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Economic Scene

Perhaps, It’s Time to Play Offense

WASHINGTON — Late last week, as Lehman Brothers was collapsing, an all-star group of economists was meeting here to ponder the lessons of the financial crisis. The group included Donald Kohn, the vice chairman of the Fed, and Edward Lazear, the top White House economist, as well as Lawrence Summers, the former Treasury secretary, and a few dozen others.

The discussion revolved around a handful of academic research papers, but it really boiled down to this: How do we get out of this mess?

At one point, Benjamin Friedman of Harvard raised his placard to inject a little sunshine into the room. If somebody had told the economists a year and a half ago what was about to befall Wall Street and then asked them to predict the economic impact, Mr. Friedman said, they almost certainly would have forecast a steeper downturn, with many more layoffs, than has occurred.

The fact that it hasn’t, so far, should be considered a victory for Ben Bernanke and Henry Paulson, the point men on the crisis. After some early missteps, they have acted aggressively to keep the financial system functioning — including Tuesday’s stunning takeover of A.I.G. — while still forcing Wall Street to suffer for its sins. The problem, unfortunately, is that neither man has done much to deal with the problems that caused the crisis in the first place.

For the past two and a half months, I’ve been on a break from column writing, and I’m struck by how much has changed during that time — and yet how little the big picture has changed. Lehman Brothers, Merrill Lynch, Fannie Mae and Freddie Mac have all essentially collapsed. But just as at the start of the summer, economists can’t even agree whether the country is in a recession.

The Bush administration, the Fed and Congress, meanwhile, continue to focus on the immediate crises, with little attention to the underlying reasons that the economy has gotten into this mess — a stagnation of incomes, an explosion of debt and a decidedly outdated, and limp, approach to government oversight. Remarkably, the presidential campaign has gotten less serious, while the economy’s problems have become more so.

So, yes, Mr. Bernanke and Mr. Paulson have done a nice job of playing defense. But when will someone start playing offense?

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A good way to see the problems with a fingers-in-the-dikes strategy is to look back to the first big bailout of modern times. Before A.I.G., before Fannie and Freddie, before Bear Stearns, there was Chrysler.

In 1979, when it was still the 10th largest company in the country, Chrysler found itself on the verge of collapse, largely because high oil prices had made its gas guzzlers unappealing. Company executives and union leaders came to Washington, hat in hand, arguing that Chrysler’s demise would wreak unacceptable damage on the American economy. Congress and the Carter administration responded by arranging for $1.2 billion in subsidized loans. The Reagan administration helped further in 1981 by restricting Japanese imports.

On its face, the Chrysler rescue was a huge success. Under Lee Iacocca, the company came out with the K-car line of smaller vehicles, like the Dodge Aries, as well as the original minivan. By the mid-’80s, Chrysler had repaid the loans. Mr. Iacocca appeared on the cover of Time magazine as “Detroit’s comeback kid,” and his autobiography became a No. 1 best seller.

You can draw a clear line from the Chrysler bailout to the recent attempts to steady Wall Street. Back then, Washington insisted on a few pounds of flesh, like a wage freeze for Chrysler workers, in exchange for aid. Mr. Paulson has done something similar by insisting that shareholders of the Wall Street firms benefit little from any bailout.

In 1979, the government structured the Chrysler deal so that taxpayers might earn a profit from it (which they did). This year, the Fed effectively purchased securities from Bear Stearns that it hopes to sell for a gain when the financial markets calm down. While it’s way too early to know if the strategy will succeed as well as it did three decades ago, it’s certainly conceivable.

But if you take a moment to think through the full Chrysler story, you start to realize that it’s setting a really low bar. The Chrysler bailout may have saved the company, but it did nothing, after all, to stop Detroit’s long, sad decline.

Barry Ritholtz — who runs an equity research firm in New York and writes The Big Picture, one of the best-read economics blogs — is going to publish a book soon making the case that the bailout actually helped cause the decline. The book is called, “Bailout Nation.” In it, Mr. Ritholtz sketches out an intriguing alternative history of Chrysler and Detroit.

If Chrysler had collapsed, he argues, vulture investors might have swooped in and reconstituted the company as a smaller automaker less tied to the failed strategies of Detroit’s Big Three and their unions. “If Chrysler goes belly up,” he says, “it also might have forced some deep introspection at Ford and G.M. and might have changed their attitude toward fuel efficiency and manufacturing quality.” Some of the bailout’s opponents — from free-market conservatives to Senator Gary Hart, then a rising Democrat — were making similar arguments three decades ago.

Instead, the bailout and import quotas fooled the automakers into thinking they could keep doing business as usual. In 1980, Detroit sold about 80 percent of all new vehicles in this country, according to Autodata. Today, it sells just 45 percent.

There is a similar chance for us to be fooled about the extent of today’s problems. Some day, house prices will stop falling and the financial markets will calm down. But the underlying problems aren’t going away on their own.

At its core, the current crisis stems from two problems. Regulators, starting with Alan Greenspan, assumed that a real estate bubble couldn’t happen and that Wall Street could largely police itself. And households, struggling with incomes that haven’t kept up with inflation in recent years, said yes when those lightly regulated banks offered them wishful-thinking loans. No bailout can solve either problem.

The past week has offered a glimmer of hope that the policymakers want to get beyond short-term fixes. Mr. Paulson drew the line at Lehman Brothers last weekend, refusing to save it from bankruptcy. On Tuesday, the Fed kept its benchmark interest rate steady, rather than pretending that ever-cheaper borrowing was a cure-all.

Now should come the harder part: a much more serious attack on our economic problems. Earlier this week, I called Mr. Hart, who has written some thoughtful things about the economy lately, for his take on all this. “We’ve been consuming more than we’ve been producing. We’ve been spending more than we’ve been earning,” he told me. “It’s been a big holiday.”

His list of solutions is a pretty good one. The tax code, he said, should be changed to reward savings far more than consumption. The resulting savings would help families prepare for retirement — and also become a pool of money that companies could invest in productive ways. The federal government should lend a hand, by investing in areas like basic science and technology, which could, in turn, help create more good-paying jobs than the economy has been able to create recently. The government also needs to bring down Medicare costs, which is the key to solving its long-term budget deficit.

That’s one path. Another would be to add to the deficit by paying for one bailout after another.

Speaking of which, Detroit’s Big Three have come back to Capitol Hill lately, lobbying for billions of dollars in handouts. This time, their executives insist, they’ll use the money to solve their problems.

Email: leonhardt@nytimes.com

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