The Financial Crisis (in 400 words)

The Oregonian asked for my thoughts on the financial crisis (I was flattered) and then asked for no more than 400 words.  So if I've omitted something you're interested in, blame the newspaper.

The economist: Bill Conerly

by Bill Conerly, Guest opinion

Friday September 19, 2008, 6:48 PM

"Whether a financial crisis turns into a severe recession or depression depends on how the crisis affects everyday businesses."

By BILL CONERLY

Financial crises have occurred for centuries, ranging from the tulip
craze to the South Sea Bubble to, more recently, the Asian Financial
Crisis. Many great banks have failed over the centuries, and although
their loss seems staggering at the time, the consequences are very
fleeting.

Today's crisis is large to Wall Street, and to the secretary of the
treasury, who comes from Wall Street. Main Street, however, is not
doing as badly.

Easy money always triggers the beginning of a
financial cycle. The Federal Reserve deserves some blame in this
instance for making the party too wild. Fraud is common in the mania
phase of a financial cycle, but not the primary problem.

Whether a financial crisis turns into a severe recession or
depression depends on how the crisis affects everyday businesses across
the country. In the classic financial panic, speculators are unable to
pay their debts. Then the lenders to the speculators are unable to
repay their debts. Like a virus, the problem spreads from the sick to
the healthy.

Today the Federal Reserve stands ready as the lender of last resort
to help banks that are fundamentally sound but temporarily unable to
continue with business as usual. The Fed has extended that umbrella to
shelter some non-bank financial institutions. The result is that
families and businesses with good credit histories and adequate income
are still able to borrow. If they were suddenly cut off from the credit
to which they were accustomed, spending would drop sharply, followed by
declining production and employment. That is unlikely to happen in this
crisis, but keep your fingers crossed.

What should everyday people do about this crisis? Sit tight. This
is no time to be dumping stocks or bonds or closing bank accounts.

What should the government's role be? The Federal Reserve's easy
money helped get the crisis going. Piling on were politicians trying to
increase homeownership, even among buyers by thosewithout the resources
or habits to support a mortgage. Adding to the problem were community
activists insisting that banks weaken credit standards for poor people.
Removing these stimulus factors will pretty much solve the problem for
the next couple of decades.

At some time in the future, however, another financial crisis will
form. Investors will become speculators, optimism will run rampant,
lending standards will crater, and we'll start another cycle. Then the
economy will recover and life will go on as normal.

Bill Conerly is an economic consultant based in Lake Oswgo and
the author of "Businomics: From the Headlines to Your Bottom Line —
How to Profit in Any Economic Cycle."