Krugman is a professor of economics and international affairs at Princeton University and an op-ed columnist for The New York Times. He won the Nobel Prize for economics in 2008. This is the edited transcript of an interview conducted on Nov. 14, 2008.
Who is Ben Bernanke, and what is his philosophical background when it comes to economics?
He hired me at Princeton. If he weren't chairman of the Fed, he'd been top of the list of people you'd be going to for advice and understanding all this stuff. He is, in fact, one of our leading scholars of the Great Depression. ...
His academic work is most nearly appropriate to this crisis. He's somebody who worried a lot about Japan and their crisis, saying, "What can we do so nothing like that ever happens here?" So if you were going to do the résumé, he would be the perfect man to be in his position. And the tragedy, of course, is knowing all of that and trying so hard, it's still not going very well.
What were you thinking when, in February 2006, he gets the nod to go down to the Fed?
I was pleased. We'd had a lot of appointments I didn't like, pretty obviously, from the Bush administration. The line a lot of us were seeing was ... that the administration, having had the fiasco over FEMA [Federal Emergency Management Agency], having had the fiasco over trying to put [former White House Counsel] Harriet Miers on the Supreme Court, when the Fed appointment came up, they actually had to choose somebody who was universally respected.
So no, this was happy. Even among the list of potentials, I think [this was] the choice that made most of the professionals in this field, left them most pleased.
Why? What was his philosophy in regard to how to deal with the economy? ... How would his Fed be different than [Alan] Greenspan's?
[Fed Chairman from 1987-2006] Greenspan is a political animal. He managed to work with the Clinton people, but Greenspan is an Ayn Rand disciple who really abused -- my view -- abused his position to help Bush get his tax cuts through. Greenspan, even before we knew about the financial mess-up, was a problematic figure. Bernanke -- I think everyone was a little surprised to hear that he was a registered Republican, not because he was known to be a liberal but because he didn't seem like a very political guy.
The Fed should be above politics, should be an institution that is primarily technocratic. It should be like the Army Corps of Engineers or the Supreme Court in better days. And Bernanke fit that model. He's an open-minded guy about monetary policy. There are people who have very rigid views on monetary policy, M2, you know, target the money supply or absolute price stability is the overriding goal above all else. And he's known to be somebody who's got a more flexible view about the role of the Fed altogether, the kind of thing that sensible people were looking to see in the Fed chairman.
Could you explain that flexibility?
... There have been central bank chairmen who say: "My job is to maintain price stability. You tell me there's a recession. Unless I see that there's a deflation coming along with it, I'm not going to do anything. If I see prices going up, even if it's obviously a temporary shock from food prices or oil prices, well, you know, I'm supposed to maintain price stability, so I'm going to squeeze the economy."
Bernanke very clearly did not have that view. Bernanke had a view about, yes, price stability is important, but it's a long-term goal. You allow short-term shocks to pass through the system. You take a hard look at problems of unemployment. You can't dictate that the unemployment rate is going to be 3 percent, but you do say if the unemployment rate looks like it's spiking up to 7, you take quick action to try and control it -- so altogether an open-minded outlook toward his role and toward the Fed's role.
Who is Hank Paulson? How was he viewed, and what did he bring to the job of secretary of the Treasury?
To be honest, I didn't know a lot about Paulson. ... Paulson is coming from the investment banking, the Goldman [Sachs] area. Goldman is the firm that produced Robert Rubin, [Treasury secretary, 1995-1999]. You expected flexibility, certainly was a cut above a lot of the people the Bush administration appointed to important positions, certainly more of a figure to be reckoned with than John Snow, [Treasury secretary, 2003-2006].
But I knew nothing about what his likely management style or his economic philosophy would be. Financial industry people, some of them, have a remarkably broad, sophisticated view of economic policy, and some of them don't. I had no idea where Paulson would fall on that spectrum.
How do they seem to work together?
We don't see most of it, obviously. It has not looked like the kind of partnership that Rubin and Greenspan had in the late '90s, which really seemed to be a partnership of equals with a lot of real exchange of ideas. It has looked as if the Fed has been off doing its thing and the Treasury mostly coming up with the money occasionally, and then after the world fell apart in September, Treasury marching off with Paulson's ideas and Bernanke appearing very much second fiddle in the public discussion, and secondly, very little sign that the Fed's thinking was being reflected in the policies.
Let's talk about the bailout first. ... What's your view of the way Bernanke would have viewed the situation, looking at the TARP [Troubled Asset Relief Program] plan? ...
When I was trying to figure out what was going on with the bailout, where did I turn? I actually turned to old papers by Ben Bernanke, academic papers, which really emphasized the problem of financial constraints due to firms having inadequate capital. And if that's where you're coming from -- and it's my guess, but I have no proof that that's where Bernanke should have been coming from himself -- then the problem was capital, and the natural form of a bailout should be capital injections, should be the government buying shares, preferred shares, some kind of shares in financial companies to push up the capital.
I also knew that if you were someone who had studied financial crises in the past and the solutions that governments adopted, that they generally did take the form of government injections of capital, including Japan in 1998, which Bernanke studied quite a lot.
Then along comes this plan, and it was nothing like that. It was, instead, "We're going to buy up the toxic waste," and wasn't clear why that was supposed to work. The intellectual justification wasn't clear. There was a lot of, I would say, mumbo jumbo. I mean, economists -- I do mumbo jumbo myself. But really, there were a lot of big words being thrown around without even people who have followed this knowing what they were actually meaning to say. It was a very odd plan and a very disconcerting sales job, not what we expected to see. I think everybody who was following this, first when Treasury announced the plan, said, "Well, they must know what they're doing," and then after a few hours of trying to figure it out, said, "I don't get this; I don't know what Paulson thinks he's up to."
I think you wrote that you gathered that Paulson basically outvoted Bernanke on it.
This is what people say. We have no idea. One of the things I worry about in trying to interpret all this is that various actors in the drama have surrogates spinning for them. Everybody does. And so when you hear that so-and-so really thought this plan was a bad idea, you don't know if that's true or just covering.
What I do know is that a number of people at the Fed -- I don't know if that extends up to Bernanke -- but a number of people at the Fed, basically they wanted to do it the way the Swedes did it, do it the way the Japanese did it, do it the way Franklin Roosevelt did it, and do capital injections, and not this very odd initial Paulson proposal.
Looking at Paulson's background, the way he had made decisions in the past, why do you think this seemed to be an attractive alternative?
Paulson is an investment banker, and investment bankers make a living, you might say, by making silk purses out of sows' ears. They make a living by repackaging and engineering financial assets to create value, at least temporarily, in the eyes of the market, where there was no value before.
And if you actually go back to the early stages of this crisis, go back to the fall of 2007, Paulson had a stillborn idea for solving the problem, never got anywhere, called the Master Liquidity Enhancement Conduit [MLEC]. ... Most of us looked at it and said: "There's no there there. I don't understand where this is supposed to create any relief." But he tried to sell it, and it was the kind of thing that an investment banker might actually do, which would somehow manage to take a bunch of subprime assets, subprime mortgages, and create AAA assets out of them. It was that sort of thing, which may work to let a bank make some profit, but doesn't actually work when it comes to policy.
And I think that may have been what was going on here, that Paulson continued to believe, even up to the bitter end, that somehow rearranging the deck chairs was going to save the Titanic, and [it was] probably coupled with an ideological dislike for the idea of the government taking an ownership stake in financial institutions.
The idea, I guess, is to spread the risk.
We were beyond the issue of risk. The problem clearly was that financial institutions did not have enough capital to do their job. The initial Paulson thing was that if we create a market for this toxic waste -- that the prices for which these guys can actually sell the stuff are too low, and that a proper price would be higher, and that they would therefore be in better shape, and that the government can come and create the market, or something like that.
There were a lot of phrases that drove me wild: "We're going to take the troubled assets off the bank's balance sheets." ... The problem wasn't that the stuff was on the balance sheets. The problem was that the stuff wasn't worth enough to give them the capital they needed to operate.
And just taking it off, the question [was, at] what price? And the only way the Paulson plan initially, the TARP I, made sense was if you believed that somehow the government was going to pay a much higher price than financial firms were actually able to sell the stuff for. And then the question of, well, do you mean the government will be overpaying? And they say: "Oh, no, no. We're saying that the prices are inappropriate."
There was a possible line of argument that way. But it was complex and dubious, and not the sort of thing you want to stake the survival of the world financial system on.
[What] you said, though, is that you thought that Paulson's initial response was distorted by ideology.
It wasn't the kind of extreme, "The government is always the problem, never the solution" themes that we've seen a lot of from the Bush administration. I can't prove this, but I think there was just a general distaste for the idea that we're going to have anything that looks like a partial nationalization of the financial system. It was just so alien to where he and his administration were coming from.
As a political being, is he also considering what he can get through Congress as well? Do you think that's a piece of the story here?
Actually, I don't think that was a piece of the story. In fact, one of the things that was a little shocking was the sheer political ineptitude of the original bailout proposal. It was a three-page proposal that basically said: "Give us $700 billion to do what we feel like doing with it. And by the way, we're immune from any retroactive investigation as well." That was a red flag in front of Congress.
I thought it was just awesomely stupid. Congressional people I was talking to were just livid. It showed some complete lack of sense of who he was dealing with. He certainly wasn't calculating what would he need to get it through Congress. Some people said that looked like a business contract, not like proposed legislation. Political realism was not a source of the bad plan. ...
You said the Bush administration's anti-government ideology still stands in the way of effective action. Do you think, even to this point, maybe it focused on the fact that there's still credit; that the banks are still loaning to banks; what's the problem here?
You've got an administration that right up until basically September 2008 was still of the belief that financial innovation is a great thing, that private capital markets get it right, forced by events to do a little bit of intervening, but always reluctant to do more.
And we need to remember that, in 2003, just when, as we now know, the sequence of events that got us to this crisis were really getting going, they held a photo op of Bush administration officials to cut up stacks of paper representing bank regulations. One guy had a chainsaw, and the rest had pruning shears. This was a very anti-government intervention, pro-"let the financial markets rip" administration, not temperamentally or ideologically inclined to say, "Hey, wait a second, this system is falling apart, and Uncle Sam had better go in there and take charge."
So with all that understood, Bernanke is a very smart guy. He studied the Great Depression at Princeton. He is one of the most knowledgeable people about these subjects. Why does he allow or sign onto this type of plan? ...
OK, you can play out the scenes. Suppose Bernanke had publicly said, "No, I don't think this is a good plan," and there had been a public squabble between Bernanke and Paulson. That probably would have been extremely destructive. And maybe if Bernanke had been in office longer -- Alan Greenspan had been there for 15 years -- he would have been able to say to Paulson on day one: "We don't want this to be a game of chicken, but if you go with this plan, I'm going to publicly disagree. You don't want responsibility for that." He probably couldn't do that.
So I'm not sure. I find it very hard to second-guess what Bernanke actually did, because it [was a] very difficult position. ... The end result was that after three weeks of craziness, we ended up with a policy that probably most people at the Fed thought was the right policy. Maybe that was all marvelously cunning strategy on Bernanke's part. I have no way of knowing.
But the only reason we got there was because of the Brits.
... The Brits came up with this plan. The euro zone countries emulated the Brits. Economists, commentators weighed in saying, "[British Prime Minister] Gordon Brown has got the right answer." I weighed in on it. "Gordon Does Good" was the title of my column. It was a kind of collective effort. You could almost say it's as if the economics gang sort of, using Gordon Brown as a focal point, pushed in to say, "Let's turn this thing the right direction."
And it's also true, I should say, that right from the very early stages of this whole debate, key Democratic figures on the Hill were pushing for a plan along these lines. So what we ended up with is something that looks a fair bit like the plan that [Senate Banking Committee Chair] Chris Dodd [D-Conn.] offered as an alternative to the Paulson plan right at the beginning. A lot of people were pushing in this direction.
But Paulson seems to have been dragged here.
Yeah. And maybe in the end, when we get all the memoirs, we'll discover that he was played like a fiddle by Ben Bernanke. I don't know. Anything could have been going on. But the end result was not so bad, except that we lost three weeks.
In the bill that is finally passed, there is this language that allows for injection. Where the heck did that come from? You were one of the first people I think that noticed it.
If I had to make a guess, I'd say it came from Chris Dodd and [House Financial Services Committee Chair] Barney Frank [D-Mass.] that they wanted that in there from the beginning, and they insisted on it.
If you actually go back to the fierce debate, it's funny, because a lot of the news media were going on and on about the executive compensation limits, that being the make-or-break thing. But those of us who are serious about the finance said: "Yes, I'd like to take these guys and make them howl, but that's not important. What's important is the equity stakes." And it was the Democrats who insisted on putting it into that. Somewhere in the story, it looks like really it's the Democratic Congress that got the language in there.
There's a feeling that Paulson knew that he could only get so much through. Is there a game of politics, to some extent, being played here? ...
I think it's possible to greatly exaggerate the extent to which the players involved knew what they were doing. ... I spent a little while in the U.S. government 26 years ago, and the general impression that I have is that the level of sheer chaos and ignorance that goes into policy decisions is greater than you can possibly imagine. So I think it was just a wild, sort of crazy-logic, pinball thing. And fortunately we ended up with something that was fairly sensible at the end.
… That's one of the things that has, of course, been such a problem, because confidence levels are shaken when these decisions kept on being made in such a sporadic and quick fashion.
I haven't been able to document it, but I'm pretty sure that we have a real problem, ... that years of politicized appointments and disregard for longtime civil servants have left the Treasury without the institutional competence. I noticed that in order to carry out our financial rescue, U.S. Treasury Department is subcontracting out to Wall Street to find people. ... I don't hear anything like that about Her Majesty's Treasury in Britain. My guess is that HM Treasury has actually got the people who know how to do this on staff. And U.S. Treasury, at this point, does not.
... Bear Stearns happens in March. How do you think Paulson and Bernanke both viewed this? ... Would they have agreed or really disagreed on what the outcome was?
I may be underinformed, but I don't have the impression that Bear Stearns was particularly divisive, partly because ... the crisis as it appeared to be at the time of Bear Stearns, although it seemed awesome and terrible at the time, was nothing like the way it seemed after Lehman. It seemed at the time as if there was a loss of confidence in the system, but what you were really doing was intervening to just sort of put up a firebreak, and if you could do that, that the system would recover. So that looked like a much more modest intervention. ...
[Were there lessons learned from the Bear Stearns situation?]
My sense is that the Bear Stearns rescue actually engendered overconfidence. They did this thing. It was dramatic, but it seemed to work. The markets calmed down, and the various arcane measures that we all look at now to measure financial stress dramatically improved. And I think actually Larry Summers, [Treasury secretary, 1999-2001], said that Bernanke and Paulson had been the new committee to save the world. Remember back from the '90s, it was Summers and Greenspan and Rubin who were the committee to save the world. So there was the sense that, "Hey, we're on top of this thing, and we've got it working." So there was a false sense, delusions of competence, you might say, coming after the Bear Stearns rescue, because it seemed to be OK. ...
So Fannie Mae [Federal National Mortgage Association]/Freddie Mac [Federal Home Mortgage Corp.] happened.
Fannie Mae/Freddie Mac -- it's funny. I don't think of that in terms of the crisis management as being an epochal event. We knew there were problems there. As a share of assets, the losses were not all that big. But these were very thinly capitalized, and they were able to be thinly capitalized because implicitly they were wards of the U.S. government. And implicit turned explicit, and no really big deal, I think, actually.
It was the period of uncertainty when people were not sure, maybe the government really would let them go under, that temporarily did a lot of damage to the mortgage market. But then what everybody expected would happen did happen, and that was OK. ...
So then the weekend of Sept. 13-14 rolls around. Lehman Brothers is ready to go down, and everybody knows of the troubles of AIG as well, and it's getting more complicated. How would you say the views of Bernanke versus Paulson would have played out in this situation?
I don't know at all. I don't trust anything anyone says about what happened that weekend, because it's turned out to be such a big disaster that everybody's going to claim that they were in favor of saving Lehman, and you don't know who to believe. So unless you have some really good sourcing, I have no idea. There's a lot of probably reinvention of people's roles.
What I can say is that, if I had been there, I would have been deathly afraid of letting Lehman fail. Actually, I wrote about it the next day, that it was "financial Russian roulette," that I was amazed that they were willing to do that. And my guess is that people at the Fed would have shared that view, that they would have looked at it the same way, saying this is like Bear Stearns, only much bigger. This is like LTCM [Long-Term Capital Management], only much bigger. The downside risk of letting this thing go is just huge. And so my guess, but that's based purely on extrapolation, is that the Fed view was probably, don't let this fail.
Why was Paulson prepared to let it fail? You can get some sense of that by looking at what conservative editorialists had to say on Monday before it became apparent just how big a mistake it had been. They were praising him to the skies: At last he's drawn a line in the sand; no more bailouts; private sector has to stand on its own; no more financial socialism. ...
What would the Fed have been looking at that would have worried them? ...
Part of its traditional role is lender of last resort, which you're always afraid of. The Fed was essentially created as a firebreak against banking crises. One bank fails, and that starts a run on the next bank, and that bank fails, and you know what happened in the 1930s, but also in fact was a regular feature of the U.S. economy.
Basically the panic of 1907, [investment banker and financier] J.P. Morgan stepped into the rescue. And people said: "Hey, there won't always be J.P. Morgan to do this. We probably should have an official institution that does it." And they had trouble with that role until the New Deal added a bunch of extra firebreaks. That is the Fed's central role and always has been. Fed and LTCM, 1998 -- the collapse of liquidity because you have a financial panic is what the Fed is there to stop.
The Fed had, by the time of Lehman, understood that there are a lot of things that aren't -- commercial banks aren't the Fed's traditional responsibility -- that can nonetheless have the same systemic effects as a bank failure. And in fact, when people ask me, "What can I read to understand the nature of this crisis?," I actually point to a [then-head of the New York Fed Timothy] Geithner speech from June 2008, before Lehman, about the parallel banking system and how it has become vulnerable to the modern equivalent of bank runs. And that's the source of our extreme fragility financially right now.
Presumably people at the Fed, presumably Geithner as well, were saying: "This is effectively maybe an investment bank, not a commercial bank. But it's got short-term debt and illiquid assets and CDS, credit default swaps, and a lot of counterparty risk. And if this thing goes under, [there] could be cascading effects through the system." That would be the view you'd expect them to have. You'd expect them to be very afraid of letting an institution like that fail.
Tell me what you know about Tim Geithner. ...
Geithner is a Larry Summers protégé from Treasury. He worked his way up during the Summers years at Treasury and did a lot of international stuff, very involved with the Asian financial crisis of the late '90s, which is, in some respects, a dry run for what we're having now, universally regarded. I spent time in meetings with him. Extremely smart, extremely aware of the stuff, very discreet, controlled, a good central banker, even though that's not where he comes from originally. But he's got the central banker ability to talk knowledgeably about a subject without actually saying something that is going to cause the Dow to move by 500 points, and the kind of person that you really need.
I don't know if he has the political skills, but the closest parallel, he reminds me of Bob Rubin, even though it's a different career path. But he comes across that way -- very calm, intellectual guy with a good grasp of the markets.
And of course New York Fed, you have to understand -- in normal times, when you're just doing ordinary monetary policy, all the action is in Washington. When you're in this kind of financial thing, the New York Fed becomes, in some ways, a co-equal partner of the Board of Governors in Washington. So he's been in the middle of the maelstrom all along. ...
The next domino was AIG. Anything that you could say about that, and again, sort of the views of what Bernanke would be thinking, what Paulson would be thinking?
What's interesting about AIG was that, in some ways, the AIG rescue was the opposite extreme. We went from government is going to get out of the business of bailouts with Lehman, and then three days later, we have effectively a full nationalization and the government taking an 80 percent ownership stake in AIG.
That's the sort of thing I suspect that the Fed is fine with, because people at the Fed know about the Swedish bank rescues of the early '90s. They know that this sort of thing is a temporary measure, is what you do in extreme circumstances. Must have been very, very strange for Treasury to find itself in that position.
As the consequences of Lehman start playing out -- problems with money markets, trouble with credit sort of drying up and everything else -- what does this do to the folks in Washington as they're sort of watching this happen? What lessons are they learning from this?
This is DEFCON 4, whatever. This was the complete nightmare. I remember looking at the stress measures on, you know, middle of the day Monday and saying, "Gee, they're looking kind of spiky." And by Wednesday, you'd basically had a complete shutdown of the world capital market. No, this is actually terror. I'm sure that Paulson is sitting there, doesn't strike me as the most reflective guy necessarily, but he must have been sitting there -- everybody was sitting there saying, "My God, we may be presiding over the second Great Depression." This is the utter nightmare of an economic policy-maker. You're sitting there, and you may have just made the decision that destroyed the world. Absolutely terrifying moment.
So what does Paulson do in that situation?
I have no idea how it was done. I have to say, what shocks me -- we did know that something like this was a possibility. Certainly from early 2008 onward, they knew that some real complete breakdown of the markets was a real possibility. And even knowing what I know about the Bush administration, I'm shocked that there wasn't a contingency plan on the shelf. ... And so they scrambled, obviously. And there have been blind quotes from people at Treasury saying: "How did we come up with $700 billion? We wanted some number that sounded big." It really does not sound like there was a whole lot of thought put into it. ...
Greenspan's [October 2008] testimony before Congress, do you view that as a historic moment, looking back at how he was viewed when he left?
Boy, has there ever been a greater retrospective downgrading? When he left, a lot of people, including Democratic-leaning economists, were describing him as the greatest central banker in history. And what's clear now -- there were various specific things -- Greenspan failed to see the housing bubble and so on, but most of all, he is on record as having said that we had virtually eliminated systemic risk, that the new parallel banking system, all of these complex financial arrangements had largely eliminated the problems, that basically we've got this finance thing under control. Whatever banking regulations we have actually, we really don't need anymore, because it's all securitized. And -- oh, boy.
He was probably the one person because of his position, who could have led to some prophylactic measures being taken during the bubble years. And instead he was dead set against it. No individual is to blame for this crisis. But if you were going to say who deserves the most disrepute, it would be Greenspan.
... Why did he take the stance he did on regulations? Why did he take the stance he did on derivatives and the fact that 2005 he was still saying there was no housing bubble? What was behind all that?
Greenspan is, when all is said and done, someone with a strong libertarian view of the world. His basic view is that private contracts get you to the right place and that what businessmen do with each other always works to the public good -- the invisible hand is on our side -- plus, a great faith in his own ability to clean up the mess when things do go wrong. He had, on multiple occasions, faced some kind of market crisis, responded by slashing interest rates and talking confidently about the future, and, in each case, been able to pull the economy back from the brink, and came to believe that you could always do that. He dealt with the dot-com bust. He dealt with the '87 stock market crash. He dealt with the Asian financial crisis. So he, or his successor, could always deal with whatever came.
In retrospect, his history is one of replacing each bubble with another bubble. And eventually we ran out of bubbles. But this is where he came from.
How do you compare Bernanke to Greenspan?
Bernanke is not philosophically as different from Greenspan. He's ended up having a very different role, but because of circumstances. But Bernanke was pretty much ... a believer in the ability of the Fed to clean up just about any mess, and not based on blind faith. His assessment of Japan in particular was that there were actually policy measures the Japanese could have used after their bubble of the '80s burst that would have allowed them to avoid that lost decade in Japanese growth.
So I go back always to the paper, Bernanke-Reinhart (2004), about the possibilities of unconventional monetary policy, having the Fed buy assets other than Treasury bills. The conclusion of that paper was that was a very effective policy, and if for some reason conventional monetary policy didn't work, the Fed could always get the economy going by doing that sort of thing. And of course they've done that. The Fed owns a bizarre mix of stuff compared to what it did before. And it hasn't been enough. ...
When one has that philosophy and one looks at what happened, where are you at this point? Have they both been dragged into a completely different philosophical sort of belief system? Or are they believing that the tsunami has just hit and no one could ever, ever stop it?
I have no idea. I have not seen from Greenspan very much in the way of admitting that his fundamental philosophy was wrong. He's been writing a lot about and talking a lot about what happened. If anything, he seems to be saying, "Well, you know, stuff happens."
The conclusion that a lot of us have drawn, which is actually we need a much stronger set of financial regulations, as far as I can make out, is not something that Greenspan has accepted. Bernanke has hinted more in that direction, though. He's been pretty circumspect. But no, you actually see very little change.
But leaving aside what these guys believe, a lot of people who were believers in a weak form of Greenspan-ism have changed their mind and say: "We really need a lot more control here. We need a lot more control during the good years so that stuff doesn't go so crazy during the bad years."
It's so difficult to judge where these guys are going, because they're so circumspect. They're so careful about what they say. This whole industry is that way. It's all built on confidence. Confidence seems to have been the contagion that has gone through this system, that has caused, to some extent, the problem. How do you view that contagion? ...
At this point, I actually think it's possible to overemphasize the importance of confidence. I put it this way: No matter how optimistic people might be feeling, the fact of the matter is a lot of our financial system is bust anyway. The losses on housing are real. The losses on subprime mortgages are real. And there is something like a trillion dollars of losses to the financial system that are going to show up one way or another, no matter how much confidence, or lack thereof, you have. The fact of the matter is the financial system has lost a trillion dollars, only about half of which has actually been admitted so far.
This is not just a psychological problem we have right now. This has got a lot of real, irreversible losses that have got to be made up somehow.
The worst possible scenario is large numbers of the financial institutions that we now have fail, and over time, new financial institutions are built. So someday in the long run, we will have a fully functioning financial system, even if policy is a total mess. But John Maynard Keynes: "In the long run, we are all dead" -- and so the point is to try and not take decades to get back to having a functioning system.