The growing economic crisis

What happened

The failure of a major bank, the plunging stock market, and other alarming economic news had financial markets on the edge of a full-scale panic this week, prompting the Bush administration to take several dramatic steps to bolster confidence. The centerpiece of the administration’s efforts was Treasury Secretary Hank Paulson’s plan to shore up Fannie Mae and Freddie Mac, the two government-sponsored mortgage companies that together hold or guarantee about $5 trillion of mortgage debt—about half of all mortgages in the U.S. Paulson proposed making government loans and even direct federal investment available to the troubled companies, which investors fear could collapse because of bad home loans and diving housing prices.

Financial markets were shaken when depositors clamored to retrieve funds from IndyMac Bank, a large California mortgage lender that was seized by federal regulators. The dollar hit a record low against the euro while, on Wall Street, bank shares were driven down by fears that more bank failures are on the way. “Everyone is drawing up lists, trying to figure out who the next bank is,” said Richard X. Bove, a banking analyst with Ladenburg Thalmann.

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What the editorials said

The alternative to the Paulson plan is “chaos,” said the St. Louis Post Dispatch. While it’s never good to tie taxpayers to the fate of private companies, in this case the “rescue appears to have been necessary.” If Fannie and Freddie were allowed to fail, “money for new mortgages would dry up” and the bottom would come out of the housing market. The government’s guarantee should be enough to save these companies, so that taxpayers don’t take another hit.

It’s a little late to worry about the taxpayers, said The Wall Street Journal. In creating Freddie and Fannie, Congress provided “an implicit taxpayer guarantee,” and everyone knows the government cannot allow these companies to fail. The question is how to use this moment to rein in “these monsters.” Paulson should put the companies into federal receivership and appoint a “czar” with power over management and a mandate to protect taxpayer interests. Otherwise, the companies will simply exploit federal protection to indulge in more foolish and risky behavior.

What the columnists said

Let’s face it, said David Ignatius in The Washington Post, the banking industry is going up in flames, and the Fed and the Treasury Department are now racing around like “a pell-mell fire brigade,” hosing down every new fire with the taxpayers’ money. But how many banks can the government bail out? The stocks of Wachovia, Citigroup, SunTrust, and Washington Mutual have all plunged from 70 percent to 92 percent in one year.

There’s already been a huge price to pay for the government’s bailouts, said Joshua Rosner in the Financial Times. The profligate use of tens of billions of federal dollars to rescue bad banks has created rising inflation and a “debased” U.S. dollar. “By the time we are finished with this tragic period in U.S. economic history,” capitalism will be on its knees, laid low by poor policy decisions and the “nationalization of bad assets.”

No wonder that some economists are saying the U.S. now faces “its most serious economic crisis since 1932,” said Andrew Leonard in Salon.com. But the cause of this crisis is not government bailouts of failing industries. Freed by the Bush administration to do what they pleased, the banking, mortgage, and financial industries gambled billions on amazingly stupid loans, creating a giant sinkhole that is now sucking in the entire economy. In the end, the principal casualty of this debacle will be the laughable idea that “unregulated markets are a sensible way to run an economy.”

What next?

In testimony before Congress this week, a somber Federal Reserve Chairman Ben Bernanke warned that there is no end in sight for the ongoing economic downturn. “This is clearly a rough time,” Bernanke said, warning of “downside risks” for the rest of the year. With the consumer price index jumping 1.1 percent in June, Bernanke said the Fed was facing “significant challenges,” since lowering interest rates to boost the economy would feed inflation. For most Americans, that means more pain ahead, said Richard Moody, an economist at Mission Residential. “There’s not enough lipstick to put on this pig,” Moody said. “U.S. workers are falling farther and farther behind.”