From the February 22, 2009 Sunday Times (London)
February 23, 2009
by Irwin Stelzer
Is it possible that every part of President Barack Obama’s economic recovery plan is flawed, but the whole might prove greater than the sum of the parts? The short answer is that nobody knows. But we now know enough to make some reasonable guesses.
The stimulus package, signed by the president in Denver last Tuesday, is a flawed mixture of tax cuts, spending, pork and the special funding for congressmen’s pet projects that Obama had promised to consign to the dustbin of history. The spending-will-save-us Keynesians are overjoyed, and the spending-will-break-us monetarists and conservatives are disconsolate, but neither group really knows what the effects of the package will be. We do know that those effects will be late in coming: it will take two months to review bids for repair work on bridges and roads - much longer for new infrastructure projects - and an additional four months to get the work started and the pay cheques out.
Despite all its flaws, the stimulus package should add some pep to the economy. But that almost-instant gratification might come with the longer-term pain of either higher taxes or inflation. Most important, the stimulus package is only the first item in the president’s recovery package. Obama chose to travel from snowy Denver to sunny Phoenix on Wednesday, and to use that venue, in which house prices have in places fallen by half, to announce a plan to help the housing market. Again, only the brave or the foolish dare predict the effect of the president’s proposal. One thing is certain: Obama learnt from the fiasco after Treasury secretary Tim Geithner’s no-details speech, and included in his announcement a mind-numbing list of details: estimated cost, as much as $275 billion. Critics moan that the 92% of homeowners who are paying their mortgages will have to pick up the bill for the small minority that bought houses they can’t afford. Defenders claim that the 92% of up-to-date payers will benefit from the reduction in the number of repossessed houses hitting the market and depressing the prices of all homes.
There are competing views on just how effective the programme will be. Lenders have already been renegotiating mortgage terms with delinquent borrowers, but because those borrowers have to play catchup on missed payments, their monthly payments have often risen, rather than fallen. Which explains why half this class of borrowers has redefaulted. Obama hopes to change all that by providing lenders with incentives to reduce monthly payments to enable struggling families to stay in their homes.
The third piece of the plan is the hardest: fixing the banks. Obama led markets to believe that his Treasury secretary had a fully formed plan. He didn’t, and the markets are still reeling. But a plan there will be, and there is reason to believe it will help. That reason: the much-maligned $700 billion Troubled Asset Relief Programme, $600 billion of which has already been spent, and actions by the Federal Reserve Board indeed eased credit conditions. The interest rates that banks charge each other have fallen. So have rates on short-term commercial paper, a key market for many firms. Issues of investment-grade corporate bonds sold without government guarantees are rising.
And there are signs that words like “nationalisation” no longer conjure up the sound of tumbrels rolling down Wall Street, as investors become resigned to the need for some radical move by the government to lumber taxpayers with some of the toxic assets now resting on bank balance sheets. Even former Fed chairman Alan Greenspan, free-market advocate extraordinaire, is reconciled to such a move. Nobody knows what the total cost will be, since we don’t know the value of those assets (if they have any value at all), or what the government might be able to sell them for when markets are calmer.
So it is difficult to guess at the effect of any plan that might emerge from the Treasury. But experience with past efforts to ease the credit crunch suggests that financial markets just might respond to another set of interventions.
Politicians in America like to talk about the three legs of the recovery stool: stimulus, a boost for the housing market, and a banking fix. They forget a fourth leg - if stools can have four legs. There will be life after the current turmoil, and another programme will be needed to clean up the budget deficits now being generated, and the effects on the money supply of the Fed’s decision to take lots of dicey assets onto its own balance sheet in return for cash.
The president has promised to address the first of these hangovers by putting social security (pensions), Medicare and Medicaid (government healthcare programmes) on a solid fiscal footing. Piled on top of the recent spending splurge, entitlements as now constituted could bring the nation to ruin. Unless benefits are cut or new taxes levied, these programmes will send deficits up and drive the dollar to record lows. Which is why Obama, nervous about market chatter over the future of the dollar, will convene a bipartisan summit tomorrow to address the looming entitlement bill.
This leaves the Fed to drain excess liquidity out of the system. Late last week its chairman, Ben Bernanke, made clear that he intends to do just that, and has the tools with which to do it. He will sell some of the assets on the Fed’s balance sheet, and lock away the dollars he gets in return.
None of this means there is a free lunch out there. The stimulus package will waste billions. The housing programme creates serious moral-hazard problems, and in the long term might make lenders more reluctant to make mortgages available. The banking bailout invites politicians into the business of allocating the nation’s capital among competing uses.
Anyone who professes certainty that the benefits of the recovery programmes will offset those negative consequences is more ideologue than professional forecaster. As is anyone who takes the opposite position.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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