The U.S. and Global economic Maelstrom

The three main causes of our economic maelstrom in the U.S., and the world at large are --

(1) Banking, investment and insurance activities had become inseparable and unproductively overlapping creating transparency and moral hazard problems. The repeal of Glass-Steagall Act in 1999 was the final straw in the inexorable march that had begun in early 1980s.

(2) The financial derivatives and securitization of loans had grown monumentally without even minimal regulation and supervision. Such derivatives created over-stated and bubble assets. The Commodity Futures Modernization Act, and the imprudent sub-prime loans accelerated the growth of the derivatives.

The estimated value of the derivatives was about 1 trillion in 2002, and the value grew to about 33 trillion in 2008. The U.S. Congress considered regulation of derivatives in 2003 but finally decided that market forces are best regulating mechanisms.

(3) SEC increased the permitted leveraging by banks from 10 percent to 30 percent. The banks took immediate advantage of this, and soon this action added to the the bloating of the over-leveraged economy.

A confluence of all these three elements has created a glut in global savings and corresponding sharp decline in demand and investment. The global economy now faces a situation deeper than the periodic recession.

However, the United States though appears to be better placed to stimulate the economy through timely and proportionate monetary (e.g., zero interest bank lending rates), fiscal (e.g., economic stimulus packages) and financial (e.g., recapitalization of the banks) policies. Europe, comparatively, has lagged in timeliness and magnitude of response -- so it is more likely that the recovery in Europe will take longer. President Barack Obama, the Congress, and the Federal Reserve Bank deserve some credit for responding to the crisis prudently though more bold actions (e.g., letting zombie banks wither away instead of accepting the burden of their toxic assets) would have been even productive.