Obama prolongs the pain - again
By Hossein Askari and Noureddine Krichene
United States President Barack Obama has chosen the path of least resistance
for rescuing the US economy from what is generally accepted to be the worst
downturn since the Great Depression.
The 2011 budget [1], the administration's latest initiative, is just more
government and a re-inflation of the economy. On the heels of a record-breaking
fiscal deficit, estimated at US$1.6 trillion in the 2010 budget (12% of gross
domestic product, or GDP) and a soaring government debt that exceeds $13.8
trillion, Obama has unveiled his proposed 2011 budget with an estimated deficit
of $1.3 trillion (10% of GDP) that will push public debt to over $15 trillion.
The premise underlying the record fiscal deficits and unorthodox monetary
policy has been the rescue of the US economy from
recession, by increasing demand and employment, and protecting debtors and
banking system from a deflation of asset prices. To finance the deficit and
prevent default, congress in early February authorized an increase in the
national debt ceiling of $1.9 trillion.
As widely expected, Obama, in his budget message, put the blame for the crisis
on bankers and regulators: "Irresponsible risk-taking and debt-fueled
speculation - unchecked by sound oversight - led to the near-collapse of our
financial system". And on what he had inherited from the George W Bush
administration: "On the day my administration took office, we faced an
additional $7.5 trillion in national debt by the end of this decade as a result
of the failure to pay for two large tax cuts, primarily for the wealthiest
Americans, and a new entitlement program. We also inherited the worst recession
since the Great Depression - which, even before we took any action, added an
additional $3 trillion to the national debt. Our response to this recession,
the Recovery Act, which has been critical to restoring economic growth, will
add an additional $1 trillion to the debt - only 10% of these costs".
The implication is that if the previous administration had adopted sound
economic and financial policies, the worst post-war recession would have been
avoided and the public debt would have been $12 trillion smaller than what was
projected for 2011-2019.
Obama went on to summarize the fallout of the crisis: "More than seven million
jobs were lost since the recession began two years ago. This represents not
only a terrible human tragedy, but also a very deep hole from which we have to
climb out. Five trillion dollars of Americans' household wealth had evaporated
in just 12 weeks as stocks, pensions, and home values plummeted. The capital
and credit markets, integral to the normal functioning of our economy, were
virtually frozen. The fear among economists - from across the political
spectrum - was that we risked sinking into a second Great Depression."
Hence, to abort a second Great Depression, the Obama administration immediately
undertook a series of "difficult steps," even though running unlimited fiscal
deficits and printing money are the easiest steps for any government:
We
acted to get lending flowing again so that businesses could get loans to buy
equipment and ordinary Americans could get financing to buy homes and cars, go
to college, and start or run businesses. We enacted measures to foster greater
stability in the housing market, help responsible homeowners stay in their
homes, and help to stop the broader decline in home values. To achieve this,
and to prevent an economic collapse that would have affected millions of
additional families, we had no choice but to use authority enacted under the
previous administration to extend assistance to some of the very banks and
financial institutions whose actions had helped precipitate the turmoil.
We also took steps to prevent the rapid dissolution of the American auto
industry - which faced a crisis partly of its own making - to prevent the loss
of hundreds of thousands of additional jobs during an already fragile time.
Many of these decisions were not popular, but we deemed them necessary to
prevent a deeper and longer recession. Even as we worked to stop the economic
freefall and address the crises in our banking sector, our housing market, and
our auto industry, we also began attacking the economic crisis on a broader
front. Less than one month after taking office, we enacted the most sweeping
economic recovery package in history: the American Recovery and Reinvestment
Act. The Recovery Act ... began to lay a new foundation for long term economic
growth and prosperity.
The 2011 budget document described
actions to stabilize the housing market and push loans to consumers. Besides
billions of dollars in subsidies to homeowners, the administration acted to
make mortgages more affordable and prevent any adjustment (what are after all
needed adjustments) of home prices from their speculative levels. It provided
continued support for mortgage guarantors Fannie Mae and Freddie Mac. The US
Treasury put in place a program to purchase mortgage-backed Securities (MBS),
while the Federal Reserve bought $1.1 trillion in MBS and pushed the
conventional 30-year mortgage rate to 4% in 2009, compared with 13% in 1985 and
9% in 2000.
In addition, to circumvent banks and push credit to consumers and small
business, both the Treasury and the Federal Reserve put in place programs for
purchasing securities backed by consumers and small business loans.
Are these foundational policies for "long-term economic growth and prosperity?"
Will these policies preserve the interest of future generations? Will they
address the increasing divide between the haves and the have-nots in the United
States?
The new administration has failed to understand the root causes of the problems
that engulfed the financial sector, the housing sector, and the auto-industry,
and that have resulted in mass-unemployment and deep recession. Instead, the
Obama administration went full speed ahead with bigger government, monumental
spending, unproductive subsidies, and unmanageable red tape. Most of its
actions have been aimed at privatizing gains, nationalizing losses,
re-inflating the American economy out of the crisis, and preventing any market
adjustment and return to sustained economic growth.
We could fantasize and ask what would have happened if Obama had been elected
in 2004 and re-elected in 2008, instead of being elected in 2008? He would have
faced a stock market crash that had wiped trillions of dollars in household
wealth, an economic recession, and growing unemployment. He would have acted in
the same fashion as he is doing now: run excessive fiscal deficits, forced
interest rates to negative levels in real terms, and injected considerable
amount of liquidity.
He would have scored an immense success: the economy grew in 2004-2006 at 4%
per year and unemployment fell to 4.3%. He would have considered that every
household owning a house was a success of his policy, even though all
underwriting standards were discarded. Inevitably, he would have left a legacy
that would have been hardly different from the one he inherited; namely a
public debt that is $12 trillion higher than warranted by balanced policies,
and the US economy would not have escaped financial collapse and a deep
economic downturn. In other words, the legacy of Obama would be about the same
as the one he inherited.
The Obama administration has not hesitated to use generous subsidies and
distort prices to spur demand. It noted in the 2011 budget document: "To
further assist the auto industry as well as the economy as a whole, the
administration also launched the Car Allowance Rebate System (CARS) - or "Cash
for Clunkers" - program to accelerate demand for new automobiles. The program,
signed into law by President Obama on June 24, provided bonuses of $3,500 to
$4,500 to buyers who traded in automobiles with mileage ratings of 18 miles per
gallon or below, if they purchased a new car or truck with improved mileage
ratings. The Cash for Clunkers program boosted auto sales by nearly 500,000
units between July and August 2009, adding about $3.5 billion to the GDP."
Did this resuscitate and revive the US auto industry to be more competitive or
just bring forward car sales by a few months, with lower sales in the months
ahead? Taxpayers might be happy to pay higher taxes for better infrastructure,
education, health, and providing shelter for the homeless, but it is doubtful
they find it acceptable to pay taxes for merely accelerating car sales.
Obama promised to bring a change. He was against "business as usual" and would
not support the policies that had yielded cycle after cycle of speculative
booms and painful busts, and that had divided the nation between the haves and
the have-nots. Yet, he put in place policies that dwarfed the Bush deficits and
he even kept key Bush appointees, in spite of strong opposition in the senate,
and appointed those who had pushed financial market deregulation as believers
in market efficiency under president Bill Clinton.
His analysis of the crisis did not mention the role of previous fiscal deficits
in eroding economic growth. He has still not appreciated the Federal Reserve's
role in destabilizing financial markets through loose monetary policy,
injecting mountainous liquidity, and firing up housing prices, commodity
prices, and sending the dollar for a free fall. Oil and food price inflation
were hurting the economy and the less fortunate citizens in the US long before
the onset of the financial crisis. By Obama's analysis, whether interest rates
were at zero% or 10% or oil prices at $18 or $147 per barrel, it would make
little difference for the economy.
Political solutions to an economic crisis are the path of least resistance, but
they are invariably costly, by adding trillions of dollars in public debt and
ultimately aggravating the recession. Let's imagine that the Obama
administration had adopted the truly difficult solution for addressing the
housing market downturn - enabling markets to return from their high
speculative prices to equilibrium prices consistent with household income, rent
and construction costs.
Why should the government intervene in the market to prevent housing prices
from declining and adjusting to non-speculative price levels? Such a solution
was condemned by many prominent academics because it would hurt borrowers who
had borrowed on the expectation that higher inflation would reduce their "real"
debt.
Yet, look what would have been the result of this "politically inadmissible"
scenario: $0.6 trillion in homeowners' subsidies would have been saved and
redeployed for employment creation in the private sector; the Fed would not
have created money out of thin air and inflated money creation to buy $1.1
trillion in MBS; the US Treasury would not have bought $0.8 trillion in MBSs
and toxic assets; home prices and rents would have adjusted long ago to market
prices; and the construction industry might have been well on the road to
recovery.
The government would have saved massive resources, $2.5 trillion, to be used
for growth, and the Fed would not be placed in a position where it would be
managing the housing sector. Certainly, borrowers who bought at speculative
prices and banks that held speculative MBSs would have lost, as many in fact
have. Nonetheless, it is not equitable to privatize gains and nationalize
losses.
More specifically, it is not the role for the state to compensate wealth owners
for depreciation of their real assets or equity. The cost of speculation in
housing did not disappear; it was simply shifted to workers, pensioners, and
taxpayers. Workers are loosing wage income, and because of near-zero interest
rates pensioners are loosing pension income, all in the cause of subsidizing
housing speculation.
The Obama administration has claimed that its budget is a blueprint for growth
and employment. If this is the case why has this blueprint not succeeded
before? Massive fiscal deficits and unorthodox monetary policies have fueled
uncertainties. A primary concern is to how to finance large increase in
government expenditures. Although the budget calls for an 18% tax increase, tea
parties are spreading in protest against higher taxes.
More real resources will have to be squeezed out of the private sector to
finance higher government expenditures, which will reduce its capacity to
invest and grow. Since foreign financing has sharply declined in 2009, the
fiscal deficit will have to absorb greater domestic savings and depress private
sector investment. At the same time, companies that create permanent jobs may
be less reluctant to expand and recruit more workers in an uncertain
environment - uncertainties in both higher taxes or higher inflation, with
either outcome detrimental for economic growth and employment.
The US does not suffer from deficient demand. Instead, it has suffered for
years from excess demand financed by large and unsustainable external (current
account) deficits. A better approach to restore growth is to emphasize supply,
increase savings and investment, and eliminate price distortions.
Cash-for-clunkers type programs can only deteriorate the government's fiscal
position and fuel financial instability, in turn prolonging the agony and pain
of the more vulnerable and less fortunate citizens.
Hossein Askari is professor of international business and international
affairs at George Washington University. Noureddine Krichene is an
economist with a PhD from UCLA.
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