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Three Reasons We Need an Economic Wake Up Call

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Several events of the past week should be a wake-up call to the Obama administration. Bottom line: the medicine isn't working. Stronger stuff is needed. Consider:

The June Unemployment Numbers
. The green-shoots school was expecting that the rising rate of unemployment would continue to slow, as it did in May. But instead the number spiked back up. A total of 467,000 jobs were lost. The unemployment rate rose to 9.5 percent, and OECD economists project that U.S. unemployment will still be in double digits as late as 2011.

The 9.5 percent official figure -- the worst since 1983 -- conceals even worse news. The number of long-term unemployed is at record levels. This is the only recession since the Great Depression in which the job loss wiped out all the job growth of the previous recovery. As our friends at the Economic Policy Institute report.

We now have fewer jobs than in May 2000 when the recovery began, though the economy now has 12.5 million more workers. And there is less than one job opening for every five people seeking jobs. Hidden unemployment is also setting records - people with part time work who want full time work, as well as people whose hours have been involuntarily cut.

Until strong economic growth returns, companies will not resume hiring. And as long as layoffs continue, that means fewer customers and the downward spiral continues.

As EPI observes, President Obama's economic stimulus simply wasn't designed for a recession this deep. And I would add that stimulus funds are getting out too slowly. Compounding the problem is inadequate government policy on three crucial fronts:

State Fiscal Collapse. The states, unlike the Federal government, are not permitted to run current budget deficits. So in a deep recession, when tax receipts fall, their only choice is to cut program spending or raise taxes. Both are of course perverse in a recession, since they only further undercut consumer purchasing power.

As the new fiscal year begins, nearly every state is raising taxes or fees, or laying off workers and reducing programs. At least 48 states face red ink. Some of the state budget crisis is self-inflicted, as in the dance to the death between California Governor Arnold Schwarzenegger and Democrats in the legislature, compounded by a two-thirds supermajority requirement for any kind of tax reform. But most states are just plain hurting.

Massachusetts, with one of the most liberal governors, Deval Patrick, just hiked its sales taxes by 25 percent. A total of 24 other states have enacted tax increases and another 12 all have tax hikes on their agendas. Federal aid under the stimulus covers just 30 to 40 percent of the state shortfall, which is expected to total $350 billion by 2011. And 39 states have cut program outlays on the needy, according to the Center on Budget and Policy Priorities.

The New York Times reports that several states are cutting out summer school. This is just plain nuts.

Some aspects of the recovery program, such as rebuilding a banking system that serves the real economy, are truly challenging. But this part is really simple. Washington is the one part of the government with the capacity to run deficits. So Congress should pass an emergency revenue-sharing law, giving the states another $150 billion immediately. The only condition is what policy wonks call maintenance-of-effort. To receive the money, the states must maintain program outlay levels and taxing systems that were in effect on a date certain, say July 1, 2008.

Most of the stimulus money is still unspent because of various bureaucratic hurdles at all levels of government. This approach would break through all that. Washington would simply cut fifty checks.

The Foreclosure Catastrophe.
When the Obama administration took office, they basically continued the Bush administration's program of voluntary loan modifications. They sweetened the deal by paying banks to reduce the principal or interest, spending $75 billion for banks (money that might have gone directly to homeowners.)

But with most distressed mortgages having been converted to securities, and the banks that collect the payments not wishing to get sued, the program is mostly a bust. The Treasury says that something like 50,000 mortgages have been modified, out of several million at risk of foreclosures. Treasury keeps telling Congress to wait a few more months to let the program kick in. But according to the New York Times' indispensable Gretchen Morgenson, the program is actually going backwards. Out of a sample of 3.5 million sub-prime and alt-a (undocumented mortgages better known as "liar loans") handled by five of the nation's biggest lenders, servicers modified 23,749 in February, but only 19,041 in May and 18,179 in June. Meanwhile, foreclosures in progress are over 844,000.

The consequence of this policy failure is a continuing downward spiral of more vacant homes, continuing declines in property values and home equity, depressed home construction, and stresses on homeowners who spend every penny of disposable income to keep their houses. The government needs a Roosevelt-scale mortgage refinancing program with one goal--to keep people from losing their homes. As Morgenson reports, when a bank forecloses, it loses about 63 percent of the loan value. Wouldn't it be better to reduce the monthly payments by 63 percent, and allow people to keep their homes? But only a much more direct government intervention can do that.

Busted Banks. The Administration's policy of pumping up busted banks, such as Citigroup and Bank of America has been a success only in the sense that these zombies are still in business. But surely the right test is whether credit is flowing again to deserving borrowers. Reports from the small business and community reinvestment communities suggest that credit is still very right, despite Federal Reserve policies of cutting short term interest rates almost to zero.

I still have to pinch myself when I realize that the President of the United States is Barack Hussein Obama. Like the rest of the progressive community, my heart swells when Obama, in Egypt, makes a brilliant speech on Middle East, or accelerates the progress of redeeming full civil rights for gays and lesbians. (I could find some quibbles on these fronts as well.) But these are not the issues that will cost him his presidency if he fails to grasp that the economic recovery and the moment of reform are slipping away.

As Republican missteps turn from tragedy to farce and back again, we should not get too cocky. The Republican ticket in 2012 could be Palin-Sanford; if unemployment is 11 percent, it will win.

Robert Kuttner is co-editor of The American Prospect, www.prospect.org and a senior fellow at Demos, www.demos.org. His recent book is "Obama's Challenge," www.obamaschallenge.com.