Former Reagan adviser Martin Feldstein says that the current economic downturn is the worst since the end of World War II and that additional government deficit spending may be needed to stimulate a recovery.
Even so, fixing the crumbling housing market by abrogating existing mortgage contracts should be done quickly, Feldstein told CNBC.
Homeowners who owe more on their mortgages than their houses are worth pose a major problem, one which Feldstein said will require rewriting their debt instruments, echoing the views of FDIC Chair Sheila Bair.
A bill to do just that was negotiated last week by Citibank with members of the U.S. Senate and could end up in the $775 billion stimulus bill President-elect Barack Obama wants to sign soon after he takes office. Other banks are expected to take part if the law is approved.
“If that isn't tackled, then all this fiscal stimulus alone is not going to do the job," Feldstein said.
“American households have lost more than $10 trillion of net worth in the stock market and housing prices. They are cutting back on their spending. ... Where's the demand going to come from?" said Feldstein.
Though he is a conservative and a supporter of Reagan’s supply-side economic theory, Feldstein said that the severity of the downturn mandates a different approach which goes beyond the hundreds of billions the government since last year already has poured into the economy.
"The economy is likely to be in worse shape a year from now and will require aggressive government spending and intervention to stem the damage," Feldstein told CNBC.
"I think we'll be lucky if by this time next year we see the economy having hit the bottom and starting up, and that's still going to leave us at a very low level of economic activity even if the turn has come at that point," Feldstein said.
The U.S. government also will have to change the tax structure for capital gains and corporations and exercise caution against inflation, said Feldstein, an economist at Harvard and president emeritus of the National Bureau of Economic Research (NBER).
Other economists do not agree that giving Washington even more power over the economy is the right solution.
"On both Wall Street and in Congress, the same old crooks and party hacks who succeeded in producing the greatest economic crisis since the Great Depression have now ended up with even more power and more control than they had before the election," writes Ralph R. Reiland, the B. Kenneth Simon Professor of Free Enterprise at Robert Morris University, in Human Events magazine.
"Where’s the change we can believe in?"
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