Forget Wall Street. What about the rest of us?

Posted by Justin Fox

Ethan Harris, the chief U.S. economist at bankrupt Lehman Brothers, says it's been "the most tumultuous two weeks of my personal and professional life." Even on Friday, with the tumult settled somewhat by Barclays' purchase of Lehman's core business and Hank Paulson's plans to purchase the American financial system, things were still kind of weird: A Japanese TV crew was filming Harris as we talked on the phone. And next week, as Barclays takes over at Lehman, he gets to find out--or at least start to find out--if he still has a job.

For Harris and everybody else on Wall Street, the gravity of this financial near-meltdown is pretty clear. It understandably all remains something of a puzzle to a lot of other people. The New York Times reported that members of Congress were stunned into silence by the dire picture painted by Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke of what would happen if they didn't create an agency to take bad debts off bank balance sheets. The picture? Financial breakdown, with banks ceasing to lend and the economy grinding to a halt.

That's clearly really bad. But what will the economy look like if Congress does approve a workable bailout plan, and the worst-case scenarios are averted?

Well, probably still pretty bad. "By the time we’re done here this is going to be equivalent to the big recessions of the past," says Harris. "Similar to the recessions of 1974 and 1982." That's a lot better than a rerun of the Great Depression. But it still means big-time job losses, and lots of painful retrenchment for consumers and business.

This is not, yet, a unanimously held opinion. There is even still some debate over whether this even is a recession. But I'm thinking that's going to fade away soon. "All my cousins already know we’re in a recession," says Bob Barbera, chief economist at ITG and, coincidentally, a former Lehman chief economist. "You need a Ph.D in economics to have a debate about it." Barbera thinks that, "in the fullness of time," it will be apparent that the recession began in autumn 2007.

Barbera also believes this recession will end early next year, which is a nice thought. But what comes afterward probably won't feel so great either. "I’d be very surprised to see a strong recovery in the economy," says Harris. "The consumer was being spurred along by two big booms, housing and the stock market, and this expansion of debt." No more. "You’ve got a much more conservative consumer in the next decade," he says.

This is what the aftermath of an epic credit bubble looks like. For the financial sector, never very good at retrenching in an orderly fashion, it's a time fraught with risk of collapse. But even if collapse is averted, the bubble still has to deflate. And it is deflating: Household debt, which grew at double-digit rates from 2002 through 2006, rose at just a 1.4% pace in the second quarter, according to data released Thursday by the Federal Reserve. This is, for the long-run financial health of Americans, a good thing. It just means there won't be much economic fun anytime soon.

"I think there is something fundamentally positive about the U.S. economy," Harris says. "Great technology, a great educational system, an entrepreneurial spirit. But those things don’t really matter that much over the next couple of years."

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