After the Deluge

By Assaf Sagiv

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specter is haunting the financial markets of the world. A crisis of enormous proportions, which developed slowly from mid-2007 and achieved dizzying momentum after Lehman Brothers collapsed on September 14, 2008, is currently becoming a global economic catastrophe the likes of which have not been seen since the Great Depression. No one dares to accuse the doomsayers of being hysterical and melodramatic now. On the contrary, pessimism has become the order of the day.
As anyone who has been following the news over the past few months knows all too well, this calamity originated in the false prosperity of the American housing market during the years 2001-2006. As a result of low interest rates set by the Federal Reserve and other factors, this market underwent a dramatic expansion without any real supervision or oversight. Lenders approved billions of dollars’ worth of mortgages to people with limited financial resources—classified as “sub-prime borrowers”—who understandably jumped at the chance to own their own homes, often for the first time in their lives. As housing prices steadily increased, lenders were confident that borrowers would be able to make good on their loans. This in turn fueled a frenzy of speculation on Wall Street. Large and small investment houses began to repackage mortgage-backed securities in a decidedly creative way that only the sharpest mathematical minds could understand. These securities were then bought and sold around the world by financiers who largely ignored the huge risks involved in such transactions. 
Alas, this financial bacchanalia did not last long. In 2006, housing prices began to drop. The beneficiaries of the sub-prime mortgage bubble suddenly started taking considerable losses that became more and more severe as time passed. From Wall Street to Tokyo, stocks went into a nose-dive. Worst of all, the chaos created a worldwide credit crunch. In short, the bubble burst, and major financial institutions once thought invulnerable burst with it.
In order to limit the scope of the disaster, governments and central banks around the world rushed to take emergency measures. Trillions of dollars were earmarked to prop up shaky financial institutions, protect bank deposits and savings, and reinvigorate paralyzed economies. However, countries such as Iceland had already suffered a crippling blow. Indeed, even the world’s largest and most powerful economies now appear unable to protect themselves from severe recession.
Among informed and uninformed observers alike, the sheer dimensions of this crisis have created an atmosphere of apocalyptic panic. Some commentators, especially journalists with a sensationalist streak, have not been satisfied with broadcasting gloomy forecasts of an approaching recession, but have rushed to announce—in tones either dismal or elated, depending on their ideology—the imminent demise of capitalism itself. Indeed, even more restrained analysts have declared that the market economy will have to undergo dramatic changes. Everyone seems to agree that the Anglo-American version of capitalism, so-called “neo-liberalism,” has suffered a major setback after three decades of economic dominance. 
Yet if the reports of capitalism’s demise are likely exaggerated, rumors of the return of the New Deal are certainly well founded. Major political and economic leaders are pushing for extensive government spending in order to revive sclerotic economies and provide jobs for the huge numbers of people who are or will soon be unemployed. Barack Obama, the new president of the United States, announced before his election—and again shortly afterward—his intention to initiate a series of large-scale public-works projects in a manner reminiscent of the programs enacted by Franklin Delano Roosevelt in order to salvage his country from the horrors of the Great Depression. The affinity between the two leaders—one of whom became a legend during his term in office, and the other even before he entered the White House—has already been translated into visual images by the American media. The November 13, 2008, cover of Time magazine, for instance, displayed a Photoshopped picture of Obama resplendent in Roosevelt’s iconic fedora, pince-nez, cigarette holder, and toothy grin. In the accompanying article, entitled “The New Liberal Order,” journalist Peter Beinart articulated the expectations of many voters when he urged the president-elect to “do what FDR did… [take] aggressive action to stimulate the economy, regulate the financial industry, and shore up the American welfare state.”
There is no doubt that desperate times call for desperate measures. Even the Bush administration, which no one would accuse of secretly aspiring to bigger government, understood this and has swiftly come to the aid of financial institutions nearing collapse. In order to cope with the challenges of this crisis, however, policymakers must demonstrate not only aggressive action, but also judgment. They must be able and willing to distinguish between what is right for times of crisis, and what is right in general. This distinction is crucial. If political and economic leaders choose to ignore it, they may inadvertently transform a temporary emergency into a permanent economic malaise.

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