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It was a bruising year for U.S. capitalism. Not only did the world’s largest economy plunge into recession, but financial mismanagement and misjudgment triggered a global financial crisis. The question now is whether President-elect Barack Obama has learned lessons of history and can rally domestic and international support to stave off a truly Great Depression. If he does, he may restore some of the luster that his country has lost in recent years. Thus far, the signs are positive.

Historians will remember 2008 as the year that a financial crisis “made in America” rocked the world. The inability of subprime mortgage holders to repay loans set off a string of failures among financial companies. But not only banks and mortgage companies were holding bad paper. Those debts had been packaged as securities and resold around the world. Those instruments plunged in value as well, leaving other financial institutions with worthless pieces of paper. The rush to salvage those assets triggered a financial crisis that sucked the liquidity out of international capital markets.

There is blame to go around for this financial tsunami. Banks gave mortgages to unworthy borrowers and failed to explain the terms of loans. Borrowers took loans that they knew they could not repay. Financial companies repackaged those loans and sold them, knowing that their value was uncertain at best. Companies bought those securities, not understanding their value. And regulators adopted a hands-off approach that facilitated the spread of toxic debt.

It is the failures of regulators that most damaged the image of U.S. capitalism and competence. Wall Street was obsessed with making money, consequences be damned. But mechanisms to supervise the market proved flawed. In some cases, there was confusion about mission. What was more important: expanding home ownership or guarding against risk? In other cases, it was pure greed. Companies entrusted with evaluating securities were compromised — more clients to issuing firms than independent arbiters of worth. Other “independent” agencies like Fannie Mae and Freddie Mac focused on profits and were convinced that the government would bail them out if they suffered losses. Sheer incompetence seems to have been the case with the Madoff scam, a $50 billion Ponzi scheme that went undiscovered for years. Ultimately, the deepest flaw was a belief that markets would regulate themselves and that greed could be contained. This faith in the self-correcting nature of capitalism has proved mistaken — to America’s and the world’s regret.

The United States deserves credit for recognizing the severity of the situation and the need for rapid action. But then, in a very public fashion, Congress dithered, putting ideology above action as Republican senators delivered a public rebuke to a Republican president, raising concerns that partisan divides were so deep that even a national catastrophe was unable to spur them to action. The legislature eventually acted, yet more damage was done.

The $750 billion relief package highlighted more problems. The legislation allowed banks to take funds without using them to free up credit markets. Banks have refused to provide information where the billions went. There is evidence that they shored up executive compensation or were used to purchase other financial entities rather than help consumers or businesses in need. There is also evidence that the bailout package was written to permit that behavior. The idea that federal funds should be used for bonuses for executives of failed institutions rather than for workers’ homes and paychecks is appalling.

Then there is the notion that the U.S. government is taking over significant parts of the U.S. economy. Those on the left gleefully note the return of “socialism”; they exaggerate but this creeping intrusion into the private sector is proof again of the need for skeptical pragmatism rather than blind ideology. As Congress debates aid to other sectors, such as automakers, the incoherence of U.S. thinking is evident.

Damage has been done to the real economy. Economists say the recession began in December 2007. The slowdown accelerated throughout the year; the U.S. economy shrank 0.5 percent in the third quarter, the worst showing since 2001. One survey of economists forecast a fourth quarter decline of 4.3 percent, the biggest drop since 1982, that would continue into 2009. Official unemployment could hit 10 percent; economists fear that real unemployment could be double that figure.

The human costs will also be severe. But longer term, there could be damage of another kind. Some fear the loss of the dollar’s reserve currency status, which could undermine U.S. supremacy in the global financial order. The plunge in the value of the dollar is a portent. Just as critical is the unraveling of the image of American competence in global economic management. This is the real foundation of American power. The Obama administration must move quickly to remove this stain and prove that Washington is an effective manager and protector of global order and stability.

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