John Mauldin describes why we should be concerned about Greece and increasing debt.

Link: What Does Greece Mean to You?

It seems we did not learn the lessons of this crisis very well. First, we have not fixed the problems that made the crisis so severe. We have not regulated credit default swaps, for instance. And European banks are still highly leveraged.

Why is Greece important? Because so much of their debt is on the books of European banks. Hundreds of billions of dollars worth. And just a few years ago this seemed like a good thing. The rating agencies made Greek debt AAA, and banks could use massive leverage (almost 40 times in some European banks) and buy these bonds and make good money in the process. (Don’t ask Dad why people still trust rating agencies. Some things just can’t be explained.)

Except, now that Greek debt is risky. Today, it appears there will be some kind of bailout for Greece. But that is just a band-aid on a very serious wound. The crisis will not go away. It will come back, unless the Greeks willingly go into their own Great Depression by slashing their spending and raising taxes to a level that no one in the US could even contemplate. What is being demanded of them is really bad for them, but they did it to themselves.

But those European banks? When that debt goes bad, and it will, they will react to each other just like they did in 2008. Trust will evaporate. Will taxpayers shoulder the burden? Maybe, maybe not. It will be a huge crisis. There are other countries in Europe, like Spain and Portugal, that are almost as bad as Greece. Great Britain is not too far behind.

The European economy is as large as that of the US. We feel it when they go into recessions, for many of our largest companies make a lot of money in Europe. A crisis will also make the euro go down, which reduces corporate profits and makes it harder for us to sell our products into Europe, not to mention compete with European companies for global trade. And that means we all buy less from China, which means they will buy less of our bonds, and on and on go the connections. And it will all make it much harder to start new companies, which are the source of real growth in jobs.

And then in January of 2011 we are going to have the largest tax increase in US history. The research shows that tax increases have a negative 3-times effect on GDP, or the growth of the economy. As I will show in a letter in a few weeks, I think it is likely that the level of tax increases, when combined with the increase in state and local taxes (or the reductions in spending), will be enough to throw us back into recession, even without problems coming from Europe. The research was done by Christina Romer, who is Obama’s chairperson of the Joint Council of Economic Advisors.

And this next time, we won’t be able to fight the recession with even greater debt and lower interest rates, as we did this last time. Rates are as low as they can go, and this week the bond market is showing that it does not like the massive borrowing the US is engaged in. It is worried about the possibility of “Greece R Us.”

Bond markets require confidence above all else. If Greece defaults, then how far away is Spain or Japan? What makes the US so different, if we do not control our debt? As Reinhart and Rogoff show, when confidence goes, the end is very near. And it always comes faster than anyone expects.

The good news? We will get through this. We pulled through some rough times as a nation in the ’70s. No one, in 2020, is going to want to go back to the good old days of 2010, as the amazing innovations in medicine and other technologies will have made life so much better. You guys are going to live a very long time (and I hope I get a few extra years to enjoy those grandkids as well!). In 1975 we did not know where the new jobs would come from. It was fairly bleak. But the jobs did come, as they will once again.

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.