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The double-barreled title deals with two aspects of the credit crisis, the uncertainty over whether banks will start lending out the billions governments have been giving them, and Allan Greenspan’s agonizing reappraisal of his personal role in the credit crisis.

Joe Nocera, in last Saturday’s New York Times raised the key question of whether the US banks that have been receiving billions of funding under the bailout package will hoard it, use it to acquire other banks, or actually lend it out. As can be expected of a Republican administration that is still philosophically non-interventionist, there is little desire to get involved in managing how banks run their business. Nocera notes that, in contrast, the British government is requiring that recipient banks resume lending.

Starting from first principles, there is a good case for government to seek commitments that banks will expand lending. First, if the banking system has now become, in essence, a public utility, then the government, as representative of the public, should have enhanced decision rights. Second, we’ve learned that a key reason that the stock market crash of 1929 evolved to the Great Depression of the Thirties is that governments permitted credit, aka among economists as the money supply, to collapse.

Looking ahead to the Obama Administration (and back to the Clinton Administration), here is a suggestion. The Clinton Administration had several successes in inducing high profile organizational commitments to actions in the public interest. Two that come to mind are Labor Secretary Reich’s initiative to get brand-name clothing lines to commit to a rejection of sweatshop production and procurement administrator Steve Kelman’s initiative to get government agencies to commit to the principles of procurement reform. These cases are obviously much less complex than the credit crisis, but I think the approach is transferable. Summon the bankers to the White House to a public conference to get some sort of commitment to principles regarding the expansion of credit.

In Canada one similar issue that has arisen was whether banks would reduce their lending rates commensurate with reductions in the government lending rate. The banks’ initial reluctance to follow led to public criticism which led to the banks to pass on the entire rate cut to borrowers. The overarching issue is similar: economic instability has necessarily made bankers’ decisions a public policy issue.

Finally, Allan Greenspan will be bringing his “mea culpa tour” to Toronto on Friday November 7, for an event billed as “an afternoon with Allan Greenspan.” I detect a few ironies. The “afternoon” is scheduled for noon to 2 p.m., ending early so the audience can return to their trading desks to close out the week. The sponsor is TD Canada Trust, which has distinguished itself for its shrewd avoidance of subprime loans. Finally, the ticket price is $325 or $450. Given that he has now recognized the error of his ways, it seems only appropriate that Greenspan do the right thing and donate the entire speaker’s fee to the United Way of Greater Cleveland or some similar organization helping repair the devastating economic and personal damage his decisions have unleashed.

Breaking a campaign promise at the start of a mandate can lead to heavy and long-lived criticism. Just ask Dalton McGuinty, who, facing a large and unexpected deficit, broke his promise not to raise taxes when he took office in 2003.

Whoever becomes prime minister after the October 14 election will immediately be confronted with the question of whether to honour the promise, made by all party leaders, not to run a deficit. The economic rationale for a deficit now is clearcut: when a recession hits the private sector, government can and must take up the slack and stimulate demand.

Even if the government doesn’t change its policies, we are likely headed for a deficit, because tax revenues will go down and transfer payments such as employment insurance will go up. To raise taxes or cut spending to avoid this automatic deficit will make the recession worse.

If the new government decides to run a deficit, there are two ways to do it. One would be to cut taxes, thereby putting money in consumers’ pockets. This is what the Conservatives did when they cut the GST earlier in the year, and what the US government did when it gave taxpayers tax rebates totally roughly $150 billion.

The second alternative would be to spend the money directly. A fiscal stimulus package could be built around the idea of rebuilding Canada’s infrastructure, with investments in areas such as health, the knowledge economy, and transportation. I prefer the infrastructure approach because I think it has a bigger immediate impact and puts in place investments (for example hospitals, research infrastructure, public transit) that will strengthen our economic performance in the future.

Given Canada’s strong federal finances, we can afford some short term deficit spending to stimulate the economy. The challenge will be to structure the program and define its terms, for example its duration, carefully. So we need both quick action and careful thinking. Let’s hope that our professional public service is hard at work on planning an economic recovery program, so they can hand it to the new prime minister as soon as the votes are counted.

The world’s first cyber-crash happened in 2000 with the bursting of the Internet stock bubble. The damage was confined to one sector of the economy, however, and the subsequent reduction in interest rates provided quick stimulus that prevented a prolonged recession. As we now know, the reduction in interest rates created a real estate bubble in the US as well as some European countries, and the bursting of the real estate bubble is leading to a global recession. I call this a cyber-crash as well, because I believe information technology has made a major contribution to our current economic problems. Here are three themes about the current recession.

Interconnectedness

A priori, we wouldn’t expect that weakness in one sector, even in the world’s largest economy, would lead to a global recession, but we’ve discovered that the US housing market is closely connected to the financial sector in the US, which is closely connected to the financial sector in the rest of the world, which is closely connected to the real economy everywhere else. So the contagion is spreading quickly from the US economy to the rest of the world.

Technological Hubris

Technology has contributed to the problem in several ways. The increase in computational power has given financial engineers the ability to create more complex financial instruments in particular linked to dubious mortgages. Information flows faster and market players can react faster. Like the political world, immediacy has increased in the economic world. As a consequence, volatility has also increased. Unlike the political world, however, technology has not increased transparency; indeed, it has reduced it, as market players know less and less about what real assets the financial instruments they are trading actually represent.

The Public Sector: Ideology or Pragmatism

It is now clear that, in part due to its free market ideology, the Bush administration did not worry about how these developments allowed an increasing portion of the financial sector to operate outside traditional regulatory constraints. The need for restructuring to either avert or respond to bankruptcies (Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch and who’s next?) has necessitated government involvement on an unanticipated scale.
Bush and Cheney are as clueless about the cyber-crash as they were about Hurricane Katrina. They seem entirely unable to think about society, rather than individuals. Fortunately, the key US economic players - Bernanke, Paulson, and FDIC Chair Sheila Bair - are more pragmatic than ideological. But will that be enough?