Hope and Trust, and the Mini Depression
When the history of the Mini Depression of 2008-2010 is written by future historians, the word "distrust" will appear again and again.
Financial stocks are in free fall because no one trusts financials any longer. A sell-off in bank, housing, insurance and other financial stocks has accelerated in the wake of Geithner's bailout plan because the administration raised expectations too high that the plan would cure troubled banks. Yet it has become clear (even to Alan Greenspan) that the only way anyone is going to trust what they see on bank balance sheets is if bank regulators take over troubled banks, at least until those balance sheets are washed clean.
Geithner must be realistic about what can be accomplished even then. After all, the bubble was pumped up by financials. Between 2003 and the peak in 2007, the American Stock Exchange financial services index just about doubled. By 2007, financial services companies accounted for 22 percent of the S&P 500 index's market value. Now that figure is closer to 12.5 percent, and still dropping. That precipitous drop isn't bad for the economy; it's good. After all, what was the financial industry of 2007? Much was wishful thinking based on speculation, wildly optimistic (and inaccurate) models of risk-management, and outright lies. In other words, hot air -- and the sooner we let all the air out of the financial economy, the sooner the real economy can begin to recover.
Meanwhile, economic distrust is spreading around the globe. What started two years ago with a sub-prime lending problem in the United States is now global, the ugly consequence of untrustworthy global capital markets and inadequate worldwide demand (led by fearful consumers in the United States). The fragile economies of Eastern Europe are in danger of collapsing. The Russian economy is shrinking. Most of Latin America is in trouble. More worrying, Japan's recession is deepening. Even China, whose rapid growth seemed unstoppable, is slowing to a relative crawl. Global investors are fleeing risk; global consumers are hunkering down.
Given all this, America's stimulus isn't nearly large enough. At the least, it should be replicated, proportionally, by every major economy. Central banks around the world must also continue to lower interest rates and open their lending windows. Bank bailouts must be coordinated. Protectionism should be avoided.
In this world of economic distrust, it's vitally important that President Obama and his administration maintain credibility on the economy. Raising false expectations would do far more harm than good. In remarks aired this morning on ABC's "Good Morning America," former president Bill Clinton said he wanted the American people to know that Obama is "confident that we are gonna get out of this and he feels good about the long run. ... I just would like him to end by saying that he is hopeful and completely convinced we're gonna come through this." Clinton's suggestion is understandable but misguided. Happy talk at this point in time is so incongruous with what most Americans (and others around the world) know and are experiencing that it could undermine Obama's credibility.
The truth is that no one has any idea how long this crisis will last or exactly how to reverse it. Anyone who says differently cannot be trusted. And because restoring trust is so central to mending the economy, our leaders must be extremely careful not to indulge right now in the audacity of hope.