What's the prognosis for the economy? (Sept 2008)

More from Calculated Risk:

Many banks will fail - especially small and regional banks with excessive concentrations in construction & development (C&D) and commercial real estate (CRE) loans. And the recession is getting worse with rising unemployment, declining personal consumption expenditures, declining industrial production and falling business investment. Economies of many other countries are in or close to recession. The Fed even cautioned on slowing U.S. exports today for the first time.

Foreign stock markets are crashing: the Russian stock market was halted today after declining 17%. The Shanghai composite index is off about 2/3 from the peak.

The situation appears grim.

This crisis might have first become visible to Wall Street and the Federal Government in August 2007, but this crisis has been unavoidable for several years. If action had been taken in 2004 or 2005 to curtail the loose lending practices, the problem wouldn’t be so severe, but the crisis would have still occurred. The damage had already been done. Unfortunately the U.S. failed to prevent this crisis, and now we have no choice but to pay the price for the cleanup.

The good news is the U.S. is finally taking the necessary steps towards eventually resolving the crisis.

Calculated Risk goes into a lot more detail.

But it should also be clear that the current Credit Crisis is based entirely on the concept of financial market deregulation that was core to the economic philosophy of the Reagan Revolution. Let me emphasize that. The current credit crisis is the direct result of the Reagan Revolution which was implemented most completely by the Bush administration together with the Libertarian Alan Greenspan's Federal Reserve. McCain was a great booster and McCain's adviser Phil Gramm was a key implementer. We are watching what the invariant result is when Grover Norquist and his fellow Libertarians gets their wish for low taxes and government "so small that it can be drowned in a bathtub."

The current problems are going to get deeper for a while - a year or more at least. Then they will stabilize when housing prices level out. After the period of stability at lower economic performance there will be an uptick IF government puts the required regulations and controls on the financial sector that will recreate some degree of trust in the securities Wall Street sells. The trust-building is going to take the longest amount of time, and it will require a rooting-out of the free-unregulated-financial-market philosophy. No modern financial market can function without extensive and well-planned government regulation.

Anyone who says the economy is going to turn around by itself in 2009 is blowing smoke. Such people are not to be trusted. Watch instead for effective legislation to correct the problems, and watch especially for Republican obstructionism when the Congress tries to pass it. The economy is not going to start real recovery until that legislation is passed, implemented, and accepted by Wall Street. That's the road marker to watch for.