Are we headed for another Great Depression?

Are we headed for another Great Depression?
By Kevin G. Hall | McClatchy Newspapers
Posted on Monday, March 17, 2008

WASHINGTON ?- The stunning weekend "fire sale" of investment banking giant Bear Stearns to JP Morgan Chase at $2 a share has raised concerns that the U.S. financial system may be at risk.

Time will tell. Here are some questions and answers about the state of the nation's economy.

Q: Bank failures, a confidence crisis, speculators, a bank credit crunch. Do today's headlines signal a new Great Depression ahead?

A: Parallels to the Great Depression are few. In the run-up to the Depression, the Federal Reserve raised interest rates to discourage speculators. That compounded forces of economic contraction. Today the Fed is slashing lending rates to spur activity.

Also, in 1929, many important global economies were slowing. Today, the world economy is stronger than it's ever been in modern times. That's kept the U.S. downturn from being even worse.

Q: What does Fed Chairman Ben Bernanke know about the Great Depression?

A: He's considered the world's leading expert on the topic. In a 2004 speech, well before becoming the Fed chairman, he outlined steps the Fed could have taken to prevent the Great Depression, steps he himself has taken recently.

Q: Like what?

A: In his speech titled "Money, Gold and the Great Depression," Bernanke said that the 1929 Fed had the power to ease problems in the banking sector but chose not to. "For example, the Fed could have been more aggressive in lending cash to banks, taking their loans and other investments as collateral," he said. That's exactly what he did on Friday and then broadened the action on Sunday night.

He also accepted as collateral some of the mortgage bonds that investors are shunning, hoping that this will help troubled assets find market-price levels so that troubled banks can gauge their balance sheets better.

Q: These are Wall Street's problems, right?

A: If you have a 401(k) plan, an individual retirement account (IRA) or own company stock, your assets are likely worth less today than they were last summer. But markets historically bounce back. A key to success is to diversify your holdings so all your financial eggs aren't in the same basket.

Q: Shouldn't I just put all my money under the mattress?

A: In times of turmoil, it's seldom clear what to do. Institutional investors seek havens such as Treasury bonds and bills, but that drives down their yields. While safe bets, they're not lucrative ones. But they beat losing money.

Gold is a traditional hedge against inflation and a weakening dollar, and it closed on Monday at $1,002.60 an ounce on the New York Mercantile Exchange. Many analysts warn that this is an inflated price that will fall once fear subsides, but many said the same months ago as gold rose steadily from less than $700 an ounce last August.

Q: What will make things right?

A: The crisis in confidence gripping Wall Street, at its core, is about bad bets made on mortgage bonds. Until falling home prices bottom out, it's hard to value mortgage bonds so that investors regain interest in them. That makes financial institutions that hold such bonds nervous that their assets are worthless, so they hoard capital rather than lend it to ensure that they can stay in business. When banks don't lend, business dries up and the economy tanks. We're probably in a recession right now.

"Wall Street is finally catching up with Main Street," explains Jack McCabe, a real estate analyst in Deerfield Beach, Fla. Florida and California's housing woes have hurt their economies for a while, and the ripples have now reached Wall Street, he said.
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To read Bernanke's speech on the Great Depression:
http://www.federalreserve.gov/boarddocs/speeches/2004/200403022/default.htm

(Lisa Gibbs, business editor at The Miami Herald, contributed.)