[StBernard] Panic Is Spreading

[Westley Annis]

Panic Is Spreading
Brian S. Wesbury and Bob Stein 09.30.08, 12:01 AM ET


Since the subprime crisis first became evident last year, we have
steadfastly believed that the U.S. would avoid a recession. And, at least so
far, this has been true. But with today's vote, two things have happened. 

First, Congress finally said "Enough already!" with the knee-jerk responses
to this crisis by the Treasury. Second, any immediate relief (if there was
really any coming) to credit problems and confidence have been put off.
However, these issues will be short lived, and once the nation is able to
focus on the long term again, all will be well.

Up to this point, economic weakness has been isolated in the housing market
or financials exposed to it, and in sectors affected by energy (airlines and
autos). But the weaknesses in these areas have not dragged down overall
gross domestic product so far. In the second quarter, real GDP grew at a
2.8% annualized rate and has increased by 2.1% in the past year. Excluding
home construction, real GDP has grown 3.1%.

Our argument has been that the economy does not experience recessions when
productivity is strong, the Fed is easy and tax rates are relatively low.
These things are true today, and this has kept the economy from falling into
recession.

However, panic is spreading. Forget job security ... normally positive and
optimistic people are now worried that they will lose their money. President
Bush said that the government's top economic experts believe that if the
Treasury plan was not passed very bad things could happen.

He said, "Banks could fail, including some in your community," further stock
market declines could "reduce the value of your retirement account," "the
value of your home could plummet" and "millions of Americans could lose
their jobs."


>From a president, these kinds of statements are unprecedented. In fact, the

only parallels we can think of were 1977 and 1979 national TV addresses by
Jimmy Carter, talking about energy and a crisis in confidence. Like then,
much of our current economic crisis has been caused by government failure,
even though conventional wisdom is blaming market failure.

The isolated storms in housing, finance and energy, are now being
exaggerated by excessive government intervention (on a knee-jerk basis),
mark-to-market accounting and panicky words from political leaders. As a
result, consumers are pulling back, credit is being squeezed even to solid,
well-run businesses, and the economy is being threatened by this spreading
panic.

If the economy fell into recession because of this, it would be an
unprecedented event. Consumer psychology has never caused a recession ...
never! In fact, there are only three times in history that psychology has
impacted the economy in any significant way.

First, at the beginning of the Korean War, people worried that goods would
be rationed (like WWII), so they spent like crazy. The same was true for the
introduction of muscle cars in the mid-1960s, which led to an exuberant
spending spree on autos. And, finally, in 1999, when everyone bought a new
computer because they were fearful of Y2K. Each of these spending sprees was
followed by an offsetting slowdown in the quarters that followed.

Never in history has a drop in consumer confidence caused a recession. But
that does not mean there won't be a first time. It could happen in the next
few months, and we would expect to see some very negative data on economic
activity. But this would be followed by an offsetting increase in activity
following the psychological slowdown.

Productivity is still booming, and so are exports; the Fed is exceedingly
accommodative, and tax rates have not been hiked. Moreover, oil prices are
below $100 per barrel. Finally, all it would take to fix financial market
problems today is a temporary suspension of mark-to-market accounting for a
targeted set of illiquid assets.

In other words, any economic problems that the U.S. faces in the next few
months or quarters is temporary. Financial markets have priced in
Armageddon, and as a result still present one of the greatest buying
opportunities of our lifetimes.

Brian S. Wesbury is chief economist, and Bob Stein senior economist, at
First Trust Advisors in Lisle, Ill. They write a weekly column for
Forbes.com.