Martin Wolf, Rex Nutting have some bad news about the financial crisis

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FT columnist Martin Wolf and veteran MarketWatch Washington Bureau Chief Rex Nutting offer their analysis of the state of the financial crisis, one theoretical, one closer to the ground.

The bad news, Wolf says, is that this recession fully matches the early part of the Great Depression. The good news is that the worst can still be averted.

Wolf offers data that indicates that aggregate demand has declined at Great Depression rates and the overriding question is whether the unprecedented stimulus will be able to offset the effects of this collapse.

It's not all bad news, though. Wolf applauds two steps taken by central banks and politicians, which may help avert another Great Depression: during this crisis, policy makers have lowered interest rates more and passed larger fiscal stimulus packages than anything seen in the 1930s.
Have policy makers done enough?

But will these measures be enough? They may, Wolf argues, if policy makers don't prematurely conclude that the crisis and contraction are over, and in the process defeat the whole purpose of the intervention. "The great likelihood is that the world economy will need aggressive monetary and fiscal policies far longer than many believe," Wolf said.

That's because robust private sector demand will resume only after the balance sheets of over-indebted households, over-borrowed businesses and under-capitalized financial sectors are repaired, or when high savings rate countries consume or invest more, Wolf said. None of the above will happen quickly, Wolf argued, and it's likely to take years.

The policy response to the global recession has been massive, and it needs to stay that way, with Wolf seeing little signs of stagflation. If policy makers reverse course, we repeat the pattern of the Great Depression, during which fiscal stimulus was withdrawn prematurely in 1936-37, and the Depression worsened. If policy makers stay the course, the long, hard journey to economic health will continue, Wolf said.

A lost opportunity for reform?

Meanwhile, the battle-honed, on-the-ground Rex Nutting of MarketWatch argues that the Obama administration is frittering away an attempt to properly regulate banks and other financial institutions primarily responsible for the crisis, and in the process retaining systemic weaknesses that could lead to the next crisis.

Nutting commended the administration for upcoming compensation reform that's likely to change a compensation structure that rewarded executives and bank professionals who made go-for-broke bets, many of which are being paid for by U.S. taxpayers, and the creation of a super-regulator to watch out for dangerous risk, but chides the administration for not addressing the problem of 'too big to fail.'

In Nutting's view, a company or organization can't be allowed to become too big because the U.S. taxpayer foots the bill if it fails, and he argued that the inability of policy makers to pass reform on institutional size provides further evidence of private sector lobbying influence in Congress as well as the Treasury.

"The lobbyists run Congress as well as the Treasury," Nutting said. "Every day action is postponed is a victory for the status quo of private gains and public losses."

Nutting argued the real danger for American citizens is that the financial system and economy will recover just enough to release pressure from the system, as it did during the 1980s Savings & Loan crisis, and the1998 Long Term Capital Management intervention, the bursting of the 1990s dot-com bubble, and other crises, to quell major reforms.

Economic Analysis: Two sobering analyses of the current crisis and recession, but there is cause for modest optimism. Economist Wolf makes a strong argument for maintaining stimulus: stay the course, and the recovery is ahead, but it will take time. Even the Reagan tax cuts in 1981 took 12-16 months to generate growth: the fiscal stimulus package has been working its way into the economic system for just four months – the blink of an eye, in macroeconomic terms.

Meanwhile, Nutting argues this crisis will be wasted absent major financial services reform. That conclusion may be a bit harsh, or ask too much of the American political system. If the nation can get a systemic risk monitor in place, along with compensation reform, those would represent major policy achievements. Questions on what constitutes 'too big to fail' and limiting firm size can wait until after the recovery is underway, and until after the U.S. Federal Reserve issues its report to President Obama and to Congress on what specifically constitutes a firm being 'too big to fail.'
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