Obama's Next Challenge

President Obama managed to get a decent economic stimulus bill through Congress, despite nearly wall-to-wall Republican opposition. However, this victory was easy compared to the challenges that await the president and the country. There are three big ones: passing a second round of economic stimulus spending by late spring; stopping the epidemic of home foreclosures; and getting the banking system functioning again.

If Obama were being graded on these three challenges, he'd get an B-plus on the first stimulus package, and an incomplete on the other two.

The recovery bill was about half the level needed, given how rapidly the economy is collapsing. One example: state and local governments will be out at least $400 billion this year and next due to falling revenues. But the stimulus bill replaces only about $140 billion of that. The result is needless layoffs, cutbacks in programs, and deferred public investments. In a severe recession, these cuts are nothing short of insane. You hear critics say that it takes a long time for infrastructure spending to be shovel-ready. But when it comes to prevention of needless cuts in existing outlays, all Washington needs to do is write a check.

Unemployment is increasing at an accelerating rate. It is very likely to be in double digits by summer. A second stimulus package, at least as large as the first, will be needed later this spring. And the politics will be even uglier. Republicans will point to the worsening economy and declare, "See, it didn't work."

Even more difficult will be the politics and economics of fixing the banking system. A surprisingly broad consensus of experts agrees that sooner or later, government will need to take the large banks into receivership. And better to do it sooner. The money-center banks are insolvent, to the tune of somewhere between one and two trillion dollars. Treasury Secretary Tim Geithner's strategy is to disguise this reality, in the hope that "private capital" - meaning hedge funds and private equity companies - can be enticed into buying toxic securities, and getting them off the books of banks. Geithner even proposes to have the Federal Reserve lend them the money.

But Geithner has not solved the problem of how to price these toxic assets. And unless he proposes to further subsidize speculative investments by hedge funds, the problem is insoluble. The longer government delays recognizing the insolvency of the banks and the need for a full government takeover, the longer the credit system stays frozen and the deeper the toll on the real economy.

Geithner is still operating according to the playbook of former Treasury Secretary Henry Paulson, who lurched from one failure to another. Geither made the transition from junior member of Paulson's team to senior adviser to Obama. But he has not revised his understanding of the problem. The time when the old banking system could just be propped up with more public money or cheap interest rates is long past.

The reality is that before this is over, government will have to spend at least another trillion dollars in emergency stimulus spending, and another trillion or two on top of that to rebuild the nation's banking system. To take the worst case, three trillion dollars is about twenty percent of one year's GDP. By coincidence, that's almost exactly what the Japanese government spent when, after dithering for nearly a decade of financial crisis in the 1990s, they finally forced banks to write down bad loans and put government firmly in charge in exchange for government capital.

Twenty percent of GDP in additional spending would push the U.S. public debt to around 70 percent of GDP, still far below its postwar peak in 1945. This is entirely possible and necessary economically. The challenge is selling it politically.

The conventional wisdom is that the deficit is alarmingly high, and there is a populist backlash against more help for the banks. Geithner is deliberately vague about his bank rescue plan. He deliberately relies on funding from the Federal Reserve because Congress is no mood to legislate another nickel for big banks.

Nor should it. The country will need this level of spending--but it should not go to the bankers who got us into this mess. They deserve pink slips, like so many millions of their innocent victims. The only way that President Obama will be able to sell larger scale spending is by making a lot more trips like his visits to Elkhart and Peoria, and telling a narrative of the undeserved suffering of ordinary American families and then connecting that story to a recovery plan big enough to do the job.

The additional money for a second stimulus package needs to go to preserve and create jobs. The added funds for "the banks" must go not to the present managers of the banks, but to the rebuilding of a banking system that serves the real economy. And the best place to begin to demonstrate that the administration is on the side of ordinary people rather than Wall Street is through a mortgage refinancing program where the aid goes directly to homeowners, not via banks or bondholders.

In short, the only way Congress will entertain spending another two or three trillion dollars in emergency funds is if President Obama makes crystal clear both the urgent need and the fact that they money is going to help regular people, not bankers. If he does that, he will make it impossible for Republicans to outflank him with a faux-populism.

It is fine to keep holding out an olive branch of bipartisanship - as long as Obama keeps governing with Democratic votes while Republicans stonewall. If he does his job, not only will public outlay on this scale become acceptable to broad public opinion; it will become harder and harder for Republicans to oppose.

Obama's political advisers seem to grasp this reality. But his top economic advisers are still tied far too closely to Wall Street. The brutal fact is that Wall Street as we know it is dead, and deserves to be dead. By the time this crisis is over, the banking system should be far more modest, both in its scale and in its pretensions. At the peak of the financial bubble, the banking system accounted for forty percent of all corporate profits. This does not add value to the real economy; it simply adds cost and risk. Rather than propping up failed banks, Obama's team should be looking forward to a drastically simplified banking system. Putting Wall Street in its place would be good economics and better politics.

Right now, spending another two-to-three trillion dollars seems unthinkable. But it will soon be urgently necessary. Obama will be able to persuade Congress to spend this scale of public money only if he spends it on the right things and gets the people on his side first.

Robert Kuttner is co-editor of The American Prospect. He is author of "Obama's Challenge: America's Economic Crisis and the Power of a Transformative Presidency."

Comments

[freshnotbitter]

The present dithering leads me to believe that the critics are right: Obama is too taken in by the old nineties Clinton staff mesmerized by "triangulation" politics in which they pre-empt republicans with stuff like "tax cuts" ($8000 to new home owners to prop up the credit bubble) and private/public mix of capital to zombie banks (because doing what Sweden and Japan and our own Mr. Siedman did would be labeled "socialist").

Memo to O: The nineties are over. The Clinton people are not the geniuses the MSM would have you believe. Doing what the Clintons want will reduce your popularity from the 53% you received when you opposed the Clintons in 08 to the 42/46% level that the Clinton gang got.

The last time I saw Siedman on TV the issue was nationalization of banks and he said he didn't understand what all the talk was about since we already nationalized banks in the 80's. Yes, the government took the banks over, fired the management, stripped out the bad assetts making the bank marketable and sold the bank back into the market.

What are we waiting for?

[LiteSleeper]

Look I'm just glad someone is finally saying what needs to be said. A second stimulus will be necessary by late spring. Obama should've listened to Krugman and pushed for something much bigger now so that he could've gotten most of it right now. However, I think the news will be so bleak by late spring that the Republicans will find it extremely hard to justify not doing anything, and tax cuts is still not doing anything. The second stimulus should be focused entirely on longer range projects that will kick in in the 2nd to 4th years of his administration. These should be long postponed infrastructure projects but more importantly on new projects that deal with green energy and a national high speed rail network. These projects should be monumental in nature as testaments to American ingenuity and tenacity. It will be all we'll have in this Depression.

[noneIn2008]

Now is the time for Congress to act and give Obama line item veto power. Or does Congress want to protect their pork from the new administration.

[rbenjamin]

Seems a bit premature to be handing out letter grades. Let's take the time to run everything through the Scantron and see what the results are.

[CONCERNED122]

WALL STREET IS NOT GIVING US BACK THE 40% DECREASE IN OUR PROPERTY VALUES WITH ALL THE FORECLOSURES, WHY BAIL OUT WALL STREET AT OUR EXPENSE? THEY OWE US.

[Phalanxman]

Americans should get wise. Let your mortgages default. If we did this en masse, we would bring the bankers to their knees. Let them own everything. Let them owe, too.

[ncsteeler]

Over the weekend, Lindsey Graham suggested banks may need to be nationalized. Obama should jump on that. Bank aid is not popular and it would be good to get some GOP fingerprints on it.

I would add Health Care refore to this list. This will take time (and an HHS secretary!) and next year congress will start to focus on re-election. Once this is in place it will never be rolled back (remember Medicare). To pay for it remove the ceiling of around $100K on income subject to FICA tax and use that extra money. If it's not enough tax the providers especially the insurance companies.

[akryan]

Your 3 big ones don't include dealing with the middle east and Packistan? Really? That's the elephant in the room that for some reason people have totally stopped talking about. They don't have good solutions, they don't have cheap solutions, and most of all they don't have quick solutions. The military-industrial complex costs almost as much EVERY YEAR as this stimulus package. As much as people would like to think otherwise, we aren't ever going to leave Iraq. We'll be in Afghanistan until we finally have to throw our hands up just like the Ottomans, Persians, British, and Soviets had to. Packistan is on it's way to becoming a failed state with nuclear weapons. The Russians are on the fast track to a de facto dictatorship with renewed expansionist ambitions. All of this is exaserbated by the fact that the entire free world is going broke. Obama definitely faces domestic challenges but don't forget the foreign ones, which are now more intertwined and dynamic than at any time in our nation's history. Oh well it's a nice day outside. I think I'll stop being a ranting blog dork for a little while and go walk my dog. Have a nice day everyone.

[freshnotbitter]

Soros recommends the Danish model for mortgages, in a post on Huffpo, and it bothers me that Obama and Geithner don't jump to it with more conviction.

Nobody is going to successfully criticize a government "take-over" of the banking system which, after all, is what regulation is, isn't it?

Here would be my priorities:

1) fix the banking system decisively without fear of republican criticism. The 30's depression destroyed lives because banks failed. Your neighborhood 30's bank was the equivalent of Bernie Madoff today. Money was gone overnight. There is no excuse for dilly-dallying on the bank crisis.

2) Downplay further "stimulus" because real recovery is not going to happen with a shot of steroids.
Stimulate to what end? Stimulate back to tripleXXX prices on housing and oil and 18 million vehicle a year car sales? That credit bubble dream is over. We woke up. Reality is today. Substitute instead real spending on real assetts that are tangible, recognizable assetts for the electorate to enjoy regardless of the economic atmosphere. This could include brick and mortar schools, a broadband highway, health care security, expanded social security (no reforms please, that's a loser), clean energy initiatives.
Ensure that republicans criticize these proposals at every opportunity with talk of Bush tax cuts.

Let the price mechanism and market forces work while throwing a life preserver to the victims. Make government more efficient.

[PghGuy]

Spot on! And additive to #1 would be:

Reinstate the Glass-Steagall Act and repeal the Commodity Futures Modernization Act

[kathy001]

"If Obama were being graded on these three challenges, he'd get an B-plus on the first stimulus package, and an incomplete on the other two."

For future reference, Mr. Kuttner; statements like this completely turn me off from the rest of your message. President Obama has inherited an economic mess that took decades to create and for anyone to expect him to turn things around in less than a month is so foolish as to make me completely ignore whatever else you have to say.

[Javani]

"A surprisingly broad consensus of experts agrees that sooner or later, government will need to take the large banks into receivership. And better to do it sooner. The money-center banks are insolvent, to the tune of somewhere between one and two trillion dollars."

Geithner, like Paulson, are aiming to bailout the securitized debt. Even the consumer debt instruments such as bundled car loans.

The "consensus of experts" are right, the big banks that gambled on derivatives should be written down for their bad derivatives and reorganized. They should take the hit, not the taxpayers. That is not what is going to happen. The derivatives will be unloaded on the taxpayers. Everything Geithner has said about saving the "secondary credit markets" he means. He can say with a straight face that auto loans are unavailable, when the truth is the opposite, if it provides pretext for taxpayer "rescue" of auto loan derivatives.

Believing the Obama administation will do the right thing is just whistling in the wind. They knew what Geithner was about...that was a requistie to his appointment. The apparatchiks are from wall street financial services sector both under Bush and Obama, or their willing accomplices, like Geithner, in the Fed. They will bail out their buddies, they will not allow their mistakes and bad ideology besmirch their records. Lehman Bros, and so on, were some of Obama's biggest financial backers.

[Phalanxman]

Obama has been president less than 30 days and you're already giving him an incomplete? He's Barack Obama, not God. Give me a break.

[alukes]

We just need more hope and change...

[demockracy]

See Kuttner and Michael Hudson talk about this here:

http://www.democracynow.org/2009/2/13/robert_kuttner_and_michael_hudson_on

The bank bailout is not just reminiscent of the Japanese experience, it provides an uncanny parallel to the Reagan-era S&L bailout -- until now the biggest financial and political scandal in U.S. history (and yet the Saintly Reagan still is beatified by the Republicans... Hmmmm....)

The reason the S&L bailout was so big was that Reagan wanted to let the lenders grow their way out of trouble, rather than bite the bullet and close them. Beware of denial...it's not just a river in Egypt.

[runfastandwin]

I hate the term toxic assets. A mortgage that is not being paid and is secured by property worth less than the mortgage is a liability, and a pretty toxic one at that, not an asset. It's positively Orwellian.

[Javani]

Ironically (if so), it was a word coined within the traders' world, what they jokingly said about their own product. They have few laws to fear. Imagine if there was evidence the peanut people called their product "toxic paste."

[andyboy]

Yes Robert that sure was a knock down drag out melee over the stimulus package. They argued like crazy over the 2% that was contested. Whew!

I think you may be getting your rounds confused though. Bush pushed through round 1.

This is Round 2 Obama just passed. The next one will be round #3.....

They go so fast don't they?

The nice thing is that all the hard working avergae Joe Americans out there will keep producing trillions that can be just stolen from them and thrown away on any and every kind of fantastical pipe dream cock-eyed plan.

[tjfdownsouth]

I really like how they took the time to review the stimulus package and make sure every dollar was directed to a good cause.

They didn't even read the thing!!! I don't care what side of the isle you are on that is wrong.

[Testiculus]

I hope this passes soon. I am tired of sitting at home and waiting for my check. Since the first stimulus package under Bush worked so great.

I say if you can't run a business now, why in the world would you want to give these idiots more money? They are failing PBHO just drop the pen and slowly back away.