KEY POINTS:
As finance ministers gather in Washington they have some bleak estimates from the International Monetary Fund about the scale and potential duration of the economic crisis, and some urgent advice, to consider.
A group of prominent economists, their views swiftly marshalled by VoxEU, are calling for quick and
concerted action both to restart frozen interbank markets and to recapitalise banks with government money, as the British Government proposes for UK banks.
Professor Barry Eichengreen of UC Berkeley said: "The Paulson plan, everyone now agrees, failed to reassure the markets because it did not credibly and directly address the need for bank recapitalisation."
But the language of the bailout law gave the US Government enough wiggle room to directly inject capital into the banks, Eichengreen said.
The IMF says that since the turmoil started in the middle of last year banks' writedowns had totalled US$580 billion ($978 billion), of which 75 per cent has been replaced by fresh capital. "However raising capital has become extremely difficult in recent months."
The IMF's estimate of the potential total writedowns of loans and others securities in the United States crisis is US$1.4 trillion, most of which (more than $1 trillion) is held by banks.
That is rather more than the losses associated with the US savings and loan crisis in the 1980s, Japan's banking crisis in the 1990s and the Asian financial crisis - combined.
The IMF has also looked at six major financial crises in the early 1990s - in Finland, Sweden, Norway, Japan, the United States and Britain - and the economic contractions which followed.
The average fall in share prices, peak to trough, was 55 per cent. The fall in house prices averaged 20 per cent.
The average loss of economic output, peak to trough, was 5.4 per cent, and the average time before economies had fully recovered was just under four years.
Looking at a broader set of 17 countries over 30 years it found that slowdowns and recessions which were preceded by episodes of financial stress - banking crises, sharemarket crashes or currency crises - tended to be significantly worse than those with other causes. Recessions associated with banking crises tended to be the deepest and longest.
Financial turmoil is more likely to be followed by recession when it is preceded by a rapid rise in house prices and build-up of debt. Contractions tend to be more severe when it is mainly households rather than businesses which are exposed.
And leverage amplifies the cycle. "When banks overextended their balance sheets during booms, on the back of higher asset value and lower perceived rise, there is a build-up of financial imbalances and rapid expansion in [economic] activity, which further boosts assets' values and reduces perceived rise, thereby fostering another round of lending and economic expansion."
When the bubble bursts, however, banks sharply reduce their lending, or the growth in their lending, as their capital falls, prompting an economic slowdown which feeds back into a further reduction in the supply of credit.
