Avoiding the Next Great Depression

Paul Krugman is warning that the U.S. has entered an economic depression. His policy prescription is misguided, but where are the conservative solutions?

My latest column for The Week examines Paul Krugman's fears that the American economy may have entered a depression and the continuing need for conservative solutions to the crisis.

What if Paul Krugman is right? Or at least in the neighborhood of right?

The New York Times columnist and Nobel laureate economist has been warning for months: The economy is not recovering.

Through the spring of 2010, Krugman’s warnings seemed to be refuted by signs of growth. But in recent weeks, that expansion has faltered. Private-sector job creation is sputtering. Yesterday's market drop was especially alarming. Back of it all is the huge anchor that continues to weigh down the economy: the crushing debt load on homeowners.

Here's a simple way to think about that load. About 44 million U.S. households carry a mortgage. For about 11 million of those, their mortgage exceeds the (current) value of their home. More than 8 million of the 11 million are still making good on their loan payments. But what happens if more people just quit paying?

One result: America's already sick banking industry would become sicker. Already, it subsists on life support. The Federal Reserve creates money, which it lends to banks for next to nothing. The banks effectively walk from one wicket, where they borrow money for free, over to another wicket, where they lend it back to the government at 3 percent interest.

This accounting game provides banks with a tidy income so they can build their reserves and (it’s earnestly hoped) resume commercial and household lending.

But what if people do not want to borrow? People do not borrow just because credit is available. They do so when they see attractive opportunities to put capital to use. Such opportunities are not exactly abounding these days.

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