Economic historians draw an important distinction between the current crisis and the Great Depression of the 1930s. At the beginning of the Great Depression, credit was tight, while the Fed has helped stabilize the economy by keeping credit easy to obtain this time.
Perhaps the closest comparison to the present situation, according to economists, is Japan's economic problems during the 1990s, which led to that country's economic growth being stalled through out the decade. Moreover, the crisis of the U.S. financial system and the Japanese experience were both the culmination of poor economic decision-making over a long period of time.
The roots of the current crisis can be traced back as far as the early 1980s when the U.S. government removed exchange controls allowing capital to go global. As a result, investors could transfer their capital anywhere in the world looking for the highest returns on both their long- and short-term investments. Capital flowing among countries became so enormous that it easily dwarfed the economic resources controlled by national governments. In the process, the power to make national economic policy was transferred from elected lawmakers to the Fed. Monetary policy replaced fiscal policy, which is determined by the democratic process.
We are now experiencing the denouement of nearly 30 years of monetarism, which is the virtual collapse of the U.S. credit market, threatening to pull down the whole U.S. economy along with it.
Robert Cropf chairs the Department of Public Policy Studies at St. Louis University.