Coming Soon: The Tea Party Recession of 2011?

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Back in 2008, during the worst of the financial crisis, I remember that many of us were shaking our heads a bit over Europe. American banks were clearly overleveraged, which led to the collapse of Bear Stearns and Lehman and Wachovia, and the near collapse of several others, but European banks mostly came through unscathed. Outside of Great Britain (and Iceland, of course), Europe suffered only a few bank failures, and they were pretty easily contained. And yet, European banks, on average, were more highly leveraged than ours. Shouldn’t they have collapsed even worse than ours? What gives?

Well, now we know: European banks were in worse shape than ours, but they were overleveraged in a different way that allowed them to hang on a couple of years longer. But now the jig is about up. Greece is about ready to fail, and after that, maybe Spain and Italy too. Ezra Klein talks to Desmond Lachman about what this means:

EK: And if some of these dominoes fall, how bad are things likely to get?

DL: What’s really at stake here is the European banking system. These countries might be relatively small, but if you just look at Greece, Ireland and Portugal, that’s $1 trillion in sovereign debt. If you add Spain, that’s another trillion. If you add Italy, that’s another $1.9 trillion. If the European banks take the hit, that could really cause another Lehman moment. It would be a credit crunch that would throw the European economy into a meaningful recession.

Bummer. But hey, that’s just Europe. At least we’ll be OK, right? Sadly, no. We’re highly exposed in a number of ways to trouble in Europe. In fact, it might even be worse this time around:

EK: And what are the chances that this leads us back into a recession?

DL: If you want me to depress you some more, let me tell you what really worries me. If we do go into recession this time around, what will be different from 2008 and 2009 is even if the recession isn’t as deep, we either don’t have the policy ammunition to fight it or we have convinced ourselves that we don’t have the policy ammunition to fight it. So what will the policy response be? Bernanke just showed you he thinks he has very little ammunition left. There’s no way Congress will go in for another big stimulus package. And the Europeans are tied up in the belief that they need to balance their budget.

Just remember: it doesn’t have to be this way, no matter how often and how loudly Republicans shriek about austerity and budget deficits. If we want them to, both monetary and fiscal policy can have plenty of bite left. Bottom line: If we plummet into a second recession, it will be solely the fault of fanatical conservatives in Congress who refuse for reasons both partisan and ideological to acknowledge that we can do something about this. It’ll be the Tea Party Recession of 2011.

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