Danny Teigman at The Star-Ledger interviews economist Barry Ritholtz about what led to the recession and how to bounce back (9/3/2009).

Link: Interview with Barry Ritholtz

The late 2000s may go down as the age of the bailout. What began with Bear Stearns in March 2008 grew to include a cadre of famous-turned-infamous American financial institutions.

As immediate panic settled, outright bailouts morphed into a multi-billion dollar stimulus package whose impacts are still trickling through the economy.

Barry Ritholtz, author of “Bailout Nation” and director of equity research at Fusion IQ, a New York financial research firm, has a case of the bailout blues. He warns the fundamentals of the country’s banking system remain far from sound.

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While economic incentives are not so toxic as Uncle Sam giveaways, consumer subsidies threaten to turn Americans into a collection of perpetual bargain hunters.

However, if you lose 20%, you must only gain 25% to recover.

Without a complete overhaul, the next financial crisis may make the current one look like a “minor scare,” he argues.

Ritholtz, 47, spoke with Your Business about the events that brought the country to the brink of economic collapse.

Q: What is the big-picture view of how the nation got to where it is?

A: There were a number of factors that took place. They’re all interrelated. It begins probably 30 years ago with the idea that excessive, complex, and costly (government) regulation is a bad thing, and we need to reduce that.

And what ended up happening is somehow that concept morphed into any form of regulation is bad. There’s a balance in the economic world between encouraging financial innovation and allowing rougue brokers to become reckless and threaten the world economy.

If you and I, as taxpayers, have the obligation to be there when these guys screw up we should have the ability to say we’re going to put a speed limit here and not let you go 180 mph.

Q: What other elements helped cause the current recession?

A: The Federal Reserve had encouraged a lot of easy money by essentially taking (interest) rates really low and keeping them there for way too long. When we make the cost of borrowing really cheap, we’re going to encourage people to go out and find things to do with their money.

In January 2001, (Alan Greenspan) started cutting rates down to unprecedented levels. They had been down to under 2 percent previously, (in the 1950s and 60s) but just for really brief periods. Rates were not below 2 percent (for several) quarters at a time.

Greenspan took rates under 2 percent for over 36 months. And he took rates to 1 percent for more than a year. Simply unprecedented.

Q: What were the consequences of ultra-low interest rates?

A: First, everything priced in dollars went through the roof. Second, you had a massive influx of people borrowing money really cheap and then putting it to work. So, that encouraged speculation.

And probably most important for our issue, housing ignited. So you cause a giant spike in home prices over the next couple of years. (Essentially what you create is) this giant backwards economic cycle where people were spending money out of their houses as opposed to earning money in a way to maintain their lifestyle. In the nineties, less than 1 percent of discretionary spending came from (a home’s equity).

By ’04, ’05, ’06, it had leaped to over 10 percent of discretionary spending. It actually ended up adding 2 percent to Gross Domestic Product.

Q: So, how did cheap money result in the age of bailouts? Why are bailouts so bad?

A: Essentially, the Treasury Department and the Federal Reserve panicked and just started throwing as much money as they could at these (banks). The phrase that we heard was that we have to save the banking system.

But if you want to save the banking system, you don’t care about individual banks. The best example of that is Japan in 1989. They had zombie banks around for 10, 15 years. They didn’t put any of their banks out of their misery, and they had a decade-long recession.

The idea of saying Citigroup is insolvent was unthinkable to them. They were a sacred cow. If the sacred cow gets mad cow disease, you’ve got to put it down. The problem with bailouts in general is when an industry or company goes bankrupt it typically means that there is a structural flaw in the setup of that company.

Instead of fixing the problem we’re essentially covering up the cracks with a lot of cash. We (still) have banks that are engaged in any manner of highly leveraged, highly reckless speculation. We have yet to fix that.

Q: When was the country’s first major company bailout and was the financial rescue a success?

A: In 1971, it was Lockheed. It was a $250 million loan. It really set the stage for what (later) took place. Since we’ve now spent trillions of dollars bailing out all these banks, and it traces itself back to Lockheed, it was a horrific failure in terms of encouraging more reckless behavior by management.