"Let's review just a few of them in the interest of not repeating them."

Bob McTeer with an interesting post on preventing a depression:

"Several policy mistakes were made during the 1930s that turned what could have been an ordinary recession into the Great Depression. Let's review just a few of them in the interest of not repeating them."

1) Money supply shouldn't decline
2) We need bank deposit insurance
3) No tax increases or balancing of the budget. A stimulus? Bob didn't say.
4) No tariffs or fooling with the currency at the expense of others
5) Leave exchange rates alone
6) Consider the implications of government guarantees

Bob McTeer feels that we are doing most of these things, and should do them in the interest of avoiding a depression. Maybe, as Greg Mankiw pointed out, we have learned enough to avoid this from happening. Please read his entire post.

I tend to agree with everything, but would include a stimulus as part of 3.

Here was my comment on his blog, in case they don't post it:

1. Don the libertarian Democrat Says: Your comment is awaiting moderation.
   October 28th, 2008 at 9:41 am

   An excellent post with good points. I simply want to address one point:

   “That is that one country’s guarantees of its bank deposits have attracted deposits from neighbor countries without such guarantees. That has led to follow the leader reactions and a better understanding of the unintended consequences of well-meaning policies.”

   For me, this is very important. Take this quote from Across The Curve:

   “One trader said that the competition from the FDIC guarantee has been a real wet blanket for the entire sector and there is no active marginal buyer.”

   And Brad Setser:

   “Prior to Lehman, there was an almost unshakable faith that the senior creditors and counterparties of large, systemically important financial institutions would not face the risk of outright default,” notes Neil McLeish, analyst at Morgan Stanley.”

   Much of the infrastructure of modern finance in effect rested on an expectation of a government backstop for the creditors of large financial institutions – a backstop that allowed a broad set of institutions to borrow short-term at low rates despite holding large quantities opaque and hard to value assets on their balance sheets.

   That observation has a number of implications, not the least that the leverage – and resulting capacity for outsized profits — of some parts of the financial sector was made possible by the expectation that the government would protect the key creditors of the financial system from losses.

   Lehman’s default shattered this implicit guarantee. The end result likely will be a series of explicit guarantees – and a rather significant government recapitalization of the financial sector.”

   The importance of guarantees, both implicit and explicit, has not been well examined. I believe that the system of implicit and explicit government guarantees is the most important point in this crisis, although there is a lot more to it. When Lehman wasn’t allowed government help, I believe that markets and investors panicked at the thought that they would actually be on their own, and had no real plans to deal with the problems without the government’s help, including the Fed. I simply believe that the massive amounts of risk taken by banks and other investors wouldn’t have occurred without an assumption of government intervention and help. This also explains some of the movements of cash once the crisis began. Once full government intervention was apparent, the crisis began to be addressed in earnest.

   As you point out, on the other hand, FDIC insurance and the Fed and government spending are important in keeping a really serious downturn from occurring. So what to do?

   I would recommend what I call Bagehot’s Principle’s:

   If the B of E exists, it will be the lender of last resort, and you need to figure that into your analysis. Consequently, you need to determine policies that make such a last resort unlikely. Here’s a view points:

   Regulation or supervision that advocates transparency and capital requirements on transactions.

   Real moral hazard for banks, say, long before a crisis can occur.

   Onerous terms in the case of a crisis and government help is needed.

   There might well be others. But in this crisis, we had:

   Poor regulation or supervision

   No real moral hazard until the crisis

   Far too lenient of terms, e.g., TARP

   Even if I’m wrong about all of this, the importance of investing based on implicit and explicit guarantees by government needs to be examined, and, going forward, the terms and conditions of government intervention need to be spelled out.

   Finally, since the taxpayer is the ultimate guarantor of these guarantees, it would not be amiss for taxpayers to demand a system that limits risk and forces a more conservative investment strategy on the market. Whether that is wise or unwise for growth is a good question, but to the extent that taxpayers are the ultimate guarantors, surely they should have some say in the conditions that could lead to their being called upon to produce large amounts of money.