Brian Wesbury today reminds us in this article that the crisis playing out on Wall Street is mostly financial in nature, and does not necessarily pose a serious risk to the economy. I've been pointing out in most of my posts here that although the economy is a bit on the weak side, we have not yet slid into a recession, and Brian agrees. Similarly, while subprime lending has virtually ceased to exist, more traditional forms of lending are proceeding apace. As Brian notes, and I agree, it is critically important that today's problems are not the result of any drastic change in government policies. Credit is contracting to a subset of borrowers, but overall credit conditions remain healthy. Some banks are going out of business, but there is no shortage of dollars in the world, and interest rates remain relatively low compared to inflation (see chart). Taxes have not gone up, and despite Gov. Schwarzenegger's worst efforts, California has apparently resolved its budget crisis without raising taxes. World trade continues to expand, and exports are the brightest star in the U.S. economy.
Update: This financial crisis can be likened to the impact of a neutron bomb which creates an electro-magnetic pulse that fries electronics but leaves buildings and people intact. Paper wealth has been destroyed, because lenders were careless and many used too much leverage. But the homes that were built remain, and most people are still working; job losses to date haven't yet approached the level of a recession or even a mild one. The paper wealth that has been vaporized represents claims on future cash flows. Those claims don't represent any new growth or new investment, they simply mean that cash will not flow from some homeowners to some lenders in the future. But the underlying source of all cash flows—work, investment, risk-taking, job creation—remains intact.