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What can be done to stop the recession?

With the recession deepening, more than a few readers are offering suggestions on how to end it.

With the recession deepening, more than a few readers are offering suggestions on how to end it. Many are wondering: Why doesn't the government just give this bailout money directly to consumers? We think there's another solution the government has overlooked.

Why doesn’t the Fed just put a moratorium on the income tax for people making $250,000 a year or less? It pumps hundreds of dollars a week in consumers pocket and it doesn’t cost the Fed anything to do it. I’d be real interested to know why this wouldn’t work.
— Joe (A real carpenter), Iowa

The way things are going, it might just yet. But it wouldn’t come without a cost. And it wouldn’t attack what we see as a very basic problem that the government responses have so far overlooked.

Friday’s report on employment, showing that a half-million jobs were lost — *poof* — in 30 days is a strong sign we’re entered yet another dangerous phase of economic decline. Economists who’ve been following the data for decades — and at least one journalist who has been writing about the economy for 25 years — are having a hard time comparing this recession to any in memory. If, as many forecasters are now predicting, the current recession lasts into the middle of next year, it will be the longest since the Great Depression (which was officially two recessions — one that started in August 1929 and lasted 43 months and another one that started in May, 1937 and lasted 13 months.)

Some economists are comparing what we’re in now to the recession of the early 1980s, which came on fast and hard. The recovery, when it came, was also pretty fast because the recession was, in fact, engineered by the government. It was a bit like getting knocked out before major surgery — when the anesthesia wears off, with any luck, you wake right up. A little groggy, maybe, but it's pretty quick.

The 1980-82 recession was actually two separate downturns, each brought about by the Paul Volcker Fed to kill a decade of 1970s inflation once and for all. In 1980, the Fed jacked up rates to double digits and held them there for a bit. Kind of like a teacher trying to break up a schoolyard fight.

But when the Fed let go, the kids keep on fighting — inflation shot right back up. So the Fed jacked up rates again — this time rates to 20 percent. Bond traders' phones stopped ringing; some just put in a half day and went to the movies.

When the Fed finally cut rates sharply in 1982, inflation stayed low. Hiring picked up and the stock market began one of the biggest bull runs in history. Ronald Reagan declared Morning in America and reappointed Volcker, who was a national hero. In another era, they would have thrown him a parade.

This recession is different: It’s a structural problem. The credit market is badly damaged because it's clogged with bonds backed by mortgages that are failing. Without a functioning credit system the economy can’t grow for long. If credit shut down altogether, you'd have to go back to a 19th century barter system (“Will write columns for food”).

Handing out checks was one of the first things the government tried, and it’s not a bad idea. You’re right that putting money directly into consumers' hands would help stimulate the economy if they went out and spent it. After all, two-thirds of the U.S. Gross Domestic Product comes from of consumer spending.

Suspending taxes altogether would do the same thing: Put money back in consumers’ pockets. It would carry a huge price tag, however. To keep the government functioning, the Treasury would have to borrow even more billions to replace those lost taxes. The interest on that debt alone would be another cost the government would have to bear — likely by raising taxes down the road.

Unfortunately, the first stimulus package didn't exactly go according to plan. Consumers didn’t spend their rebate checks. Mostly they paid down debt or put the money into savings. Those who did spend it used a lot of it to pay for higher gasoline prices, which means we sent a lot of the tax rebate to oil producers outside the U.S., creating little benefit to the U.S. economy.

That’s why the Fed and the Treasury have been focused on rebuilding the banks by pumping hundreds of billions of dollars into the system. The hope was that banks would start offering credit again, and we’d pull ourselves out of a slump before the recession deepened.

The problem is that banks — just like the consumers who stashed away their checkbooks — have taken the money and used it to shore up their books to ride out the storm. Credit is still hard to get.

So it’s time to try something else, and there’s an obvious place to turn: the rising pace of mortgage defaults and foreclosures. Policy makers have been debating this for a year, but so far no one has gotten serious about cleaning up the mess made by years of rogue lending and irresponsible borrowing.

As long as home prices continue falling, you can’t get the economy moving again. Consumers watching hundreds of billions of dollars in of home equity disappear aren't going to start spending until they see the bleeding has stopped. And until you put a floor under house prices, you can’t put a floor under the value of all the bad debt backed by the mortgages on those houses. That mortgage-backed debt is what’s clogging the credit system.

This is all widely recognized and accepted by most responsible economists, and the Fed has recently come around to focusing on the problem. For over a year, the government has relied on lenders to work out bad mortgages voluntarily; so far progress has been painfully slow. It’s time to try Plan B: Let bankruptcy judges modify loan terms from the bench. It’s the only form of consumer debt that currently off limits.

With that restriction lifted, homeowners probably wouldn’t even need to file for bankruptcy. The risk that a judge might offer a lender a lousy deal would likely prompt them to negotiate more aggressively on their own with homeowners trying to get out from loans with ruinous terms.

Some homeowners, of course, can’t afford their homes even with more favorable mortgage terms. If so, the bankruptcy judge could order the home sold. That’s the kind of decision a judge — not a lender — should be making.

Instead, the government’s latest “housing relief” plan would use government money to push mortgage rates down to 4.5 percent, but only for new buyers. If you’re stuck in one of the bad loans Wall Street sold you, tough luck. The best you can do is cut your losses, take a hit and sell your house. The creditworthy buyer who gets to move into your house — or buy it and rent it back to you — will do so with a subsidy paid for with your taxes.

Not exactly what the American Dream was supposed to be all about.

A recent email reached my inbox that I’m trying to determine is true or not. The first bailout was I believe $750 billion dollars to the banks to cover mortgage loans. What I got were some numbers to the effect that if you took then entire legal U.S population over the age of 18 and divided it by $750 billion you would find that the government could have given everyone about $250,000. I guess my question is would this not have helped the economy much more than bailing the banks out or would it have caused a major inflation crisis?
Kevin W., Address withheld

This is a good example of what you might call Internet math. Kind of like those mailings that claim to be able to wipe out debt for free.

The US Census estimates there were about 185 million adults in the U.S. in 2007. If you divide $750 billion by 185 million, you get $4,054.05.

Don’t spend it all in one place.