Stimulus for the Long Run

Stimulus for the Long Run

October 23, 2008

When Congress returns to Washington following the election, its first priority will be to pass another stimulus package for the sinking economy. It’s already clear that the package will involve about $200 billion in new stimulus or a boost equal to about 1.4 percent of GDP. The question is what form should the package take. The path of least political resistance is another round of tax rebates for American families, which they could spend to jumpstart demand and, ultimately, the business investments and jobs to meet that demand. The catch is, that path is very unlikely to work this time. Moreover, the new president-elect and Congress can put that $200 billion to uses that will stimulate long-term growth and income gains much more effectively.

Most people won’t spend small windfalls when they’re worried about losing their jobs or homes next month or finding themselves unable to pay their health care premiums or their kid’s tuition. Instead, they save such windfalls or use them to pay down debts. That’s just what happened this past spring with most of the tax rebate in the last stimulus. With unemployment rising, home values continuing to fall and the stock market down nearly 40 percent over the last year, most Americans are even more anxious today and feeling a lot poorer. In this environment, two-thirds of more of those rebate checks would simply be saved, providing virtually no stimulus.

But we still need that stimulus, if only as an insurance policy against future economic shocks that could deliver serious new blows to faltering economy, such as a run on the dollar that would drive up interest rates or another wave of financial failures if the deterioration in the housing market get worse. And since the recessions in countries that suffer financial meltdowns are usually longer and deeper than normal, we should prepare ourselves for another year or more of tight times.

There are better paths for the coming stimulus package than tax rebates. A piece of it should go to ease some of the recession’s immediate pressures and pain: Extend unemployment benefits for the millions more Americans likely to lose their jobs in 2009, and give states and cities infusion of funds so they don’t have to make sharp cuts in the payrolls of teachers, police and other public workers, or in Medicaid services for sick low-income people.

The President-elect-to-be and Congress, however, should direct the lion’s share of the $200 billion in a new direction: Investments in the basic elements of growth for next decade. In effect, we should use the stimulus to drive policy reforms that will affect the shape and strength of the next expansion, rather than simply its timing. A third or more of the new funding should go to infrastructure — and most of that not for traditional roads and bridges, but for the public requirements of the low-carbon, energy efficient economy we know we have to build. The package could provide, for example, the first support for modernizing the nation’s electricity grid. The Federal Government also could make itself a model of climate-friendly and energy-efficient ways of doing business, with large-scale, new investments to upgrade the heating, cooling and lighting systems of all federally-owned buildings for low-carbon energy efficiency and to shift the federal fleet to hybrid and other energy efficient vehicles. The package also could include new tax preferences for businesses and households to upgrade their systems.

Investments in public transportation could be another important focus for stimulus spending. Today, public transportation accounts for just one percent of U.S. passenger miles, compared to 5 percent in Canada, 10 percent in Europe and 30 percent in Japan. For the short term, the stimulus package could include subsidies for local transit systems to cut their fares by half or more. For the long-term, the package can include down-payments on a new national program to promote the construction or extension new light rail systems for metropolitan areas, which can also create jobs quickly.

Through this recession and into the next expansion, wage and productivity gains will increasingly be tied to a person’s capacity to operate in workplaces dense with information and telecommunications technologies. Knowing that, we also can direct some of the stimulus to a plan we developed and which Senator Obama has endorsed, to provide grants to community colleges to keep their computer labs open and staffed in the evenings and on weekends for any adult to walk in and receive free computer training. Since we know that every American student also needs to develop computer and Internet-based skills, the stimulus also can include the first funding for an innovative program to provide inexpensive laptops developed by the MIT Media Lab for every sixth-grade student. Finally, the stimulus package can fund the extension of broadband installation and service for users in every school, local library, and local and state human services offices.

These are all investments which we know we have to do, if we really intend to make the U.S. economy more efficient, innovative, and sustainable. We also know that Congress will pass some $200 billion in new stimulus within a month’s time. The new president-elect can use this coming occasion not only to create more jobs, but to do so in ways that will help drive the development of a real, 21st century workforce and genuine 21st century economic infrastructure. And taking this course could be an early and important opportunity for him to practice both his new politics and a new form of economic leadership.

Who’s in Charge?

October 17, 2008

As American tangle with an accelerating economic downturn, scarily-volatile stock markets, and an array of bailout and other emergency programs, yet another pitfall has become apparent: There’s no one at the helm of the economy or efforts to help it. President George W. Bush is nearly entirely absent, the Treasury Secretary cannot commit the nation to new policies, and now Congress has left the city to campaign. The two presidential candidates, including the next president, also cannot assert any authority even if either of them wanted to, since Congress is adjourned and the president couldn’t respond to an Obama recommendation without undermining his party’s candidate, nor respond to a McCain proposal without reinforcing the Democrats’ case that the two are in joined at the brain.

So, the economic crisis continues to worsen. The problems in housing, finance and now the overall economy aren’t on recess, nor will they take hold their fire until the next president is inaugurated. In fact, more problems will emerge, both political and economic. For example, this week, three of the nine banks slated to get the first bag of cheap, federal bailout money reported very respectable third-quarter profits. Wells Fargo, State Street Bank and J.P. Morgan-Chase together earned $2.6 billion in profits for the quarter, even as they agreed to accept $25 billion each in new capital from American taxpayers. Of course, they agreed: The money will cost them 5 percent, or half of what Warren Buffet received for his $5 billion capital investment in Goldman Sachs last month, so now they can expand their business at a cut rate. The CEO of J.P. Morgan-Chase called his $25 billion injection a “growth opportunity.” But by what methods of accounting do they need emergency government assistance? And the deciders in the administration? The spokesman said, ‘We are not here to make money off these companies,’ a view which I expect would draw attacks from most members of Congress if they were here, both campaigns, and the public. In fact, if interest rates rise before the banks pay back the capital, these loans to healthy, profitable banks will actually cost taxpayers plenty, since every cent of their $75 billion will be borrowed, and the recipients are paying below-market rates.

Presumably the Treasury has criteria for extending these bailout loans, but since there is no transparency and, with Congress gone, no one to call for it, we cannot know what they are. But can they be, if sound, profitable banks qualify? With a sinking economy sinking and millions of Americans facing unemployment and home foreclosures, is it the first priority of those in charge today to finance new growth opportunities for profitable banks? Is that their government’s reward for their managing to avoid bankruptcy?

In fact, it looks like one of the final and morally corrupt acts of an administration that has introduced a big dose of Asian-style “crony capitalism” between the most senior of the White House and the Treasury, and Wall Street.

This is happening, in part, because in the midst of a genuine crisis, the United States finds itself nearly leaderless. British Prime Minister Gordon Brown and other European leaders this week called for a ‘Bretton Woods II’ summit to redesign the global financial architecture. They want to meet within a few weeks to begin the figure out how the International Monetary Fund, World Bank and the Bank of International Settlements in this new era and, presumably, to discuss new terms for overseeing capital flow among countries. Who would speak and negotiate for the United States? It’s likely that Barack Obama will be the president-elect by the time they meet, but he won’t be the president, and therefore unable to exercise presidential authority. The man who will still be president, George W. Bush, with be utterly without domestic support or credibility in economic matters. He will have no way of selling a new international package to the American people or Congress. These kinds of issues arise during any presidential transition, but they’re especially acute this time, because we find ourselves in the middle of a cascading economic crisis that will not wait until next January.

Senators Obama and McCain need to prepare now. Both candidates should convene a group of trusted economic advisors to review all the options for dealing with the deteriorating housing market, the instability in our financial system, and the real economy’s accelerating problems, without reference to the campaigns. This group should report its findings and recommendations to the president-elect on November 5, and he should present his recommendations to a lame-duck Congress that same week. Campaign operatives may assume we have until January, but the man who becomes president-elect must know that he will have to take action as soon as the votes are counted.

Our next blog will take us through what actions the president-elect ought to recommend.

Nothing to Fear More than Fear Itself

October 9, 2008

Congress tried late last week to stall the financial crisis by pledging to spend $700 billion on devalued securities held by financial institutions, and by Monday morning it was clear that the pledge wasn’t enough to reassure investors or restart lending. Instead, a classic panic has set in here and around much of the world as public confidence in banks, other financial institutions and the markets themselves nosedived, along with confidence by banks and other financial institutions in most potential borrowers. This panicked mindset threatens the economy more today than the continuing turmoil in the housing and financial markets. Now we have to recreate baseline confidence before we can repair the continuing damage to our financial and housing markets.

Financial and broader economic panics thrive on a combination of huge and unexpected setbacks and a serious absence of information. They unfold when people face enormous uncertainty about matters vital to them, such as the value and security of their homes and, retirement accounts and college savings — and see everyone else, including those with the power and position to manage those matters, struggling with the same uncertainty. People feel threatened and powerless to do anything about it not because they have no options, but because they have no basis to evaluate or choose among them, and worry that more unexpected calamities could overtake whatever course they take. That’s where tens of millions of Americans — and Europeans and Asians as well — have found themselves this week. They don’t understand why the value of their homes and investments has plummeted so suddenly, and see that those ostensibly in charge of the economy in Washington and on Wall Street have little grip on of this as well. The result is that spending and investment are shutting down, dragging the entire economy into what seems very likely be the worst downturn since the 1930s.

The remedy to this panic is information, which only the nation’s leaders can generate and demonstrate they understand. For example, the Federal Reserve and the FDIC should have legions of examiners working around the clock re-auditing the conditions of all major financial institutions, starting with commercial banks. The Treasury and Fed could then report to the public on each institution’s financial health and their confidence in its continuing financial health. The largest group would still be judged healthy; another group could be designated as worth watching, with measures to help it move to the first group; while those in trouble would be identified with a plan of action to help them recover, if possible. Without this information, most people have been panicking that almost every institution and every investment might well be in serious trouble.

This program won’t solve the capitalization crisis across financial institutions, much less the crisis gripping housing markets which itself has driven so much of the current upheaval. But it would staunch the panic as investors, business owners and families come to feel that they finally know where the problems lie and what the government and nation’s business leaders will do to address them. At the same time, our leaders can finally begin to address seriously the housing and capitalization crises in an economic environment in which businesses and people will be able respond reasonably and predictably.

Congress Acts: A Little Better Than Nothing

October 3, 2008

The $750 trillion bailout plan that the Senate approved, and which the House is expected to endorse reluctantly, could give us all a little more breathing room in the current economic crisis, but it won’t resolve anything. It’s much the same plan the House voted down a few days ago, with a bushel of tax breaks calculated to draw more votes but unrelated to the turmoil in the capital markets. It should stave off a short-term panic, but it won’t stabilize the credit or housing markets. Such a little impact seems hardly an effective use of $750 billion.

It’s hard to know how many members of Congress understand the forces seizing the financial system or how this plan would actually affect it, especially since the Treasury’s original three-page plan outline has become a highly complicated, 750-page piece of legislation. Most lawmakers know they have to act quickly to at least begin to address a crisis that’s become a critical focus for the voters most of them will face in five weeks. The truth is, economists don’t agree on the best course, with a broad range of theories and proposals — and telling agreement on not much more than the likelihood that the government’s plan won’t do the job. It’s not even likely to get all of us through the general election on November 4 without further upheaval.

To be fair, most members of Congress are caught between two opposing and very discomforting forces: Pass a bailout plan that will anger many of their constituents, or reject it and be held responsible for the next wave of economic shocks. It’s a fact that the markets will slide sharply and quickly if they believe that the government cannot pass any response — but also that this plan will only modestly soften or delay those consequences.

Why are we all left with these two sorry alternatives? I’m afraid we’re all prey to what economists call path dependence, when an outcome is heavily influenced by how a development began. A classic example is the ubiquitous success of Microsoft Windows. It’s arguably not the most efficient, powerful or effective operating system, and a rational market would normally have moved to other systems over time. But personal computing started with DOS, people and institutions became invested in its particular approach to the technology, and it continues to prevail. In this case, the Treasury hadn’t developed a plan even as the crisis unfolded, responding in an ad hoc way to the collapses of Bear Stearns, Merrill Lynch, Freddie Mac and Fannie Mae; bailing out some and not others based on their judgment of the moment about whether a rescue was needed to avoid system-wide panic.

By last week, after letting Lehman Brothers fall and facing a real prospect of multiple major failures and bank runs, the Treasury pulled together a three-page outline which it called a plan. And once that plan was distributed, it became the focus and organizing principle for the congressional debate, and path dependence took hold. The plan is inadequate — it doesn’t recapitalize financial institutions nor address the underlying deterioration in the housing market — but without a substantial period to bone up and consult experts, most members of Congress don’t have the ability to step back, ask basic questions of the plan, and approach the crisis in a different way.

Ironically, this suggests the same ‘best case scenario’ thinking that the Treasury and Federal Reserve have brought to this problem for two years, and which the Bush Administration has used for even longer in Iraq.

For now, this is the only plan we have. It should have some benefits. For $750 billion, or several million dollars per-American, we will place a floor under the losses of financial institutions for their speculations in the market for housing-based securities and derivatives. Our own best-case scenario is that this floor will be enough to attract outside equity investors for these institutions, recapitalizing the system over the next six months or so. But the bill includes only weak and marginal steps to help stem the foreclosures and falling housing values driving this crisis; and if the floor is not enough the attract outside equity investors, we will be right back where we started fairly quickly.

We could face the next phase of this systemic crisis soon, and as the problems spread across Europe and into Asia, intensified by a deepening recession, it could well be a dominant problem well into 2009 and the first great test for the next president of the United States.