Recession? Depression? How Deep, How Far and What Can Be Done?
By Joshua Holland, AlterNet
A survey of what some of the best thinkers believe we're facing in the
coming months and years -- and the best ways to prevent complete
AS THE FINANCIAL crisis gains steam, moving from overextended American
households to global banking giants, fear of a major crash is
spreading. Talk of "Another Great Depression" has entered the
mainstream discourse, 1 out of 6 homeowners are "under water" -- owing
more to the banks than their houses are worth -- and $2 trillion of
retirement wealth has evaporated over the course of a few short
months. The markets have not been "calmed" by the government's heavy
interventions; the Dow Jones Industrial Average touched a five-year
low this week, and is now 40 percent below its peak of one year ago.
The question on most people's minds is just how far and deep the
fallout from the crisis will go. Are we looking at the kind of
recessions we've seen -- and survived -- in the early 1980s, early
1990s and at the beginning of this century, or are we staring into an
abyss that will be far more painful, one that will profoundly
transform our lifestyles?
There's no definitive answer. We're in uncharted waters, and anyone
who says they know what will transpire in the next few years is
selling snake oil. But some deep thinkers who have a solid command of
the structures of the global economy can help us understand the best-
and worst-case scenarios, the way the crisis is changing some of the
economic establishment's most cherished and long-standing assumptions
and what role government -- the American government and those overseas
-- might play in minimizing the damage created by Wall Street's
I contacted a number of leading experts this week -- all highly
respected in their field -- to get their reads on the possible impacts
of the financial sector's meltdown, the likelihood of the recent
bailout having the desired effect and where we might go from here.
There was quite a bit of consensus on several points. First, all
agreed that we're in the early stages of a deep recession. Second,
most believed that it was in no way inevitable that the crisis would
develop into a full-blown 1930s-style depression, and some were
skeptical that such an event is even possible in today's economy.
Third, all agreed that the length and depth of the crisis would hinge
on the actions taken by governments in the coming months. Finally,
there was something approaching a consensus that the economic and
political establishment has been deeply shaken by the events of recent
months, and that the banking mess might lead to a very different
approach to governing the "free market."
The Worst-Case Scenario
In a nutshell, the lack of transparency in the system -- the fact that
nobody knows precisely who's holding what liabilities on their books
-- has the potential to lead to a global loss of confidence among
investors and institutions, and what would effectively be the
modern-day equivalent of a bank run on the myriad institutions that
hold (or guarantee) "toxic" debt-backed securities.
That prospect has already led to a near-freeze in the flow of loans
that individuals and businesses require, and if the credit system
doesn't shake loose it will make the economic contraction that's
already begun longer and more severe and lead to further financial
That might create a vicious cycle in the "real" economy, as jobs are
lost, people lose their homes, local governments' revenues -- in the
United States, based largely on property taxes -- are cut and their
work forces slashed.
As Max Wolff, an economist at the New School, wrote me via e-mail,
"we're dependent on our banks. Thus, their pain is ours. Millions will
be fired. Retirements will be decimated. Opportunity will vanish,
(and) consumption will fall. Everyone is already deeply influenced.
This will become more obvious and more painfully evident with each
passing day. When it rains on the top of the hill, those who live on
the bottom of the hill drown." He added, "there's now a major flight
from all risk assets" which will "cause massive pain and dislocation
in the developing world." Wolff predicted that "large sections of the
consumption economy" will vanish, which will "slam into the leading
exporters' markets and undermine much of the recent surge in commodity
"We have now baked a severe and largely global recession into the
cake," Wolff said. "The losses are already way too large to swallow.
... The numbers about failures from car dealerships, stores and many
small businesses are alarming and will get worse." He added: "The
epicenter of the crisis is already shifting out of America and
That point was echoed by Walden Bello, a giant in the global justice
movement and founder of the Third World Network, a group of NGOs
focusing on development and poverty relief. Bello offered that "given
the globalization of national economies over the last two decades, the
downturn is going to be a synchronic one, and there is going to be no
decoupling of one region from another." The crisis in the United
States will continue to expand worldwide, at just the moment when
international cooperation is most necessary. "For instance," Bello
said, "China's main market is the United States, and China purchases
many of its industrial inputs and raw materials from Japan, Korea and
Southeast Asia. So Japan and Southeast Asia cannot rely on Chinese
demand to make up for a fall in U.S. demand. China, East Asia and the
U.S. are tied together like prisoners on a chain gang."
Robert Pollin, co-director of the Political Economy Research Institute
at the University of Massachusetts, thinks there's "a good chance this
crisis will become a general crisis, pushing unemployment up to the 10
percent level, as we experienced in 1982-83. This would mean a severe
slowdown for everyone," regardless of whether they're in the financial
markets or struggling to keep up with a mortgage. "A severe employment
crisis would hit lower-income people the worst -- that is, people who
have little savings and rent, rather than own, their homes," he wrote
me via e-mail. Pollin also believes, "the odds are closer to the
worst- rather than the best-case scenario, mainly because I think we
are already too far gone for this to be a mild downturn, no matter how
successful" the government's bailout of Wall Street might be.
Is a Major Crash Inevtitable?
"I won't go so far as to draw parallels with the Great Depression,"
James Galbraith, a senior scholar with Bard's Levy Economics
Institute, told me by phone. "I don't think that's appropriate."
In the best-case scenario, Galbraith said, "the government has the
power and should use it, first of all to secure the liquidity of the
banking system and the payment system, and then to resolve the
underlying housing problem. These things should be done, can be done
and if they are, the whole experience would be relatively mild. I
mean, it'll be severe by the standards of the past 20 years, but it
can be contained and resolved in the next two to three years." He
predicted that "if the system is kept liquid," the crisis may be short
in duration. "What will happen is that the financial sector will
shrink, it will disintermediate, but it will not collapse."
When I interviewed Dean Baker, co-director of the Center for Economic
and Policy Research, two years ago, he was one of a very few voices
warning of the dangers the housing bubble posed to the larger economy
(at the time, he had been discussing it for a couple of years). This
week, Baker said that the best-case scenario for the underlying
housing market would be for prices to "quickly fall by 10 to 15
percent, returning to their long-term trend levels." That would allow
the real estate market to begin to clear "a vast overhang of vacant
properties" and unfreeze the credit markets.
In the bigger picture, Baker argued that the recession, while painful,
might be mitigated by "large injections of government stimulus ($300
billion to $400 billion) combined with a substantial fall in the value
of the dollar." A broader stimulus package -- cash injected into the
economy to help keep goods and services moving -- "can sustain demand
in 2009, while the fall in the dollar can begin to boost net exports
in the second half of 2009 and 2010." Baker added, "even in this case,
unemployment is almost certain to rise above 7 percent by early 2009,
but hopefully will not get too much higher."
Although Pollin is not optimistic about the prospects of a quick
recovery, he told me that in his view the best-case scenario "at this
point would be a mild recession that lasts roughly a year. This would
be similar to the recession that occurred after that last financial
crisis, the 2001 stock market crash. In that case, unemployment rose
to only about 6 percent, where we are now. Financial markets would
stabilize over the next six months."
A Positive Outcome Will Require Good Governance
All of the experts I surveyed agreed that the modified "Paulson Plan"
passed by Congress won't work, but many also thought a large injection
of cash into the banking system was a necessary first step. The
crucial factor in our economic prospects for the coming years is what
will follow next.
Robin Hahnel, an economist at American University, told me that "while
it's not necessary for the U.S. financial crisis to become a world
financial crisis, and for the U.S. recession to become a depression of
the magnitude and duration of the Great Depression of the 1930s, if
the short-term, medium-term and longer-term responses continue to be
as incompetent as the short-term response in the U.S. has been so far,
this worst-case scenario could happen." Hahnel noted that "for the
most part, governments in Europe have gone about their bailouts in a
competent way -- building up equity in stricken financial institutions
by buying shares, making loans to banks in exchange for banks making
the loans they have refused to make so far, and making credible
government guarantees to depositors."
Pollin agreed. "I do think the bailout will contribute to stabilizing
global financial markets, relative to a situation where the U.S.
government did absolutely nothing," he said, noting that it was
inaction that resulted in the demise of Lehman Brothers -- the
decision "to allow the free market to work as its supposed to" -- and
that "led to the total panic that has since gripped markets."
But, he added, "that doesn't mean that this was the right bailout
strategy. It wasn't. Indeed, it was close to being the worst possible
strategy ... because it did nothing to assist homeowners who face
foreclosures; it contributed to the sense of panic by emphasizing this
huge sum -- $700 billion -- coming out of the Treasury, when in fact,
the Fed could have managed the crisis without any tax dollars being
committed." He added that the plan "didn't offer any measures to
regulate the markets and thereby create a sense of stability moving
Pollin laid out steps that he believed must follow the government's
interventions thus far if we hope to stave off a far deeper crisis,
including: a new system of financial regulations; increasing the cash
reserves required of institutions that deal in the speculative
economy; restructuring people's mortgages; and a significant economic
stimulus package designed to "create jobs and get people a new stream
Baker emphasized that "paying too much for banks' bad assets is a very
inefficient way to address their main problem -- they're
under-capitalized" (meaning they don't have enough cash on hand to
cover their potential liabilities and also make new loans). In calling
for a major stimulus package for the "nuts and bolts" economy, Baker
noted that it's "far more efficient to directly inject capital."
Galbraith told me that the "Paulson Plan" was an "act of desperation
from an overwhelmed Treasury Department" and that to the extent it
might "do anything at all" it would do so "both inefficiently and
slowly." He was adamant that it had to be considered as only a first
step, and that other measures must follow in short order.
Galbraith said it's "absolutely essential" that the government do more
to protect homeowners. "If nothing is done, the fact that there is
excess inventory of 4 million homes in foreclosure and many more to
come" will be a drag on the housing and credit markets "for a long
But that's just the first of what he called "three necessary steps"
for stabilizing the "real economy." The second is dealing with the
inevitable fiscal crisis that will face states and localities, which
"will be cutting expenditures as their property taxes implode."
Galbraith urged the federal government to bail out struggling local
governments with revenue-sharing plans and infrastructure investment,
"on the condition that they maintain their level of spending," meet
"their public sector needs" and avoid "mass layoffs of their work
force." Finally, Galbraith said, the elderly and near-elderly who have
seen their retirement accounts take a heavy hit are going to need help
-- through increased Social Security payments if need be.
If those steps aren't effective, Galbraith suggests that more dramatic
measures be taken, including a temporary suspension of the payroll
tax, which would give every working person (making under $97K per
year) an effective 7.65 percent raise to make ends meet, while giving
businesses a tax break on their payrolls.
Those measures would greatly expand a budget deficit that has already
become bloated during the Bush era. But, as Pollin pointed out, "The
fiscal deficit in 1983 was 6 percent of GDP -- that was under Reagan
-- and that pulled the economy out of crisis then. Right now, the
fiscal deficit is in the range of 3 percent of GDP. Increasing the
deficit to, say 5 to 6 percent of GDP now would inject more than $300
to $400 billion in new spending into the economy -- to go for state
and local spending on schools and health care, investments in energy
efficiency and renewable energy, raising unemployment insurance
benefits and food stamps."
Reason to Be Hopeful, as a Failed System's Flaws Are Exposed to the Light of Day
It was during an earlier economic crisis that Richard Nixon famously
said, "we're all Keynesians now." According to those I contacted,
that's more true today than at any time in recent history; there's
broad agreement in Washington that more government action will be
When I asked Galbraith about the prospect of running up large
deficits, he responded that today "no serious person" in the economic
establishment is a deficit hawk, adding that "it's striking how
quickly consensus is moving" in Washington toward the idea that a
major bailout of the "nuts and bolts" economy is needed. (Deficit
spending to kick-start the economy during a downturn, as opposed to
financing tax cuts for the wealthiest or paying for wars of choice, is
a tried-and-true policy tool.)
Despite the general consensus among the experts I surveyed that we are
almost certainly headed into very rough waters, there was cause for
optimism as well, in that most agreed that aggressive and coordinated
actions by government could contain the damage. More importantly, the
bright spot in this crisis may be (stress on the word may) the blow it
deals to the center-right, anti-regulatory paradigm that has guided
economic policymakers both at home and in many of the world's capitals
over the past three decades.
Of that paradigm, Bello said, "goodbye to all that," adding, "We
should not underestimate the sea change that is occurring.
Neoliberalism and free-market fundamentalism have been severely
discredited, as has globalization." He predicted that "capitalism
itself will come under severe questioning, and many will think that
regulating or re-regulating it is not enough. I think you will find
the same fundamental questioning happening throughout the world." He
added, "Radical economics and Keynesian economics will regain
respectability, and neoclassical or neoliberal (trickle-down)
economics will be delegitimized."
Pollin wrote that he has hope that "the commitment to financial
deregulation by mainstream economists and politicians -- Democrats as
well as Republicans -- is now dead." He added: "It is time to
recognize that unregulated financial markets always have, and always
will, cause financial crises. There are no historical exceptions to
this observation at all. This point has to be grasped."
According to Baker, the degree to which that point sinks in is an open
question. "In principle," he said, "the Wall Street mentality that has
dominated the political thinking of both parties should be on the
defensive. These guys had it all their own way, and it led to a
colossal disaster." But, he added, "in this country, failure doesn't
count against you. It will be necessary for progressives to demand an
end to Wall Street-driven policy. If there is successful organizing on
this front, then it is possible that the next administration will take
a very different course. But the Wall Street boys have to be pushed
away -- they will not surrender power voluntarily."
Hahnel offered a word of caution, noting that "80 years ago people
thought (unregulated) free market finance was dead. If the funeral had
a name, it was Glass Steagall (the New Deal-era legislation that made
banks choose between issuing mortgages and securities). In 1999 Phil
Graham, Robert Rubin and Bill Clinton killed Glass Steagall, signaling
the return and triumph of free market finance. Hopefully this crisis
will kill free market finance once and for all. 'Never again' is the
He added what was perhaps the most salient point: "I hope this lesson
will be the beginning of a larger lesson: The economics of competition
and greed does not serve us well."