A CNN poll earlier this week said that 60 percent of Americans believe we are headed for a depression.

A CNN poll earlier this week said that 60 percent of Americans believe we are headed for a depression.

Yesterday afternoon I talked with MnIndy’s favorite business/economics journalist, Doug Henwood of Left Business Observer (who also hosts a weekly radio show on WBAI in New York and KPFA in Berkeley that’s archived at the LBO site), to see what he’s thinking about the economy and about the panic in credit markets, which so far seems unfazed by the bailout bill or by any of the other measures the Fed and the Treasury have undertaken. (We last spoke with Henwood about the economy in September, a day after Lehman Brothers went under and AIG got bailed out; that interview is here.)

“I think there’s certainly the risk of a severe recession,” Henwood tells MnIndy. “I don’t know where you put the dividing line between a severe recession and a depression. An unemployment rate of 10 percent is a severe recession. An unemployment rate of 15 percent starts looking like a depression. But that’s kind of arbitrary.

“Certainly the risk of something really nasty looks the highest it’s been since the end of World War II. There have been a couple of instances in the past where it looked like we were teetering at the edge and then managed to avoid it.

“The fact that the level of panic in the markets looks so high despite all these extraordinary interventions is a little scary. Now, on the other hand, if you want to draw some comfort from that, sometimes when people are thinking the world is coming to an end, that can be a sign that we’re close to the bottom. Or that we’re closer to the bottom than we are to the beginning.”

There’s a transcript of the interview below.

Listen: Doug Henwood on the troubles (15:21)

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Minnesota Independent: I wanted to start by hearkening back to the last time we talked, a day or so after Lehman Brothers went down. You said at the time that the bad scenario–the situation we needed to watch out for–was one in which the credit markets, bank-to-bank and bank-to-business lending, dried up. That seems to be happening now as I read Nouriel Roubini and others on the crisis. What is going on with the credit markets?

Doug Henwood: They’re pretty much frozen up. The inter-bank market is virtually completely frozen. They quote interest rates, but they’re pretty meaningless because there’s no loan volume. Banks are basically refusing to deal with each other because they don’t trust each other. They’re just hoarding their cash and putting it into government securities. We’re also seeing signs that lending to business is drying up — the commercial paper market is contracting very rapidly. Commercial paper is a form of unsecured borrowing by large corporations, financial and non-financial, that is usually a very large market. And it’s usually blue-chip corporations who normally would not have a difficult time borrowing. But that market is contracting.

The Federal Reserve has just announced some support facility for the commercial paper market, so we’ll see if that does anything to kick-start the market. But it looks like there’s just a general atmosphere of panic that’s causing anybody with money to hold on to it. And it doesn’t appear that there’s any change in that psychology imminent.

MnIndy: Are people rushing to get out of credit markets part of the problem here?

Henwood: Yeah, at some point this becomes self-fulfilling, because everyone gets scared and they run away, and the running away drives down the prices and drives up interest rates and drives down stock prices. And people look at that and say, “Oh my god, it’s falling apart.” It’s a vicious cycle that keeps feeding on itself.

The whole point of government intervention in situations like this is to break that cycle — to put some sort of floor under prices and also some floor under the decline in confidence. So far, despite very extraordinary measures — not just the bailout that passed last week, but all the central bank activities around the world — to pump money into the markets, pump reassurance into the markets, very innovative lending by the Federal Reserve and other central banks … They’re clearly pulling out all stops, and have made it clear they will continue to pull out all stops, and maybe even find more stops to pull out if they haven’t exhausted the supply completely.

That has not yet put a floor under prices or provided much foundation for confidence. It may; historically, for the last couple of decades, government bailouts have always succeeded. They haven’t necessarily been able to prevent recessions, but they have been able to prevent panics from just completely unwinding everything.

But so far, not so good.

MnIndy: Why are banks freezing up in their lending to each other, in simple terms? Because they’re afraid of each other’s solvency, of all the bad paper on their books?

Henwood: Yeah … This is all really uncharted territory. The original problem, as everyone knows now, was a lot of bad mortgage debt. But on top of all those bad mortgage debts, the investment banks built an enormous structure of very heavily leveraged and opaque instruments. Now that is coming undone, and very rapidly. And nobody knows, really, how bad it is. The danger of leverage, which is a fancy word for borrowed money, is that it’s wonderful on the way up. The borrowed money can really juice things up on the upside. But when things turn down, it accelerates things as they head back down to earth.

That’s what’s happened. I think a lot of these very heavily leveraged structures are imploding. A lot of progressives who opposed the bailout, for example, say that if we just get money to the mortgage borrowers who can’t meet their obligations, then that would protect everything else. But in fact there are all these other leveraged structures that are imploding as well, and that’s what the bailout and all the other extraordinary gestures are intended to address.

But the scale is so huge, and the level of panic is so high, and the possibility of disaster is so frightening, that people are just — it’s everyone for themselves.

MnIndy: Why does the bailout package that was passed last week, and for that matter, the $630 billion in new funds that the Fed injected earlier in the week, to less notice — why have they had so little impact on this?

Henwood: It’s been a short period of time, for one. I’ve noticed that people, even as sophisticated as Paul Krugman, have been saying the bailout is a failure. Well, the thing is less than a week old, so it’s a little early to judge.

The history of past banking crises and government bailouts is that these sometimes take years to work out. Our own savings and loan rescue took several years. The Nordic banking crises of the early ’90s took several years to work out. The Japanese banking crises of the ’90s, which were never really adequately addressed with any kind of government package, took more than a decade to work out.

So we don’t really know. The whole idea is that this is supposed to make things less bad. But it can’t make things good, and it certainly can’t do anything overnight. But I think it’s also just the scale of the problem. There’s just so much leverage in the system, and this is where the regulators — the central banks, our Federal Reserve, the Treasury, independent regulatory agencies — just failed so miserably. They let this borrowing, this leveraging, all these opaque instruments, get so out of control. They could have stopped this five years ago, but they didn’t. Especially back during the Greenspan years. Greenspan thought that whatever the markets do is okay. Who is he, a mere human, to doubt the collective wisdom of the market? So he stood back and even cheerled onward as all these structures were being laid on. Now they’re being undone.

The best hope is that they can be undone at a reasonable pace so it doesn’t all come crashing down overnight, [instead] it gets spread over the course of several years. That would, I think, mitigate the economic impact somewhat.

But we’re already in a recession, I think, and it looks like it’s only going to get deeper in the coming months. We haven’t really had a deep recession in the United States since the early 1980s. We had a fairly mild one in the early ’90s, a fairly mild one in the early ’00s. We did have slow recoveries from those recessions; it took awhile to get out of them. But they were not deep. The economy did not contract greatly and the unemployment rate did not rise all that dramatically. For consumer markets in the early ’00s, there was virtually no consumer recession at all. The housing markets, which are usually hit in a recession, barreled ahead. Car sales, which are also usually hit hard in recessions, and durable goods purchases, also usually hit in recessions — that didn’t happen.

So we haven’t had a consumer recession of any kind in this country for about 17, 18 years, and we haven’t had a really broad, deep recession in about 25, 26 years. It looks like we’re overdue for one of those. It could be a shock to many people.

MnIndy: During the debate that led to the passage of the bailout bill last week, there were a lot of words of assurance that the taxpayers will do all right in the long run. The Treasury will get most of this money back, might even make money. And yet, as far as I can tell, very few concrete protections were written into the bill. What’s your understanding of the protections we have for the public investment here?

Henwood: They look — at least in the language of the bill, they don’t look all that reassuring. But one thing about the whole structure is that the bill gave the secretary of the Treasury very broad discretion to do what he wants to. Barney Frank said the other day that it also means the secretary of the Treasury can buy stock in corporations, in banks that are in trouble.

Now, the history of these bailouts — there’s a very interesting review of the history of these banking crises and bailouts that came out a couple of weeks ago from a couple of IMF economists. Their conclusion was that buying bad assets, which was Paulson’s original proposal, doesn’t work as well as just directly injecting fresh capital into banks. That certainly wasn’t Paulson’s original intention, but apparently the way Congress wrote the legislation, they can do that.

The thinking on Wall Street, as far as I can tell, is that while Paulson might not do that, Paulson will be history in a few months, and it’s highly likely that if we happen to have a new Democratic administration and a new secretary of the Treasury, they will take that equity route. It’s not only more effective, according to a survey of the historical evidence, but it also offers the taxpayers an upside. If they manage to stem the crisis, or limit its effects, the banking sector will eventually recover and the stocks of the banks will rise again.

Looking at the history of some comparable bailouts in the Nordic countries and Japan, we see that stock markets continue to fall for a year or two after a banking crisis begins, but then they begin to rise, often rather dramatically. So there is a good possibility that if the government buys stock in these troubled institutions, and they manage to turn themselves around, then the Treasury can — if not make money in this deal, at least recoup a lot of what it spent. So I think there’s a good chance that this $700 billion price tag is a ceiling, and we may actually get away with less than that. We don’t know, but that is a possibility, and a not completely outlandish possibility.

MnIndy: Doug, last question. And again, I’ll go back to our talk in September. You said then that you thought the chance this would descend to something catastrophic for the real economy, something like a depression — which, according to a CNN poll this week, 60 percent of the public thinks we’re headed for — was not a terribly near possibility. Three weeks down the road, would you still say that, or is all the panic likelier to be self-perpetuating at this point?

Henwood: You know, it’s really hard to say. I think there’s certainly the risk of a severe recession. I don’t know where you put the dividing line between a severe recession and a depression. An unemployment rate of 10 percent is a severe recession. An unemployment rate of 15 percent starts looking like a depression. But that’s kind of arbitrary.

Certainly the risk of something really nasty looks the highest it’s been since the end of World War II. There have been a couple of instances in the past where it looked like we were teetering at the edge and then managed to avoid it.

The fact that the level of panic in the markets looks so high despite all these extraordinary interventions is a little scary. Now, on the other hand, if you want to draw some comfort from that, sometimes when people are thinking the world is coming to an end, that can be a sign that we’re close to the bottom. Or that we’re closer to the bottom than we are to the beginning.

So some of the signs of panic are suggesting that maybe people are getting a little carried away with the worry. I don’t know. It’s very risky. There’s a possibility that those high levels of anxiety are actually contrary indicators.

But on the other hand, there’s a serious risk that things could come unraveled. There’s just a whole lot of problems out there, and we may not have the luxury of dealing with them in a comfortable fashion at a time we choose. They may just come crashing down all at once. If enough people think we’re heading into a depression and they stop spending money, that runs the risk of becoming self-fulfilling. It’s a scary time. There’s no doubt about it.