[DEBATE] : "Investors Are Recognizing That the Financial Crisis Is Not the Fundamental Problem"

[Yoshie Furuhashi]

<http://www.nytimes.com/2008/10/16/business/economy/16econ.html>
October 16, 2008
Markets Suffer as Investors Weigh Relentless Trouble
By PETER S. GOODMAN

Stock markets plunged anew on Wednesday, nearly wiping out the record
gains of Monday and sending another wave of wealth destruction washing
over American households.

The government's rescue of the banks has been widely embraced, but the
frenzied selling, which pushed the Dow Jones industrial average down
733 points, underscored how the economy's troubles are too broad to be
fixed by the bailout of the financial system.

Investors are recognizing that the financial crisis is not the
fundamental problem. It has merely amplified economic ailments that
are now intensifying: vanishing paychecks, falling home prices and
diminished spending. And there is no relief in sight.

Wednesday's rout began in the morning with the latest evidence of the
nation's economic deterioration — reports showing that retail spending
slipped in September and broader signs of a pullback among suddenly
thrifty American consumers.

Selling picked up momentum in the afternoon as the Federal Reserve's
chairman, Ben S. Bernanke, cautioned Americans that the bailout would
not swiftly lift the economy and that continued weakness was certain.

"Stabilization of the financial markets is a critical first step, but
even if they stabilize as we hope they will, broader economic recovery
will not happen right away," Mr. Bernanke said in a speech to the
Economic Club of New York. "Economic activity will fall short of
potential for a time."

By day's end, the Dow had surrendered most of Monday's 936-point gain,
dropping 7.87 percent. The broader Standard & Poor's 500-stock index
was down 9 percent, and the technology-heavy Nasdaq was down 8.47
percent. Expectations that a worldwide slowdown will reduce demand for
oil pushed prices below $75 a barrel. Signs of improvement continued
in the credit markets, making it somewhat easier for companies and
states to secure financing, but interest rates remained elevated.

Mr. Bernanke's remarks — offered in the sober tones of a man cognizant
that a stray syllable may prompt the loss of more billions on Wall
Street — underscored the reality that the economy's troubles go well
beyond the financial crisis. The United States and many other major
economies are almost certainly headed into a slog through economic
purgatory, one that could last many months.

"People have focused so much on the immediate financial crisis that
they haven't realized how much the real economy is going down, largely
independently," said Dean Baker, co-director of the Center for
Economic and Policy Research in Washington. "I don't think there's a
way we can get out of this without a full-fledged recession and a lot
of people losing their jobs. All we can really talk about is
ameliorating it, making sure the people who are hit have support."

On Monday, as the Dow posted its fifth-largest one-day percentage gain
in history, some investors found quantifiable proof that the crisis
was solved. Yet an unpalatable historical detail complicated that
idea: The four previous largest percentage gains occurred from October
1929 to March 1933, in the early days of the Depression.

Then, it must be noted, the markets swung far more widely than they do
in this era, and an epic collapse would still be required to bring the
United States anywhere near a comparable depression.

Mr. Bernanke, a leading academic expert on the Depression, offered
pointed assurances that no repeat of that disaster would unfold on his
watch. The Fed stands ready to use all its tools to battle the
financial crisis, he said. He exuded confidence that the American
economy "will emerge from this period with renewed vigor."

But when? Mr. Bernanke could not say. That uncertainty added to the
gnawing worry gripping the economy.

"Ultimately, the trajectory of economic activity beyond the next few
quarters will depend greatly on the extent to which financial and
credit markets return to more normal functioning," he said.

Strikingly, Mr. Bernanke expressed concern about how huge amounts of
capital are increasingly concentrated in a handful of enormous
financial institutions.

"The real concern that we have is that we have got and developed, in
this country, a very serious 'too big to fail' problem," Mr. Bernanke
said. "And that problem, we've just recognized now in the current
situation, how severe it is."

It seemed a curious concern for a man whose central bank has worked
with the Treasury to engineer a series of shotgun corporate weddings,
such as Bank of America's purchase of Merrill Lynch and JPMorgan
Chase's acquisition of Bear Stearns — deals that have further
concentrated money in fewer hands.

Mr. Bernanke's prognosis and the latest carnage on Wall Street lent
urgency to the debate over what the government should do now to soften
the blow to the economy.

In Washington, and on the campaign trail, conversation centers on
putting together a second round of so-called government stimulus
spending, following the $152 billion unleashed this year via tax
rebates to households and tax cuts for businesses.

Democrats in the House are drafting a roughly $150 billion package of
spending measures aimed at spurring the economy, according to senior
aides, including aid for states, large-scale construction projects to
generate jobs and the expansion of unemployment benefits. Senator
Barack Obama of Illinois, the Democratic presidential nominee, is
urging $175 billion worth of relief measures.

The Republican nominee, Senator John McCain of Arizona, has declined
to outline his own proposal, though his senior economic adviser,
Douglas Holtz-Eakin, said he is "open to any measure that genuinely
stimulates the economy."

Republicans on Capitol Hill have emphasized tax cuts for businesses in
any stimulus package, a stance that puts them at odds with Democrats,
though recent signs suggest greater potential for a compromise.

"We need fiscal stimulus," said Douglas W. Elmendorf, a former
Treasury and Federal Reserve Board economist, and now a fellow at the
Brookings Institution in Washington. "The outlook is much darker than
it was even a few months ago."

The checks the government sent to households last summer appear to
have kept the economy growing, but economists are skeptical such a
course could work again.

"The spend rate will be really low because people are scared to
death," Mr. Baker said.

When economists met with House leaders on Monday to suggest a course,
the favored means appeared to be aiding state and local governments,
whose property tax revenues are diminishing as home values fall. Local
governments are a crucial source of employment and social services
relied upon by the poor.

"The states are taking steps right now that are deepening the
recession, through no fault of their own," said Jared Bernstein,
senior economist at the Economic Policy Institute in Washington.
"They're forced to either raise taxes or cut services. Neither of
those are where we need to be right now."

The crisis on Wall Street has sown fears that banks would hold tight
to their dollars and starve the economy of capital, preventing
businesses from securing finances to hire people and expand. If the
bailout succeeds in restoring confidence, that should eventually get
money flowing and lift economic activity.

But regardless of Wall Street's travails, a broader set of
difficulties has been taking money out of the economy, putting the
squeeze on American households and businesses.

The economy has lost 760,000 jobs since the beginning of the year, and
millions of workers have seen their hours cut, shrinking paychecks
just as plunging real estate prices prevent households from borrowing
against the value of their homes.

In short, American spending power is declining, and this has become a
downward spiral: As wages shrink, workers spend less, and that limits
demand for workers at the businesses that once captured their dollars.

Many economists now assume that unemployment, currently at 6.1
percent, will climb to 9 percent by the end of next year. Some now
envision it could reach 10 percent — a level not seen in 25 years.

"At this point, the thing has probably just got to play out," said
Martin N. Baily, a chairman of the Council of Economic Advisers under
President Bill Clinton and now a fellow at the Brookings Institution.
"I don't know that there's anything that we can do to avoid a mild
recession. The question is what can we do to avoid a very severe
recession."

Peter S. Goodman contributed reporting.