The Great Depression of 2008

It's a scary headline, but one that could have easily happened if the "Great Bailout of 2008" wasn't proposed last week. Last Wednesday morning commercial paper that companies need for everyday business was frozen and a run on money market funds had begun. Lehman Brothers was no more, AIG was about to disappear, Merrill Lynch had been bought by Bank of America, and Morgan Stanley and Goldman Sachs were on the ropes with their futures in doubt. And this was only a part of the nightmare scenario.

The impending financial catastrophe also involved growing concern over money market funds. One major money market fund had "broke a buck" which means its value was less than a dollar. The run on money market funds had begun and it is likely that a significant number of money market funds could not have met the demands for withdrawals. Money market funds normally invest their assets in government securities, certificates of deposits, commercial paper of companies, and other highly liquid and low-risk securities. The problem for the money market funds was that some of the commercial paper they owned and other securities were no longer liquid or low risk. So the money market funds began to accumulate cash and the entire credit market was seizing up.

The housing market was continuing to collapse and the stock market was beginning to collapse. A major sell off in the stock market, by itself, would not have been sufficient for Secretary Paulson and Chairman Bernanke to call a meet with the leaders of Congress and propose a 700 billion-dollar bailout. It took a combination of all of the aforementioned events and circumstances, in addition to other factors that have not been detailed. When the meeting was over the members of both parties had extremely somber looks on their faces. For the first time, they had been told the true nature of the catastrophe that was occurring. The piecemeal approach taken by the government was failing and unless a more comprehensive approach was instituted a financial catastrophe akin to the Great Depression was almost inevitable.

I don't have the expertise to critique the proposed plan. In fact, one of the problems with the proposed plan is that it contains so many unknowns. However, to have continued the piecemeal approach, or to have done nothing, would have led to disaster. Is a depression no longer possibile? Hopefully, yes. But in these times no one can say anything with a great deal of certainty.