Strategies to End the Crisis

In the United States, conventional mortgages and business loans remain scarce, four million homeowners face foreclosure by 2010 and plummeting demand for goods and services throughout the economy is destroying more than 100,000 jobs a month. Construction and manufacturing jobs are disappearing at an alarming pace.

Bank bailout efforts by the U.S. Treasury, Federal Reserve and their counterparts abroad are failing because those address symptoms, not the systemic ills that caused the credit crisis. While global investors and traders may not articulate their fears in such esoteric terms, failure to address systemic problems is driving down corporate sales and profits and destroying stock values.

At the banks, officials at the national level have provided liquidity, injected equity and guaranteed overnight and other short-term borrowing. However, large money center banks simply are not interested in using the massive funds provided to them to make sound loans to consumers and businesses on the scale needed to get the economy going.

These money center banks are no longer interested in providing liquidity to regional banks by bundling their loans into bonds for sale to insurance companies, pension funds and other fixed-income investors that sit on vast pools of capital.

The bonus systems and compensation structures at large banks permit executives to earn much larger sums doing other things — engineering mergers, currency and derivatives trading and the like. Money center banks have become part of larger financial conglomerates over the last 25 years.

These are run by executives who believe they should be able to earn millions of dollars each year doing deals and creating exotic securities rather than by making loans and helping smaller banks raise needed funds.

The compensation restrictions put in place by the U.S. Treasury when it injected capital into the largest banks only apply to a few top officers and are easily circumvented. They change little in what is wrong with executive incentives at the large money center banks.

Beyond that, demand for goods and services in the United States and Europe is being driven down by the undervalued currencies and massive purchases of dollars and euros by China, oil exporters like Saudi Arabia, and other emerging economies. Their huge trade surpluses translate into trade deficits in the United States and Europe and the need for massive borrowing to keep up demand for goods and services in Western economies.

That caused the housing bubble and over-borrowing in the first place, and without a policy to realign currencies to redress trade imbalances, we simply can't get beyond the current credit crisis without ruinous government deficits, reckless consumer borrowing and indenturing our children to foreign creditors.

The U.S. Congress is talking about another stimulus package, but tax rebates would only give the economy a temporary lift. As we saw last spring and summer, those measures gave consumption a boost — but slipped back after a few months. That gave GDP growth a sugar high late in the second quarter and prevented growth from slipping too much in the third quarter. Now, flagging construction and retail sales are taking the economy into an abyss.

The best purpose for another stimulus package would be to help get the economy through the first half of next year, while the Treasury and Federal Reserve take even more assertive steps to straighten out the banks and address other structural problems such as the trade deficit, energy development and inadequate public facilities.

For example, municipalities have long queues for renovating public schools, libraries, bridges and highways, and other community amenities, such as recreation and arts centers. In the private sectors, onshore natural gas development and alternative energy sources, such as wind and coal gasification, need not be sidetracked by the recent dip in oil prices, with the help of targeted federal incentives.

The key would be to get projects accelerated that are already well conceived but currently sidelined by falling state and municipal tax revenues or by weak business conditions in the private sector.

Infrastructure spending that fires up projects already in the pipeline would leave a more lasting legacy than facilitating a few more restaurant meals and trips to the mall. Such spending would also have a greater multiplier effect on GDP than tax rebates, as it would result in fewer imports.

In parallel, we need aggressive programs to straighten out management at money center banks, assertive steps to correct currency misalignments with China and other countries with huge trade surpluses, and efforts to reduce oil imports through reduced gasoline consumption and investments in both conventional and alternative energy sources and conservation.

The latter includes incentives to build more hybrid automobiles quickly, more offshore drilling and onshore natural gas development, investments in nonconventional energy projects, and more energy efficient buildings.