As the economy teeters between bad and worse, one question looms: What's the best course of action? Here's what can be done. And what can'tWall Street got its hopes up on Mar. 11. Elated by a Federal Reserve move to stop the credit crunch, the U.S. stock market posted its biggest one-day gain in five years, with the Dow Jones industrial average rising more than 400 points. Look out, though. Fed officials are the first to acknowledge that their initiative attacks only one problem, the liquidity squeeze at big banks. It does nothing about the central risk to the U.S. economy: an unprecedented crash in home values that is sapping households' wealth and confidence while putting an enormous strain on the banking system.
How bad will this downturn get? No one can know because we've never experienced such a headlong slide in the housing market—and this comes at a time when its current value of $20 trillion accounts for the vast majority of most families' wealth. Right now most economists expect the U.S. to experience a mild, short recession in 2008. But there is at least a possibility of a steeper decline that the traditional recession remedies—interest-rate cuts here, deficit spending there—won't be able to handle.
What should be done? For policymakers in Washington—Fed Chairman Ben Bernanke, Treasury Secretary Henry Paulson, and congressional leaders—the sensible course is to insure against the small but scary possibility that things could go very wrong. The potential "insurance policies" are government actions that have a real cost but lessen the risk that a mild recession turns into something worse. The International Monetary Fund endorsed that approach on Mar. 12 as First Deputy Managing Director John Lipsky urged policymakers globally to "think the unthinkable and guard against a downward credit spiral."
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