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Paul Krugman writes about the knock-on effects of the government paying off all of AIG’s obligations at 100 cents on the dollar:

Brad DeLong says that the loss of public trust due to the kid-gloves treatment of bankers has raised the probability of another Great Depression, because the public won’t support another round of bailouts even if it becomes desperately necessary. I agree — but I think the bigger cost is that we’ve greatly increased the chance of a Japanese-style lost decade, with I would now give roughly even odds of happening. Why? Because bank-friendly policies have squandered public trust in all government action: try talking to the general public about stimulus, and it’s all confounded in their minds with the deeply unpopular bailouts.

By itself, the AIG story would be damaging enough. But it’s part of a pattern — and that pattern has ended up undermining the economy’s prospects, big time.

It’s surprisingly hard to disagree with this.  The most optimistic take, I suppose, is that the economy will continue to recover slowly, there won’t be another big shock that requires extraordinary government action, and we’ll get out of this OK.  And I suppose that’s still the most likely scenario.  But public anger over the bank bailout, which was blazing earlier in the year, hasn’t really abated.  Sure, the tea parties are mostly over, but anger over the bailout is still smoldering, and it’s pretty likely to increase as we continue to see headline after headline about how happily Wall Street is recovering in the middle of a deep recession thanks to all those bailout dollars.  Congress could tamp down some of this anger if it enacted some serious regulatory reforms over the next few months, but what are the odds of that?  Call me a pessimist, but I don’t think they’re very good.

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