How economy looks to the man who wrote the book

Nobel laureate Paul Samuelson blames crisis partly on 'fiendish' financial engineering on Wall Street.

How does the man who literally wrote the book on economics regard the current financial crisis and emerging global recession?

Paul A. Samuelson's first answer is a bit understated.

"It's very serious," says the author of "Economics," the tome that served as a primer on the subject for several generations of college students. It is, he says, much more than the bursting of a big price bubble in the housing market, a phenomenon the US has experienced before with less ill effect.

Then the 1970 Nobel Prize winner unloads both barrels. It's so bad now, Dr. Samuelson says, in part because of "fiendish, Frankenstein financial engineering" by Wall Street that "obliterated" the transparency of the resulting derivative financial instruments now sinking banks and other institutions in the United States, Europe, and elsewhere.

He also criticizes federal regulators for allowing "unconscionable superleveraging" – that is, some financial firms borrowed as much as 30 and 40 times their own capital to make investments, creating a perilous financial position.

Samuelson, now a professor emeritus at the Massachusetts Institute of Technology in Cambridge, suggests that the US government "may have to do a lot of spending" to get the economy back on track. That approach, he adds, is "reminiscent" of what President Franklin Roosevelt did to help bring the nation out of the Great Depression of the 1930s, a time when Samuelson was studying economics at Harvard University.

College-educated Americans of a certain age probably know Samuelson as the economist whose textbook gave them a grounding in that subject. For decades after it was first published in 1948, "Economics" was the bestselling economics textbook in the US. It has been translated into 41 languages. In total, more than 4 million copies have been sold.

Of course, Samuelson is not the only economist to suggest the time is ripe for greater fiscal stimulus.

Dean Baker of the Center for Economic and Policy Research, a Washington think tank, calls for Washington to provide $300 billion to $400 billion to states and municipalities to spend on infrastructure, green retrofitting of buildings, and other useful projects that will provide new jobs or maintain old ones.

Baker suspects the labor market will remain weak through 2010 or 2011.

Lower interest rates useful

Samuelson also welcomes last Wednesday's coordinated half a percentage point cut in interest rates by six major central banks, including the Federal Reserve. Some economists had been calling for a full percentage point cut to what is known as the federal funds rate, from 2 percent to 1 percent.

"I'm grateful for half a percent," says Samuelson, hinting that lower interest rates would be useful even if they result in somewhat more inflation in perhaps five years. The extra money in the system, economic theory goes, will eventually be spent by Americans and revive economic growth. A modest increase in inflation, he says, "doesn't mean the end of the world."

Samuelson recalls when John Williams, a professor of finance at Harvard in the 1930s who was also on the board of the Federal Reserve Bank of New York, said in class that he wouldn't lend money to anyone, apparently because he didn't see potential borrowers as trustworthy for repayment.

"We are having that sort of problem today," Samuelson says.

Another economist, Michael Cosgrove of the University of Dallas in Irving, Texas, calls for the Fed to add "permanent liquidity into the system" through its control of monetary policy. He sees the $700 billion rescue package recently passed by Congress as a "defensive action," with the Fed buying the distressed assets of financial institutions, but presumably selling these back into the market at a later stage. The 3 percent growth in bank reserves in the past year is "pretty puny," he says.

"It is going to take quite a long time to build up trust" in the financial system, Professor Cosgrove holds.

Paulson is "experienced, savvy"

Samuelson is not a fan of the Bush administration and its earlier drive to deregulate the financial industry. "The market system is the best system in the world," he says. "But without regulation it is a very bad system ... with tremendous built-in fragility."

He criticizes some Bush appointments for their deregulation program, but does describe Treasury Secretary Henry Paulson as "a pretty experienced, savvy person" and Fed Chairman Ben Bernanke as "pretty cool."

The veteran economist also criticizes corporate chiefs for their extravagant earnings and directors in the corporate boards for approving the high pay. Directors are chosen by the CEOs because they are known not to be "troublemakers," Samuelson says. And he disapproves of the "plutocratic democracy" in the US where well-to-do donors to political campaigns "buy in advance privileges" that may damage the public good.

Samuelson doesn't expect the economy to come roaring back this year or even next, despite the recovery measures taken so far.

That is a common prognostication.

Seeing this fear, both presidential candidates have proposed measures to deal with the problem of housing foreclosures.

Sen. John McCain last Tuesday apparently embraced a proposal by Harvard University economist Martin Feldstein that the federal government should offer any homeowner with a mortgage an opportunity to replace 20 percent of the mortgage with a low-interest loan from the government, subject to a maximum of $80,000.

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