The biggest challenge for President elect Barack Obama is to stop Congress turning this recession into a depression, says Adam Lass. Reckless government spending and “crony capitalism” got us into this mess. And throwing endless credit at non-productive industries will only end up creating inflation and destroying the dollar.

This from The Rude Awakening:

The American people voted for change…and now they’re going to get it. But the change they get may not be the change they expect Obama to deliver. Something more sinister may be coming our way.

After an historic election and inauguration, president-elect Obama will enter office with a huge list of challenges. These challenges — from a contracting economy to large-scale corporate bankruptcies to soaring national indebtedness — will undoubtedly restrict his agenda.

Let’s hope Obama recognizes the need for incentives, profits, and capital investments in the economy. The economy cannot be taxed and regulated without potentially severe consequences. Former Fed Chairman Paul Volcker (and the last Fed chairman to provide adult supervision for the banking community) is an Obama adviser. So Obama should be apprised of the consequences of Carter-era deficit spending and money printing.

At the very least, Obama must act as a check on the potential for a Democrat-dominated Congress to turn a recession into a depression.

For example, some in Congress are floating a proposal to steal your 401(k), sell the proceeds, and invest in “government-guaranteed” retirement accounts. The only thing this Marxist idea would guarantee is a depression. Call or write your congressman if you feel that your 401(k) is in danger. We shouldn’t allow them to steal more from prudent savers than they already have.

Keep in mind that presidencies rarely resemble campaigns. President Bush campaigned on limited government and a humble foreign policy, and we got the opposite. To top it off, we had the illusion of real growth, with credit and housing bubbles that led to the greatest misallocation of resources in history.

The free market has been falsely accused for this financial crisis. But the free market didn’t get us here; a combination of government spending and crony capitalism did. Much ink is wasted on how we need to re-regulate Wall Street, but the fact is that the problem would never have grown so large without agency conflicts.

The agency conflict on Wall Street is the mentality of “heads I win, tails you lose.” CEOs, traders, and mortgage-backed security factories were paid more for taking more risk. So it shouldn’t surprise us that they overdosed on leverage to magnify returns, without considering risk.

Performance pay should be based on creating long-term shareholder value, not on meeting next quarter’s earnings estimate. A good place to start would be bonuses in the form of restricted stock that does not vest for 10 years. I doubt Lehman would have blown up if employees were paid modest salaries with the potential for sizeable ownership stakes in the future.

Much of our current mess resulted from totally complacent, incompetent boards of directors. Carl Icahn has good ideas for how this can be addressed without excessive regulation. Icahn explains how most corporate boards behave like government bureaucrats in this post . In my view, we need an economy in which everyone acts like owners, rather than CEO-pillagers.

A banking system built upon on a foundation of paper money also contributed to this crisis. The Treasury and Fed allowed institutions to grow “too big to fail.” Without taxpayer subsidies (i.e., Fannie and Freddie — two of the worst crony capitalist institutions in history) and the subsidy of Fed rate cuts, housing prices would have kept growing in step with household income. Instead, house prices went to the moon. Precious capital was thrown into a black hole when mortgage-underwriting discipline went out the window and homebuyers deluded themselves with bubble psychology.

When the current deflation fears are finally slain by widespread recognition that paper money is limitless, we’ll probably see a return to inflation and higher long-term interest rates.

For now, though, demand for bonds remains strong (rates remain low). So the government will likely keep issuing record amounts of new Treasuries and use the proceeds for bailout after bailout, instead of for productive uses. In other words, the government will toss billions of dollars at walking corpses like AIG – a company that produces nothing but spectacular losses and embarrassing headlines – instead of tossing billions of dollars at companies that produce essential items like barrels of oil or bushels of wheat. When governments toss easy credit toward non-productive industries, the supply of currency soars relative to the supply of goods and services. We call this phenomenon, “Inflation.”

The U.S. government’s massive borrowing requirements over the next several months will absorb a lot of the private capital that would otherwise fund various productive enterprises. So that means that farmers and miners and manufacturers will struggle to secure the credit and investment they need to finance their production. And if farmers can’t get credit, they can’t plant crops, which means that grain supplies are likely to fall…and prices to rise.

As Albert Einstein observed, “The significant problems we face cannot be solved by the same level of thinking that created them.” If the federal government proposes “solutions” to this crisis with the same type of thinking that got us here, we could be in for a very long period of economic pain. America’s status as a destination for foreign capital is at stake.

If the new government fails to act wisely and understand how we got here, the only “government guarantee” we’ll have is depression.

Source: Government-Guaranteed Depression