You may remember back in January that I was not happy and very outspoken about the size of the Obama Stimulus plan. I was not impressed by the content or with the mix between tax cuts and direct government spending. You may recall that the Blue Dogs interminable resistance to do anything that might wake their sleeping Republican voters and the desire on the part of POTUS to appease the unappeasable remnants of the Republican party led to a very watered down plan. At the time, all that I could hope was that it might be enough to get the ball rolling. However, I felt that the historical multiplier –especially for taxes– was not going to kick in the way it had in the past.
The release of the miserable unemployment data yesterday (not all that unexpected as you’ll recall) as well as an estimate of our output gap now clearly squares with my earlier view as well as the earlier views of Brad deLong, Paul Krugman, Mark Thoma and Joseph Stiglitz among others. The stimulus was clearly not the blue pill the economy needed. (That last link is from me saying this same thing in July.)
The Washington Monthly says the decision to appease centrists and Republicans looks even worse in retrospect. Now, the media gets it. Color me completely unsurprised because I told you so back then that it wasn’t going to be enough. I even mentioned it recently when it appeared the stimulus plans of German, France, and Japan had already lifted those economies from the worst of it last spring. These countries emphasized direct government spending. We mostly shuffled a few funds as stop gaps and the created a bunch of tax cuts that no one really needs right now.
In February, when the debate over the economic stimulus package was at its height, a handful of “centrist” Senate Republicans said they’d block a vote on recovery efforts unless the majority agreed to slash over $100 billion from the bill.
The group, which didn’t have any specific policy goals in mind and simply liked the idea of a small bill, specifically targeted $40 billion in proposed aid to states. Helping rescue states, Sen. Collins & Co. said, does not stimulate the economy, and as such doesn’t belong in the legislation. Democratic leaders reluctantly went along — they weren’t given a choice since Republicans refused to give the bill an up-or-down vote — and the $40 billion in state aid was eliminated.
In the past, government hiring had managed to somewhat offset losses in the private sector, but government jobs declined by 53,000, with the biggest number of cuts on the local and state levels. Even the Postal Service, which is included in the public-sector job statistics, dropped 5,300 jobs.
“The major surprise came from the public sector, where every level of government cut back,” Naroff said. “The budget crises at the state and local levels have caused an awful lot of belt-tightening.”
With the release of financial regulation reform and healthcare reform that has Wall Street breaking open the bubbly, I just want to join the chorus of highly skeptical economists. The tune of the last few days is hard to miss. Take this piece from the NY Time’s Dealbook as an example: Only a Hint of Roosevelt in Financial Overhaul. There’s also Paul Krugman’s Op-Ed Column today Out of the Shadows which is the typical on-the-one-hand-on-the-other hand economist behavior. (Could I just mention in passing that I like the OLD Paul better? The one that was an out spoken advocate for liberal economists? I’m not sure what happened at that White House Dinner, but I’m beginning to think we now have a Manchurian economist at Princeton. Oh, where is our Shrill One?) Oh, and you can still read my first impressions here. I’m going to start with Financial Reform but don’t leave me yet. Brad deLong takes on Christine Romer’s The Lessons of 1937 at The Economist and since he still hasn’t been invited to dinner at the White House, it’s classic Brad.
So what does Krugman think about the Alphabet Soup Agency reheat slugging its way through that perpetual Hall of Wall Street minions we know as our Congress? He believes that it throws some light on the shadow banking industry in that the Alphabet Soup gang at the FED get to see more balance sheets and books. There is also a stab at standardizing the process, but custom fitted Credit Default Swaps remain. The essential riskiness remains. Let’s examine the Krugman critique.
But what about the broader problem of financial excess?
President Obama’s speech outlining the financial plan described the underlying problem very well. Wall Street developed a “culture of irresponsibility,” the president said. Lenders didn’t hold on to their loans, but instead sold them off to be repackaged into securities, which in turn were sold to investors who didn’t understand what they were buying. “Meanwhile,” he said, “executive compensation — unmoored from long-term performance or even reality — rewarded recklessness rather than responsibility.”
Unfortunately, the plan as released doesn’t live up to the diagnosis.
Well, maybe the White House Pastry chef did not completely overwhelm the shrill one.
Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but then fails to say anything about addressing those practices. The long-form version says more, but what it says — “Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen.
Furthermore, the plan says very little of substance about reforming the rating agencies, whose willingness to give a seal of approval to dubious securities played an important role in creating the mess we’re in.
In short, Mr. Obama has a clear vision of what went wrong, but aside from regulating shadow banking — no small thing, to be sure — his plan basically punts on the question of how to keep it from happening all over again, pushing the hard decisions off to future regulators.
The US economy is in a fragile state right now which begs the question: Why do our policy makers seem oblivious to lessons from the great meltdowns of the past? Adam Posner of the Daily Beast asks the question out right: Does Obama Have a Plan B? Posner asserts that the administration appears to be hellbent on recreating the Japanese Lost Decade. This is something that I’ve been harping on for months as has Paul Krugman and Joseph Stiglitz–two big brained economists with Nobel prizes.
So it is with some irony if not humility that we should approach Treasury Secretary Geithner’s Public Private Investment Plan presented on March 23. A number of major American banks have lost huge amounts of money, and clearly have insufficient capital if they are not literally insolvent. Why else would they be pushing so hard to change the accounting rules to avoid showing what they really have on their books instead of raising private capital? Why else is the U.S. government taking so long to perform “stress tests” and trying to get expectations of overpayment for some of the bad assets on the banks’ books before the test results are out? In short, the U.S. government is looking to shovel capital into the banks without sufficient conditions, hiding rather than confronting the actual situation.
That is just like the Japanese government in their lost decade, or the U.S. officials during the 1980s before they really tackled the savings-and-loan crisis. In those cases, the delay simply made the problem worse over time and in the end the government had to put more money into the troubled banks directly, taking over or shutting down the weakest of them. Whatever the political culture, it would seem we have not learned from experience. Or perhaps we cannot act on our learning. The universal barrier would appear to be the political difficulty of recapitalizing banks. That seems obvious, but the constraint it puts on good policy is enormous.
That is why the Geithner plan is so complex and jury-rigged, to avoid the need for public requests for more money for banks. Unfortunately, it is unlikely to succeed absent additional public money and more-intrusive government action. The plan will buy some time and certainly some appreciation in bank share prices. Current shareholders will be getting a new lease on life with subsidies from taxpayers. For that reason alone, the plan certainly will cost the taxpayer more in the end than a more direct recapitalization with public control would have.