$7 Trillion Meltdown 101: How We Got Here, What to Do Now

It's worth it for non-economists to better understand how got into this mess -- and how to get out of it.
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Now that the federal government is committed to spending or guaranteeing as much as $7.8 trillion to salvage the financial system, it's worth it for non-economists to better understand how got into this mess -- and how to get out of it. President-elect Obama has picked a centrist economist team that includes leaders who played a role in short-sighted decisions that exacerbated the current crisis. But, as Bloomberg News puts it:

In turning to Clinton administration veterans for his economic team, President-elect Barack Obama is banking that people who had a role in the current financial crisis will be best able to fix it.

Timothy Geithner, Obama's choice for Treasury secretary, was involved in the decision to let Lehman Brothers Holdings Inc. go bankrupt, which exacerbated a global credit-market freeze. Lawrence Summers, his pick for White House economic adviser, ran the Treasury when Congress repealed the Glass- Steagall Act, breaking down walls between commercial and investment banking.

What happened? Greed and deregulation ran amok for years, while most of the world's governments and leading financial institutions placed their bets on the shakiest of investment vehicles: securities and other intruments based on risky mortgages and a mindless faith in an ever-expanding housing "bubble."

Here's a new basic interactive MSNBC guide on who is to blame in the economic crisis -- several institutions, regulators and officials, such as Alan Greenspan.

The New York Times puts the blame squarely on the deregulatory, free-market philosophy of the Bush Administration in a new front-page article.

Given all that, it shouldn't be surprising that the Associated Press reported Monday that financial industry lobbyists worked successfully to convince the Bush administration to ignore warnings that risky loans imperiled the economy. As the AP reports:

The Bush administration backed off proposed crackdowns on no-money-down, interest-only mortgages years before the economy collapsed, buckling to pressure from some of the same banks that have now failed. It ignored remarkably prescient warnings that foretold the financial meltdown, according to an Associated Press review of regulatory documents.

"Expect fallout, expect foreclosures, expect horror stories," California mortgage lender Paris Welch wrote to U.S. regulators in January 2006, about one year before the housing implosion cost her a job.

Bowing to aggressive lobbying -- along with assurances from banks that the troubled mortgages were OK -- regulators delayed action for nearly one year. By the time new rules were released late in 2006, the toughest of the provisions were gone and the meltdown was underway....

The administration's blind eye to the impending crisis is emblematic of a philosophy that trusted market forces and discounted the need for government intervention. Its belief ironically has ushered in the most massive government intervention since the 1930s.

Unfortunately, as The New York Times pointed out in a Sunday editorial, now the current response to the crisis has been to throw money at the hydra-headed monster of failing financial institutions without directly aiding the homeowners most at risk of defaulting on their mortgages -- or even have officials explain clearly what they're doing, including Henry Paulson's erratic flip-flops on how he's going to use $700 billion in bailout money.

One reason that federal leaders believe they don't have to clearly explain or show what they're doing is the sure knowledge that even well-educated Americans are too befuddled by economic issues to penetrate the fog of spin. To help remedy that, I've put together some of the best explanatory journalism and resources on the current meltdown here, from This American Life's "The Giant Pool of Money" to the New York Times' series on "The Reckoning." I've also provided links to various charts, articles, bloggers such as economist Brad DeLong, and broadcast pieces. Just as valuable is this smart new article from The Atlantic bby disgraced Wall Street trader, Henry Blodgett, now a journalist, on why Wall Street doesn't learn from its mistakes. (Brad DeLong gave a clear explanation of our current economic crisis and the political fall-out as a guest on the radio show I co-host, "The D'Antoni and Levine Show," here.)

You'll also find at this resource site, for instance, 60 Minutes' "The Bet That Blew Up Wall Street" and Nobel Prize Winner Paul Krugman's explanation in a recent New York Review of Books of "What to Do."

Some excerpts from Krugman's essential points:

What the world needs right now is a rescue operation. The global credit system is in a state of paralysis, and a global slump is building momentum as I write this. Reform of the weaknesses that made this crisis possible is essential, but it can wait a little while. First, we need to deal with the clear and present danger. To do this, policymakers around the world need to do two things: get credit flowing again and prop up spending...But for now the important thing is to loosen up credit by any means at hand, without getting tied up in ideological knots. Nothing could be worse than failing to do what's necessary out of fear that acting to save the financial system is somehow "socialist."

The same goes for another line of approach to resolving the credit crunch: getting the Federal Reserve, temporarily, into the business of lending directly to the nonfinancial sector. The Federal Reserve's willingness to buy commercial paper is a major step in this direction, but more will probably be necessary.

All these actions should be coordinated with other advanced countries. The reason is the globalization of finance...

The next plan should [also ] focus on sustaining and expanding government spending - sustaining it by providing aid to state and local governments, expanding it with spending on roads, bridges, and other forms of infrastructure.

[On regulation:] What we're going to have to do, clearly, is relearn the lessons our grandfathers were taught by the Great Depression. I won't try to lay out the details of a new regulatory regime, but the basic principle should be clear: anything that has to be rescued during a financial crisis, because it plays an essential role in the financial mechanism, should be regulated when there isn't a crisis so that it doesn't take excessive risks...Now that we've seen a wide range of non-bank institutions create what amounts to a banking crisis, comparable regulation has to be extended to a much larger part of the system.

An unprecedent crisis requires fresh thinking and a willingness to do whatever's necessary responsibly to save the economy. Krugman concludes, "We will not achieve the understanding we need, however, unless we are willing to think clearly about our problems and to follow those thoughts wherever they lead. Some people say that our economic problems are structural, with no quick cure available; but I believe that the only important structural obstacles to world prosperity are the obsolete doctrines that clutter the minds of men. "

(Among those obsolete doctrines, many progressives say, are the anti-union myths and ideology being spread by opponents of both a bailout of the auto industry and of organizing rights for workers.)

All of of us need to understand, as we follow Obama's economic team and the ongoing bailouts, just what's being done with our taxpayers' dollars -- and the failed oversight that got us here in the first place.

UPDATE: David Sirota argues recently that the financial sector's $700 billion bailout was not only heedlessly out-of-control and unmonitored but based on wildly exaggerated claims about the severity of the credit crisis. That latter claim is open to debate, but it's worth reading his case against the financial bailout: "We Were Punked."

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