THE BLOG
02/06/2009 05:12 am ET Updated May 25, 2011

How to End the Recession

As the country struggles with this vicious recession, we look for ways to rejuvenate the economy and reverse the downturn.

What end recessions are the following:

First, producing and saving, as opposed to spending and borrowing.

Second, economic stimulus in the form of tax cuts and rebates, which are truly stimulative and go to the people that need them most, and not random bailouts nor new massive government bureaucracies.

Alarmingly, both the Bush and Obama policies are on the wrong track.

What should be intuitively clear is that spending is no way to repair our woes. Indeed, spending irresponsibly is exactly what got us in the current lugubrious position. If your family had large debts and annual expenses exceeding its income, would you accept advice from financial experts beseeching you to spend even more, and borrow further? That sounds absurd, and it is. The definition of insanity is doing the same thing again and again, expecting different results. Why then are we trying to get out of this hole by digging further with the same infernal shovels of consumption and debt?

President Bush and his Treasury Secretary have long failed to provide relief. But now, I have a very bad feeling about the incoming administration plans as well. Instead of focusing on cuts of marginal tax rates, President Elect Obama has come up with an economic stimulus plan that is completely misguided. The Obama team proposed a payroll tax credit rather than a real tax reduction. An increase in spending coupled with lower tax collections is an increase in taxes, not a tax cut, because it means the government will have to collect more taxes in the future. And when you don't cut rates but instead give people a lump sum of $500, you create little stimulus and further weaken the country's financial strength by adding to the national debt.

Or take the incoming administration plans to reform healthcare, which comprises 14% of GDP. It is simply not possible to spend $1 trillion so quickly and do it well. This kind of hurried spending is gravid with danger and will not abet the economic recovery.

Or consider the plan to create "green jobs." Not only do we not have the slightest clue how to do that, but we don't even know if there is demand for whatever product those jobs will produce, especially not with oil prices down 54% last year. Moreover, government should not be engaged in creating jobs. Taking resources from the private sector can't possibly be an efficient way to utilize our means.

As stimuli plans go, this one is deeply flawed and will put us on the wrong track, exactly at the time when we need change we can rely on and not another false start.

Meanwhile, the Bush administration has been engaged in a gargantuan endeavor to bail out banks. Thomas Jefferson said that banks are more dangerous than standing armies. Judging by the damage done by Wall Street in the past year, he was correct. Nonetheless, Secretary Paulson has been handing the most abominable banks hundreds of billions of our money. Citigroup alone received a $300 billion guarantee of its debt, a gift, and a very large one at that, from Americans to the shareholders of Citigroup. Many other banks got large sums as well (and to add insult to injury, the banks on the receiving end of all this liquidity have been hoarding the cash rather than lending it).

With this bailout we are saddling the Federal Reserve's balance sheet with toxic assets banks foolishly loaded up on. What we have been doing is replace private credit, which has been destroyed, with the credit of the federal government. But we taxpayers ultimately shoulder that burden. The Fed's balance sheet is really ours, and even if we try to sweep the problems under the carpet in Washington, the day of reckoning will come and we will have to face those losses. More federal debt undermines confidence and compounds the very problem it was meant to fix. It might even create a new crisis in which we will find it hard to pay our social security and healthcare obligations to aging baby boomers. This Mad Hatter tea party approach is good for Alice in Wonderland, not for a prudent economic policy at this crucial time.

If we are going to rescue anyone, we should rescue homeowners and not banks. We can do that by issuing homeowners new government loans based on the current appraised value of their homes, so that they no longer owe more than their house is worth. This will stabilize the value of the collateral underlying all those non-performing loans, allay fears and stop the credit freeze. And if we want the banks to lend, we need to force them to recognize their losses and write off their bad loans, which predictably they have been reluctant to do.

Finally, as far as confidence goes, one can't simply tell people to be confident and expect them to comply. People have a very good reason to be scared, and they won't become panglossians because Washington implores them to. Confidence is created by having consistent policies, not erratic, ad-hoc decisions. The crucial flaw in the Bush administration's actions has been that they actually increased uncertainty by being so unpredictable, with different responses to different institutions, rapidly changing strategies and obscure reasoning that created confusion and drove capital away.

Rather than deal with the source of the problem and drain the swamp, the Treasury department is chasing the individual mosquitoes, engaged in a desperate effort to pump up that atrocious credit bubble again, support the stock market and avoid a recession. That strategy is doomed to fail, especially when so many decisions seem to be made over chaotic weekends, in a bizarre effort to get things done before "markets in Asia open."

Stock prices ultimately reflect reality, and they should not be manipulated. If we deal successfully with the underlying problems, pay down debts, cut taxes and go back to producing and saving, the recession will be over and equity markets will respond accordingly.

Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at aschram@wellcappartners.com.