American consumers and American financial institutions are suffering dyspepsia from an extended trip to Las Vegas. The consumers drank and ate too much, and the banks gambled too much and lost big.

Now, to keep a deep recession from turning into a depression, the federal government wants the banks to lend money to the consumers so they both can get more dyspeptic. Understandably, the consumers don’t want to borrow, and the banks don’t want to lend.

Just a bit ago, U.S. households had 39 percent more debt than income. (That debt-to-income ratio has dropped slightly in the recession.) In 1962, consumers had 37 percent less debt than income. In 2001, they had only 1 percent more debt. “The U.S. debt-to-income ratio rose as much in the past 7 years as it did in the previous 39 years,” says economist David Rosenberg of Wall Street’s Merrill Lynch. Household net worth (assets minus liabilities) has been declining at a record rate. “Households are shrinking their balance sheets. Delinquencies in prime and subprime mortgages are at record highs. One in ten households are in foreclosure or in arrears” on their debt.

Merrill Lynch should not be talking about financial irresponsibility. It gambled heavily on derivatives, particularly those tied to housing. In a shotgun marriage, Bank of America took over Merrill at a ridiculously high price — and now Bank of America is in the soup. In fact, it’s crucial to understand that the major banks and Wall Street investment banks (now simply called “banks”) are dead broke. Busted. They hold these derivatives — popularly called “toxic assets” — and there is no market for them. So you wonder why the banks don’t want to make loans?

Banks resuming their lending to consumers would be like two drunks helping each other across the street — yet that’s what the government wants. Consumers, even though they are tapped out, are the only hope to stimulate the economy. Stimulating residential and commercial real estate is out of the question. The first remains deep in the hole, and the second is plunging in right now.

What about manufacturing? In years past, when faced with a recession, the government would take moves to stimulate manufacturing. But look at the numbers: 50 years ago, manufacturing was 28.7 percent of employment, according to the Alliance for American Manufacturing. Now it’s 9.8 percent, and there are one million fewer workers making things than there were half a century ago. We’ve shipped those higher-paying jobs abroad to jack up corporate profits and chief executives’ obscene remuneration.

In San Diego 50 years ago, manufacturing was 27 percent of total employment, says Kelly Cunningham, economist for the National University System Institute for Policy Research. Now it’s down to 8 percent. Half a century ago, San Diego had 74,000 manufacturing jobs, and 51,000 were in aerospace. Now there are only 6400 aerospace jobs.

The consumer dyspepsia is more acute in San Diego. Housing prices soared more rapidly than almost anywhere in the country. Then they crashed more traumatically. San Diego consumers had borrowed against that phony increase in the value of their homes. Further, more than in other cities, San Diegans had exotic mortgages with rates that rose through time. “Definitely, our households are more heavily in debt” than households in most other U.S. locales, says Cunningham.

And remember, even before home values began to soar, San Diegans were too deeply in debt. “San Diego housing costs are 46 percent higher than they are in the nation, and the cost of living is 31 percent higher,” while incomes are only 24 percent above the national norm, says Cunningham. Now the boa constrictor is squeezing harder.

Businesses that rely on consumer spending are feeling the pinch. In 2005, there were almost 43,000 retail outlets (including restaurants) in San Diego. Two years later it was barely above 40,000, and this year it could easily fall to 38,000, says Cunningham. “Retail employment between December of ’07 and December of ’08 was down 8500 jobs, the biggest drop of any sector,” says Alan Gin, economist at the University of San Diego. San Diegans’ consumer confidence “is at an all-time low. The index is half of what it was a year ago. I don’t see any positive signs for consumer spending right now.”

Abe Lincoln said that government should only do what the people can’t do for themselves. Ross Starr, University of California, San Diego economist, feels the same way. With broke banks not lending and consumers not willing to borrow, that leaves the federal government. It can still borrow, and it should do so to finance infrastructure investment, as well as other initiatives such as aid to states that are severely ailing, says Starr. Infrastructure projects should create jobs and boost consumer income. In time, depleted household savings will rise, and consumers might want to spend responsibly again.

In the meantime, the banking sector remains problematic. “We need a financial sector capable of channeling those private savings into investment. It is not doing that right now,” says Starr. For several years, these banks have been gambling on derivatives “that are really poisonous. It’s hard to tell how many booby traps the financial sector is sitting on.”

“There is no question that some capital was misallocated,” says James Hamilton, also an economist at the University of California, San Diego. “You would have to be crazy to deny that. We put a lot of resources into building up the housing stock. Was that a mistake? You bet it was.”

In my judgment, Wall Street was not only gambling on derivatives but also on counterproductive activities such as leveraged buyouts, a dubious process by which a public company is taken private, loaded up with debt, and brought public again — accomplishing absolutely nothing except making a few people rich and ladening a company’s balance sheet with low-quality (often junk) leverage. Thank goodness leveraged buyouts have almost disappeared in the credit crunch.

Consumer spending is now more than 70 percent of the U.S. economy (and about the same percent in San Diego). “We were importing goods from countries that we promised to pay later. That was not sustainable. It has left us poorer today,” says Hamilton. “We were borrowing hundreds of billions from China and other places. Was this constructive? It was not.” He is concerned that the borrowing the United States will have to do to finance the stimulus program could worsen the deficit greatly and complicate the process of the Treasury raising money.

And, notes Starr, we will have all this additional borrowing at a time when the demographics are going against us. “The bulge in population currently aged from their early 40s to early 60s will be retiring over the next two decades, requiring increased medical care” and other entitlements such as Social Security. The U.S. has known about this for decades but has not prepared for it. “The balance sheet of the federal government is a pension fund with an Army and a Navy.”

That should make you feel better. Go out and borrow and consume!