The non-financial sectors of our economy will not suffer much from even a prolonged banking crisis, because the general economic importance of banks has been highly exaggerated.Mulligan argues that the return to capital in the non-financial sector is still high. But it was also high prior to the Great Depression (I am not arguing we are going to have one, but...). It is hard to believe, however, that the drying up of credit will not hurt the rest of the economy. State governments, for example, are coming under great difficulties, and this is before taxes start to fall from reduced spending.
In the fall of 1929 America's leading economist, Irving Fisher, argued that "Stock prices have reached what looks like a permanently high plateau." When the Depression did arise he contributed an important explanation of debt deflation. Perhaps, Mulligan will be our next Irving Fisher.
Compared to Mulligan's article, this piece by Laurence Kotlikoff and Perry Mehrling is tame. They argue that the financial crisis brings offsetting gains as asset prices fall. Focusing on financial losses alone, overstates the problem. But financial bubbles lead to misallocation of capital. Capital has been wasted and will have to be written off. These are real losses. Of course, some people will be able to purchase homes at cheaper prices, but the losses will impact on further investment. They are probably correct that Paulson and Bernanke will not make the mistakes that translated the credit crisis of the early 1930's into the Great Depression. But when an economy deleverages from the levels we have seen, the economy is going to suffer.