CHAMPAIGN, Ill. - Lessons from the Great Depression are likely guiding an unprecedented wave of government bailouts now propping up American International Group Inc. and other cash-strapped financial firms, a University of Illinois economist says.
J. Fred Giertz says officials hope intervention by the Federal Reserve that also rescued lending giants Fannie Mae and Freddie Mac will keep the financial sector's woes from infecting the rest of the nation's slumping economy.
"Some economists say the reason we went from a nasty recession in 1929 into a 10-year depression was mismanagement by the Fed that allowed the banking system to implode through runs on banks and bank failures," Giertz said. "So what should have been a serious but ordinary downturn turned into the worst depression in modern times. That may be one reason why they're so willing to intervene now."
The recent bailouts could help ward off a deeper economic downturn, but also carry risks, said Giertz, interim head of the university's economics department. Other financially troubled companies are watching, he says, and the prospect of a similar government safety net could influence business decisions.
"Private businesses typically rise and fall on their own," Giertz said. "If they think they'll have to live with the consequences of bad decisions, they may act differently than if they think in their heart of hearts that the federal government will step in and bail them out."
Ultimately, bailouts that have poured billions of taxpayer dollars into private businesses will bring more government regulation of Wall Street, said Giertz, a member of the U. of I. Institute of Government and Public Affairs.
"You can't have it both ways," he said. "You can't have unregulated financial markets, then also step in and bail out the failures."
Giertz says the ongoing crisis in financial markets has increased the potential of a recession, and stronger economic growth that had been expected this summer will likely be delayed until the beginning of 2009.
"I've been saying a recession is possible, but more than likely we won't have one," he said. "Now, I think the chances are higher, probably close to 50 percent."
A recession would likely be modest and short-lived unless instability in the financial sector spills into the overall economy, which is holding up better than most people think, Giertz said.
"Gasoline prices are disruptive and the average person isn't moving forward as much as they'd like because their raises haven't gone up as much as inflation," Giertz said. "So they're frustrated, but I don't think you could convert that into deprivation or real hardships for most people."
Editor's note: To contact J. Fred Giertz, call 217-244-3108; e-mail jgiertz@illinois.edu