On your last paragraph, I would think that it's the precipitous drop that would be a problem, no? Much like tax policy, people talk about whether taxes should be at X level or Y, but really it's the rate and direction of change that's important (that's McCain's explanation, for example, for voting against the Bush tax cuts initially but later being in favor of extending them, because allowing them to expire is effectively a tax increase for some and he believes that doing so in a bad economy would make things worse.)

And another point about going back to 1999 level GDP- we wouldn't go back to the level of federal spending of that year, we'd have much higher expenditures (esp in the case of SS and Medicaid which are rising dramatically, even to the point that we'd be starting to have problems now even if the economic growth rate was good and we had positive GDP change.) That makes a huge difference, doesn't it?

I think that plan actually looks pretty good and would tentatively support it. Now I'm more pessimistic about whether it would “work.”

On first glance it seems to actually confront reality and encourage the main goal — continuing lending — that the current treasury plan does not. However, it would only work if there would widespread socioeconomic changes because the current lifestyle that many people leave is unsustainable (indeed, paying off their prior one is) and this plan would not address that.

Again, everyone points to Japan as a model, but their citizenry was economically cautious by nature and the malinvestments were much more well contained to a small group of people than our overleveraged society. If we adopted a hybrid plan like that one AND had leadership to create lasting changes with how people valued quality of life (including flight back to urban areas and other things to reduce transportation dramatically) then that might work until we could develop new efficiencies.

I would argue that our underlying assumptions are misguided because they rely on continuing economic “growth” just to function properly. Under the Great Depression, GDP dropped by about 35%, which would take us to about $9.5 trillion, or the level of 1999. It's kind of weird that this would be catastrophic even though I don't remember 1999 being a vast wasteland. If you or anyone else is interested I could write a post about that sometime.

The people that could make it through deflation and still have lots of cash and buy lots of assets cheaply would see their fortunes rise immensely in 10 years.

I mentioned that I didn't want to paint a picture of what will happen if the bailout fails at this time, but this summarizes it completely.

It's also very hard to sit back and watch tens of millions of people suffer. It's easy to sit here and say what we “should” do from a logical standpoint, but I have a hard time seeing how elected representatives could sell it.

Still it would be a great fit over all for Obama's strategies, but I fear he is too much a captive of this moment in history to do much.

It's really easy to go down the other path that I think won't work because it takes much smaller interventions at each step and then to keep going further and further down, so I fear Obama will do that.

As DLS points out, deflation doesn't have to be “massive” and points to Japan. This is what people are aiming for replicating here. Japan faced the same basic problem and managed to work it out over time instead of through massive debt destruction. It took them about 12 years to start growing again and the way they did it was to make very cheap money and “ignore” the problem.

I would argue that we are unlikely to be able to emulate Japan for a number of reasons. First of all, the Japanese had very high savings rates and nest eggs. The average citizen had months if not years of cash stored up and the government had little debt. When people lost their jobs in the crisis they had quite a lot of time to look for new jobs and live off their savings, and the government had lots of leeway to manage the crisis.

Obviously neither our citizenry nor government has this leeway. However this is what a “hybrid” solution would look like. The point of that would be to let the banks have debt destruction, but then the government would recapitalize them directly. (It costs a lot less to do this than to buy the assets in the first place, because of leverage. So for the government to buy assets at half value it'd still have to pay 5x more than letting all the debt be destroyed and recapitalizing the bank that had 10x leverage). Then also there would need to be greater governmental programs to make sure that individuals were given debt relief and money for expenditures so they would be able to spend money and continue to buy things at relatively high costs.

Secondly and perhaps more importantly, the bulk of their decline happened while the United States and Europe were experiencing the largest boom in history, and later in the decade (after the Asian currency crisis) Russia, China, etc. joined in as well. Even though Japan was in bad shape domestically, they continued to do very well in exports and their imports were falling in price.

I think that the current problems are more likely to lead to worldwide recession .

Kathy

Deflation associated with public gloominess will persist despite any federal make-work or “stimulus” spending or other programs, or other attemps to force the economy to revive. (Massively increasing the money supply of course makes no sense to do.) Again, see Japan.

Social Security and Medicare will fail without intervention. Like it or not, that's reality. Once these programs run deficits, more revenues must be found in order to continue to pay benefits in full. (Of course, benefits can be reduced and perhaps long-term growth can be curtailed, but the beneficiaries and the Democrats will howl.)

The banks and investment firms and insurance companies? Let them fail; don't give them money or loans. Same for the Detroit Big Three and other companies ready to clamor for “rescue” of themselves.

Those at the leading edge (the head) of the Baby Boom cohort, who have benefited the most throughout the cohort's existence, will continue to do better than the rest. Those at the trailing edge (the tail)) will once again suffer the most. All of our society and economy are likely to suffer in the next 20+ years with population aging, health care cost explosion and disability explosion, asset sell-offs that should dwarf today's real-estate bubble popping (homes currently _still_ cost too much and _should_ get cheaper than they are now!), and all kinds of economic problems with consumer-producer imbalance and worker-dependent imbalance.

My inclination is to ask: do you think there's any possibility of a hybrid solution that partly boosts assets and partly cleans out the bad debt? I have no idea if that even makes sense, it's just my natural tendency when two different approaches each have severe downsides, to consider whether a patched approach could get to the needed solution while softening the landing.

http://www.youtube.com/watch?v=S27yitK32ds

“Rule one: Rush the decision. Time the game to fall in the week before Congress is set to adjourn and just 6 weeks before an historic election so your opponents will be preoccupied, pressured, distracted, and in a hurry.

Rule two: Disarm the public through fear. Warn that the entire global financial system will collapse and the world will fall into another Great Depression. Control the media enough to ensure that the public will not notice this. Bailout will indebt them for generations, taking from them trillions of dollars they earned and deserve to keep.

Rule three: Control the playing field and set the rules. Hide from the public and most of the Congress just who is arranging this deal. Communicate with the public through leaks to media insiders. Limit any open congressional hearings. Communicate with Congress via private teleconferencing calls. Heighten political anxiety by contacting each political party separately. Treat Members of Congress condescendingly, telling them that the matter is so complex that they must rely on those few insiders who really do know what's going on!”

(FYI: Republicans have blocked voting on bills by Dems for more oversight and regulation.)