JEFFREY BROWN: It was just a year ago this week that the Dow Jones industrial average cracked the 14,000 mark. But after the worst week in Wall Street’s history, the markets are down more than 40 percent from those highs.
The crisis has spread worldwide and raised the specter of a major and prolonged global economic slump, all of this despite repeated government actions.
Where are we now? For that, we turn to: Paul Krugman, professor of economics and international affairs at Princeton’s Woodrow Wilson School and a columnist for the New York Times; Amity Shlaes, syndicated columnist for Bloomberg and author of “The Forgotten Man: A New History of the Great Depression”; and Sebastian Mallaby, senior fellow for international economics at the Council on Foreign Relations and a columnist for the Washington Post.
Well, Paul Krugman, you wrote in your column today that policymakers have, quote, “reached the moment of truth.” What does that mean? And where do you see the situation?
PAUL KRUGMAN, columnist, New York Times: Well, the combination of the depth of the crisis and the fact that all the finance ministers are in Washington this weekend means that they really had better come up with something, at least a very strong statement of principles, you know, if not the details of a plan for a global rescue.
If they don’t, then there’s going to be even worse panic on Monday. This is the moment. It’s clear to everybody now that we need a coordinated rescue. We need capital pushed into the system. We need some sort of guarantees to keep money flowing. If they don’t do it this weekend, it’s a very, very bad scene.
JEFFREY BROWN: You were with us, I think, last week just ahead of the bailout package being signed. And I remember at the time you said, “Not a great package, but we have to do it.” A week later, nothing — seems to have stopped the drop.
PAUL KRUGMAN: Well, yes, I mean, in some ways what has happened was what I was afraid would happen if the thing wasn’t passed. In a way, that’s an opportunity.
Now, you know, the package as originally proposed is ancient history, so now Paulson and Congress can go back and do it right. But the urgency is much, much greater.
Really, it’s been almost four weeks since all hell broke loose, when Lehman was allowed to fail, and those four weeks have been largely wasted. And we really can’t afford much more delay. This is 1931 taking place 77 years later all over again.
Setting the Stage for G-7
JEFFREY BROWN: Amity Shlaes, you wrote about that period, 1931. Where do you see us now?
AMITY SHLAES, Bloomberg: It is like 1931 in the credit crunch aspect for sure, but a credit crunch does not have to become a Great Depression. What makes a credit crunch into a Great Depression is policy errors, such as raising taxes -- we're about to do that -- protectionism -- we're cavalier about that -- arbitrary vilification over years, through revenge through the courts and through Congress and hearings against the bad guys, instead of focusing on reform.
JEFFREY BROWN: Instead of focusing on reform. So what should happen now?
AMITY SHLAES: I think, before we had done all this deposit insurance umbrella, we should have talked about even a return of Glass-Steagall, the law that divided investment banks from commercial banks, the architecture to change the game that is clearly broken, instead of merely focusing on supplying liquidity, which is important, but not the only thing.
JEFFREY BROWN: Now, Sebastian Mallaby in trying to calm things down today, President Bush said that we have the tools. He was insistent on that. Is he right? What tools do we still have? Paul Krugman talked about the meetings coming up this weekend. Where do you see things?
SEBASTIAN MALLABY, Council on Foreign Relations: I'm actually very worried about these meetings, because I think that every time the markets look to governments for a deus ex machina, they then become disappointed when they pick apart the details of what the government has said.
So if you look back at the Paulson plan, when it was first announced, there was a huge market rally. And then, when it was voted down the first time, that was the, you know, dramatic day when it dropped.
And then when it finally passed, by then people had figured out that the government didn't really know how they would spend the $700 billion, and so it had really no effect.
And the same way I'm worried, when you're talking about a multilateral group of governments, some of which are already saying, kind of leaking that they don't really believe in this G-7 announcement tomorrow, even before it happens, the Europeans are going to go back the next day to Europe and have their own European summit on Sunday.
So the stage is set for everyone to be looking at this group, for the group not really to deliver very much, and then, even if they did deliver something, when you looked at the implementation, I predict that there will be a lot of disappointment about the details.
JEFFREY BROWN: But at the same time -- let me just -- one follow-up here. Is there any question at this point that a global solution is required?
SEBASTIAN MALLABY: Look, we are in a global problem. And because the expectations are running so high, as Paul said rightly, it would be worse to do nothing.
You know, after 9/11 we discovered that far-off countries like Afghanistan could affect our interests. Now we discover that small countries like Iceland can affect our interests. We are all in this together.
So I'm not against trying, but I worry that the consequences of so much expectation around tomorrow morning's meeting will be huge disappointment on Monday.
JEFFREY BROWN: Well, Paul Krugman, go ahead.
PAUL KRUGMAN: Well, I was going to say, you know, it's not as if we're completely at sea here. We had a plan announced by Gordon Brown's government in Britain on Wednesday which has met with a lot of approval from economists. It looks -- you know, no one is sure that if everyone did it would end the crisis, but it really looks like a very good plan.
If we had some kind of commitment, some kind of agreement that something like that would, in fact, be done by a number of countries -- it doesn't have to be everybody -- but, you know, we're not talking about a very steep hill to climb here, at least not intellectually. There is no excuse for not getting something out this weekend.
The fact that there's been disappointment with previous announcements is saying, well, those were bad policies. It's a little bit like saying, well, because the current government is doing a bad job, government can never work.
We need this rescue. It's up to the policy guys in Washington right now to do it.
JEFFREY BROWN: Well, Amity Shlaes, are you suggesting that we're wrong in looking to the policy guys, as Paul Krugman just put it, or to the G-7 meetings this weekend?
AMITY SHLAES: A big meeting like that is very important. One of the things I discovered in looking at the Depression was the destruction that Roosevelt wrought when he torpedoed the London Monetary Conference, very similar event, spring of 1933.
He said, "I don't care. I'm a populist. I will turn to the farmers." And that let Europe go in the way, you know, Europe was slipping into fascism, so there are political ramifications, as well as economic ones.
Moving toward cautious regulation
JEFFREY BROWN: Sebastian Mallaby, the Washington Post today had a column that was titled "The End of American Capitalism?" with a question mark, a very provocative question, obviously, but on many people's minds.
Is that the right question to ask? What's the answer? What kinds of questions are out there about the larger system now?
SEBASTIAN MALLABY: Well, it's an attractive debate to have, because it's got a, you know, big title and a big question mark and it's sort of, you know, arresting.
But when we were in the Depression in the 1930s, there was actually an alternative system, Soviet communism, that some people believed in. Now, as you look around the world, we can talk about gradations of capitalism. How big should the role of the state be? What level of regulation one should have?
But we're talking about shades of gray. I think there was already a lot of pressure, even before this financial crisis got serious, to the effect that already government was going to be growing its role in the world economy, partly because the center of gravity was shifting towards economies like China, which has a big role for the government.
Capital was flowing to sovereign wealth funds, to central banks around the world. There was talk about -- legitimate talk about the inequality that was coming from a dynamic globalized economy and the need for government to step in with safety net programs to address that.
So I think there was already pressure. So if you set this against some idealized, you know, perfect market system -- the Reagan rhetoric and all that -- yes, sure, we're not going to have that, but we didn't have that anyway, and we shouldn't have had that anyway.
And so now we're going to move a couple more steps in the direction of cautious regulation. I hope it doesn't overshoot.
PAUL KRUGMAN: Can I just weigh in on that? Because during the Great Depression, John Maynard Keynes had a great remark. He said we had magneto trouble, roughly speaking, alternator trouble. You know, the engine is mostly fine, but there's one part that's malfunctioning.
And that's what's happening now. It's not that capitalism is dead. It's not that the whole American system is dead, but this financial thing that we've created, with these institutions and derivatives that we don't understand, needs to be fixed.
And that's -- you know, it's not that we have to tear everything up. And we don't have to become Maoists. We just have to fix this part, but we'd better do it soon.
Depression versus recession
JEFFREY BROWN: Should we be even asking this question, I mean, those kind of big questions at this point?
PAUL KRUGMAN: Always. Always good questions to ask. But, you know, I'm mostly concerned right now about how we avoid a financial meltdown in the next month and how we avoid a really deep recession in the next year. And then, you know, after that, let's talk about the future of capitalism.
JEFFREY BROWN: Amity Shlaes, you want to weigh in here?
AMITY SHLAES: Oh, well, sure. We tend nowadays to conflate recession and depression and think of them as the same thing. You heard that a little bit in one of President Bush's speeches. A recession and a depression are not the same thing. We have recessions all the time. They're not pleasant, but we get past them.
Also, we want to keep in mind, one of the factors that made this crisis happen was the foreign money that came to the United States. And it did that maybe because the bond raters put the wrong letters on the bonds, made them look too good, but also because the United States is a relatively attractive place to invest.
And I don't see, in all the crises overseas, in Russia, of Mr. Putin, or in China, that situation changing. Longer term, Europe has some incredible social obligations that are weighing it down, that are more than our Medicare Part D.
So this is our focus, to keep the U.S. relatively competitive. Then things will get better, indeed.
JEFFREY BROWN: But, Amity Shlaes, staying with you, you know, several generations of Americans have now been raised on the notion that the stock market works, right, and we depend on it for our retirement funds, our college funds for our kids, so many different things. What do we tell people now?
AMITY SHLAES: The stock market mostly does work, but it doesn't always work, and it doesn't work when it's not honest.
And you look at the factors here, those bond rating agencies that said things were good when they weren't. These very amorphous securities, no one owned them, no one was responsible for the loan, no one cared that the person who borrowed had no money, also, all the capital flowing in, not evaluating very carefully.
So this is an excess of capitalism or markets, but not a failure.
A prognosis for the downturn
JEFFREY BROWN: So, Sebastian Mallaby, bring us back here now from the big picture to this weekend. You said you're worried about the possibility that we're putting too much onto this. What's the alternative? What else happens over the weekend? Or what do we wake up with on Monday?
SEBASTIAN MALLABY: I'm afraid the truth is we are where we are. I mean, the markets are looking at this meeting tomorrow morning, so we better hope that they do something.
I think Paul is right that, you know, the British plan has been well-received, that a guarantee on bank debts of various kinds, not just deposits, but the commercial paper they issue, the short-term bonds they issue, I think that is probably the right way to go. I hope they come out with that.
But I'm worried that, any time you have an international agreement, and each of the member governments go back to their own capitals, and then start, you know, leaking how they'll actually implement it, people will see that it's not all the same agreement, that people are kind of wiggling out of it at the corners.
And I worry that then you get a repeat of the dynamic around the Paulson plan, where at first people are ecstatic, and then, as they look at the details, they worry, because it won't necessarily be implemented in the ideal way that one would hope.
JEFFREY BROWN: Well, Paul Krugman, just one last thing on the sort of where we are here as we wind up. I think there's still a lot of confusion -- I know I feel it after this week -- of the mix of how much of this is about fundamentals?
You know, last week we were talking about bad loans and bad institutions. We started this week talking about psychology. It was more about panic. Then we started talking about real economic downturn.
So, at the end of the week now, what's the mix? What's the right way to think of this?
PAUL KRUGMAN: Well, look, we've got a real economic downturn which is largely baked in, but can get much worse if the credit thing goes out of control. We have hundreds of billions of dollars of necessary losses, stuff -- loans that were made during the peak of the housing bubble and you're going to take a lot of losses on those.
But we've got all of these sort of secondary effects, these multiplier effects because of the ongoing panic, the scramble to raise capital, the scramble to contract balance sheets. And those are the things that can be short-circuited.
It's hard to avoid mixing metaphors here, but we can try to limit this excessive downturn and, in so doing, almost limit the downturn of the real economy.
So, yes, there's no way to avoid bad stuff happening to the economy. There's no way to avoid bad stuff happening to a lot of investments. But it doesn't have to cascade into this enormous collapse scenario which is what we're risking right now.
And, you know, it's the same thing -- there were good reasons to have a recession in 1929. It was probably unavoidable that you were going to have a recession in 1929. But it did not have to turn into the Great Depression. And we're in that situation all over again.
JEFFREY BROWN: All right, we will leave it there. Paul Krugman, Amity Shlaes, and Sebastian Mallaby, thanks very much.