No Depression just recession.

This is the conventional wisdom but the conventional wisdom not long ago was that the securities that are now virtually worthless had great ratings. That is why all those banks now taking billion dollar writedowns bought them. How reliable are the ratings of the chances of depression by conventional economists? It is true that the conventional theology about not interfering in markets that helped fuel the Great Depression has been thrown overboard this time.The same conventional economists who in normal times trumpet the virtues of the market unsullied by government intervention are now trumpeting the virtues of government intervention to cut interest rates and to stimulate the economy. But this could very well cause problems itself such as inflation especially when combined with humungous expenditures on war and the military.


NY Times, March 23, 2008
The Nation
Depression, You Say? Check Those Safety Nets
By CHARLES DUHIGG

The stock markets are spiraling like whirling dervishes, one of the
nation's largest financial institutions has flirted with bankruptcy
and the former Federal Reserve chairman Alan Greenspan invoked the
ghost of past calamities when he wrote that the current economic
turmoil is likely to become the "most wrenching" since World War II.
Meanwhile, home foreclosures are at their fastest pace in at least 30
years and in a survey conducted by USA Today and Gallup, more than
half of respondents indicated that they had fears the downturn could
become a depression.

Some innocent bystanders might be forgiven for wondering why that
last word — "depression" — has started popping up. Is it possible
our
economy could speed past a recession into a full-blown depression
like that of the 1930s, when American unemployment reached 25 percent?

Well, the economists are here to say that you can dig up the family
silver and stop training the kids how to jump onto a moving train.
While many who study the nation's economic health agree that a
recession has probably already begun, and that it may be long and
severe, they also say the odds of a full-blown depression are almost
nonexistent.

Why? Because so many of them have spent so much time studying the
Great Depression and trying to figure out how to react more
effectively if things turn really bad again. Take last week, for
example.

"I used to give a lecture explaining that the Great Depression could
never happen now because of the regulations that emerged from that
crisis," said Barry Eichengreen, an economist at the University of
California at Berkeley. "But we're learning that there is a shadow
banking system, of hedge funds and investment banks, that are outside
of those safety nets. What happened to Bear Stearns last week looked
a lot like a 19th-century run on the bank. And that's why the Fed
reacted so quickly."

Indeed, when the government moved last weekend to help save Bear
Stearns, the fifth-largest securities firm on Wall Street, from
bankruptcy, policy makers were motivated by concerns that the
investment bank's failure could start a chain reaction of collapses
at other investment houses. Stopping those dominoes was such a
priority that the Federal Reserve helped broker the sale of Bear
Stearns to its rival JPMorgan Chase.

A century ago, such government hustle would have been unthinkable.
Even the distinction between a recession (a significant decline in
economic activity that lasts more than a few months) and a depression
(a decline that is much longer and deeper) didn't really matter,
because turmoil in the economy was often taken for granted.

Between 1857 and 1929, while regulators largely stood idle, the
American economy swung through 19 national boom-and-bust gyrations
that sometimes threatened to wipe out whole industries within months.

But in the wake of the Great Depression, American policy makers began
actively managing the economy with a handful of tools, including
adjusting interest rates and using massive government spending to
spur growth. Since 1945, there have only been 10 boom-and-bust
cycles, most of them much shallower than earlier ones, and the
unemployment rate has never topped 9.7 percent.

Much of that stability, economic historians say, stems from reforms
designed to calm consumers during downturns, like the Federal Deposit
Insurance Corporation, which guarantees most checking and savings
accounts up to $100,000 if a bank fails.

But as the Internet boom and recent housing bubble demonstrate, even
relatively stable periods can be part of a cycle of extreme ups and
downs. The prolonged expansion that just ended had an unusually long
run of more than six years. As a result, some are speculating that
the crash will be equally drawn out.

"The biggest difference with this recession is that it's starting in
the housing market," said Victor Zarnowitz, an economist at the
Conference Board who is also a member of the National Bureau of
Economic Research's business-cycle committee. For the first time in
more than 50 years, the nation faces a broad risk "that people's most
important asset, their home, will lose value," he said.

As homeowners see the value of their homes decline, they become more
likely to delay purchases of the big items — like automobiles,
electronics and home appliances — that are ballasts of the American
economy. When those purchases decline, large manufacturing firms,
suddenly short on funds, could begin laying off employees. Those
workers, uncertain about the future, might in turn stop buying
Starbucks lattes and movie tickets, and in a worst-case scenario,
that could spur coffee shops and theaters to begin layoffs of their
own.

Such a chain reaction was one reason unemployment during the Great
Depression was so persistent and widespread.

But today, say economists, fundamental changes make such contagion
unlikely. For one thing, incomes are more stable. Many more Americans
hold jobs in service sectors, like medicine or education. And more
Americans work for the government, which is less inclined to fire
people just because the economy turns gloomy.

Moreover, there are safety nets that can be traced to the Great
Depression, like Social Security, unemployment benefits, food stamp
programs. These "give people a sense of security even when they're
out of work," said the Harvard economist Benjamin Friedman. "That
establishes a floor for how panicked consumers become."

Even if consumer confidence hit rock bottom, that most likely would
not be enough, by itself, to cause a depression. For things to become
really dire, the nation's financial institutions would have to fail
at the same time that unemployment began significantly rising. Only
if banks suddenly closed, or it became impossible for companies to
access short-term lines of credit, would things begin spiraling out of
control.

A credit shortage, in fact, has played a significant role in today's
economic turmoil, and was the reason some economists began invoking
the Great Depression. But those comparisons were more to stress how
differently policy makers are behaving today than their counterparts
did in 1930, when a wave of panics started that eventually caused
one-fifth of the nation's banks to fail.

Today, the Federal Reserve is so cautious about the stability of
major financial institutions that regulators sometimes jump into
action almost immediately, as they did in the Bear Stearns case. One
goal of such an intervention, say economic historians, is to slow
down the turmoil as much as possible. In the 1920s and early 1930s,
policy makers became overwhelmed by a cascade of crises they were
unable to temper.

"In the 1920s, everyone was still reeling from the First World War,
which had realigned capital structures and boundaries and had put the
defeated countries in positions where they had much less economic
flexibility," said Peter Temin, an economic historian at the
Massachusetts Institute of Technology. In particular, one cause of
the Great Depression was that policy makers in the United States and
elsewhere were either reluctant or unable to increase their
countries' supplies of money, which at the time were often backed by
gold.

"Today, we have a lot more flexibility and we can prop up banks and
the economy to give us enough time to let things stabilize,"
Professor Temin added. Already, some lawmakers are proposing to help
refinance or purchase failing mortgages in order to slow down how
quickly other problems might spread; that approach, however, might
carry risks of its own, like encouraging irresponsible behavior and
increasing government deficits.

Of course, all of these techniques do not guarantee an easy path to
rosier times. Some economists and financiers say it's likely that the
current recession will extend for at least a year. Others think the
American economy will suffer from an extended malaise as Japan did in
the 1990s.

But whatever name economists give the current downturn, we are
unlikely to see the bread lines, shantytowns and dust bowl of the
Great Depression. More likely, these economists say, would be a
sudden increase in the number of people selling belongings on eBay.

Hollywood, which until now has largely catered to American tastes,
might begin more explicitly choosing scripts based on how they would
play in rising economies like India and China. And while exports of
manufactured goods might accelerate, the outsourcing trends that sent
some American jobs abroad might reverse. Already, Germany-based BMW
is expanding a South Carolina plant, betting that the weak dollar
will make American workers cheaper than those in Germany or Japan.

Which isn't to say that anyone is starting to hum "Happy Days Are
Here Again." Even the Federal Reserve chief, Ben Bernanke, has warned
against becoming too sanguine.

"To understand the Great Depression is the Holy Grail of
macroeconomics," Mr. Bernanke wrote in a 1994 paper, when he was a
professor at Princeton focused on analyzing the financial cataclysm
that began in 1929. While economists have made great progress, he
continued, "we do not yet have our hands on the Grail by any means."

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