Smile. The Economy Isn't in a Second Depression

A woman is watching her grandson at the shore when a huge wave washes him out to sea. She beseeches God for help, and sure enough, the next wave deposits the boy back where he was, unharmed. The woman looks up and says: "Thank you, Lord. But he had a hat."

That old joke about ingratitude is especially apt as America dwells relentlessly on economic problems and the financial crisis. Things are bad, all right, especially if you're out of work or about to lose your home. But in this holiday season, as we count our blessings, please recall that the situation could have been much, much worse. One year ago there was serious talk about a downturn rivaling that of the 1930s. "Let's not mince words," New York Times columnist Paul Krugman wrote on Jan. 5, 2009. "This looks an awful lot like the beginning of a second Great Depression."

Someone or something deserves thanks for the surprising fact that the economy seems to be growing again; banks that took bailout money are repaying the government sooner than expected; and the unemployment rate actually fell a couple ticks in November—albeit to a still-miserable 10%. If you're not religious, feel free to thank the resilience of the American people. Or the virtues of free-market capitalism. Or even—dare I say this?—the timely interventions in 2008 and 2009 of the White House, Congress, and the Federal Reserve.

True, the government did a lot of things wrong, but it also did a lot right. President George W. Bush's Treasury Secretary, Henry Paulson, pushed for an unpopular Troubled Asset Relief Program that helped stabilize the financial system. The Fed under Chairman Ben Bernanke slashed short-term rates to near zero and invented new ways to lend that kept credit flowing to essential functions when normal channels were clogged. As households and businesses madly cut spending, President Barack Obama filled the gap in demand by pushing through Congress a $787 billion stimulus package.

All these things more or less did what they were supposed to—they tided over the economy until the natural forces of economic regeneration could begin to kick in. That's no small feat. Columbia University economist Frederic Mishkin, a former Fed governor (and therefore not impartial), estimates that this financial crisis was actually more serious than the one that turned into the Great Depression.

You don't hear much about the bright side on talk radio or in Congress. Second-guessers are jumping all over the government's rescue of American International Group (AIG) last year. With the benefit of hindsight, they criticize the Federal Reserve Bank of New York for its rushed decision to pay AIG's counterparties 100 cents on the dollar to terminate derivative contracts. They say the New York Fed should have paid them less, which would have saved taxpayers money. The Fed "refused to use its considerable leverage," Neil M. Barofsky, the TARP special inspector general, wrote in a November audit.

Well, maybe. But in the chaos that prevailed last September and October, the Fed and the Treasury worried that putting too much pressure on AIG's counterparties might deepen the global financial crisis by heightening fears that important players wouldn't make good on their obligations. At this late date, lecturing the crisis fighters about having wasted money is like reprimanding ambushed soldiers for firing too many bullets. The real problem was not the response to the crisis, but the years of missteps and neglect that caused it. Congress is working now on ways to better regulate such complex financial institutions, plus a new mechanism to shut them down smoothly without having to pay off their creditors in full at taxpayer expense.

Anger over the cost and unfairness of this financial crisis is understandable and can even be salutary if it drives people to root out wrongdoing and close loopholes. However, anger that sprays out in a thousand directions is dangerous. Undiscriminating rage clouds judgment, invites tea-party grandstanding, and prevents the kind of deliberative give-and-take that will be required to make sure this mess doesn't happen again.

Japan provides a tragicomic tale of the damage that can occur when the public gets angry and the government takes the easy way out. (Keep in mind that Japan's main stock market gauge is still down 74% from its level of 20 years ago, so whatever Japan did, we should try to do the opposite.)

A bit of history: When Japan's real estate bubble burst in the 1990s, ordinary citizens opposed taxpayer bailouts for the specialized housing lenders that had helped inflate the bubble. But after promising not to use public funds, the Finance Ministry eventually pumped in a bit of money in 1995. It was only about $7 billion. Still, the public was so outraged that the opposition party nearly managed to topple the government.

That $7 billion brouhaha precipitated a bigger problem in 1997, when Japan's crisis deepened and big commercial banks and securities firms started failing. Frightened of the voters' reaction, the government did not ask for enough money to recapitalize the financial sector. It resorted to accounting dodges and brave declarations that the problem was solved. It wasn't, of course. The failure to fix the banking system prolonged Japan's slump for years.

Cynicism and rage could put the U.S. in the same hole, warns Anil Kashyap, an economist at the University of Chicago's Booth School of Business who recounted the cautionary tale from Japan in a December 2008 paper with Takeo Hoshi of the University of California at San Diego. Fearful, Congress has deflected blame onto the Fed and other agencies. Ultimately, though, preventing the next crisis will require building those agencies up, not tearing them down. Also, many economists argue that the economy could slip back into recession or torpor without more fiscal stimulus and more asset purchases by the Fed. Yet Congress and the central bank are wary of a public that has come to equate almost any government action with taxpayer ripoffs.

Dispiriting, isn't it? On the bright side, we've already made a lot of progress. All we need now is the civic courage to keep doing the right things.

    Before it's here, it's on the Bloomberg Terminal.