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The Problem for Main Street

Why Ecoomic Stabilization is Necessary

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Washington, Oct 3, 2008 | comments

INTRODUCTION

To many, the major economic proposal facing Congress this week seems to have little connection with the realities of their day-to-day lives. In part, that is because the severe disruptions are occurring in a portion of the financial system that is invisible to most Americans: the credit markets.

In evaluating the health of U.S. financial markets, observers often look to the Dow Jones Industrial Average or the Standard and Poor’s 500. Most Americans have a fairly good idea about the stock market, because many are invested in equities through individual retirement accounts or 401(k) plans. Arcane terms such as “swaps,” “spreads,” and “commercial paper” are foreign to most Americans; but they are key indicators of the health of the credit market – and they are currently flashing red. This problem is serious because the credit market, at its basic level, is the circulatory system of the economy. Its smooth functioning is vital for businesses to fund their day-to-day operations, and for consumers to buy cars or obtain student loans.

Now that credit system is paralyzed. Banks are not lending to one another because they do not trust the financial health of their counterparties, and they feel the need to conserve capital to weather the next potential crisis. Investors, meanwhile, are shunning most securities except those with little or no risk. Without trust, confidence, or a tolerance for risk, markets in the U.S. are breaking down.

The tight squeeze in credit markets, if left unaddressed, has several potential ramifications. It could impair the ability of companies to meet payrolls or to finance expansions, leading to more job losses; it could make it increasingly difficult for prospective home buyers to obtain mortgages; and it could block students’ access to college loans. In short, what critics deride as a huge “bailout for Wall Street” in fact aims at preventing painful consequences on Main Street – consequences that, at worst, could cause a deep and long recession. Separating Wall Street and Main Street is a false dichotomy; they are two sides of the same coin.

Throughout the year, the Federal Reserve and the Department of the Treasury – aware of this potential fallout – have sought to treat, one by one, the financial market side of the problem, such as the failure of major banks, and the near collapse of the mortgage giants Fannie Mae and Freddie Mac, among others. But difficulties have continued to mount, suggesting the need for a broad, comprehensive approach. The choices are not appealing. They entail a huge government intervention in the economy, and large potential costs to taxpayers – made all the more distasteful by the widely shared impression that Congress is just saving imprudent or unscrupulous investors from the problems they created with taxpayers’ dollars. But a failure to act invites a far greater risk to U.S. capital and credit markets that in the end will punish all U.S. businesses and families.

This paper traces the causes and symptoms of the problem; the signs of a potential recession in the U.S. economy; and some of the effects of the credit crisis already are being felt in the day-today economic life of Americans.

Read the full report here.
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