Monday, February 02, 2009

100 days of stimulating and bailing-out

Business Times - 03 Feb 2009

100 days of stimulating and bailing-out

Obama's early months will be dominated by one agenda: giving the economy the right jolt


'ECONOMIC Signs Turn from Grim to Worse' screamed the top front-page headline of The Washington Post last Friday, reflecting the sour mood in Washington as well as on Wall Street and Main Street.

Sales of new homes are plummeting. Businesses, including corporate giants like Microsoft and Ford Motor, have announced massive layoffs as unemployment claims continue rising while stock prices keep on falling each day.

Later, the US Commerce Department reported that consumers and businesses cut spending during the last three months of 2008, causing the US economy to shrink by 3.8 per cent - the fastest economic contraction in 25 years. The toxic mix of a global credit crunch, a collapsing US real estate market and a decline in consumer spending are combining, as the prophets of gloom and doom predict, to create the conditions for a rerun of the 1930s great economic depression.

After about two weeks in office, public opinion polls indicate that most Americans continue to give President Barack Obama a sky-high approval rating and refrain from blaming him for the economic crisis that started on his predecessor's watch.

In fact, notwithstanding his personal popularity and the combined Democratic majority that controls Capitol Hill providing him with all the power he needs to promote his ambitious economic agenda, President Obama has gone out of his way to seek support from the Republican opposition for his proposed US$819 billion economic stimulus package.

Meeting with Republican lawmakers in the White House and on Capitol Hill and disowning any 'pride of authorship', Mr Obama asked both Democrats and Republicans to work together in Congress on the bill to stimulate the weakening economy. And as part of an effort to win Republican backing for the bill, he agreed to expand the tax-cutting component of the stimulus package.

But change comes very slowly to Washington, if at all, and while the bill passed by a comfortable margin in the House of Representatives last Wednesday, it did not win even one vote from the Republicans; so much for the new era of bipartisanship on Capitol Hill.

Now comes a vote on a similar stimulus package bill in the Senate (that is scheduled to take place today ), followed by negotiations between Democrats and Republicans that may - or may not - produce a compromise bill on which lawmakers in the two legislative bodies would vote in a week or so. It is hoped Mr Obama will be able to sign the final version of the stimulus legislation before the middle of this month.

Republican leaders are criticising the White House for trying, as one Republican put it, 'to stimulate more government and more debt'. They are demanding a major overhaul of the bill and are calling for greater focus on tax cuts. Their opposition to the stimulus package reflects both ideological considerations and, in particular, traditional conservative distrust of government's role as an agent of economic change.

On top of that, there are specific policy differences with the administration over certain provisions in the bill - for example, one that provides US$150 million to insure honey bee farmers. But the expectation in the White House and on Capitol Hill is that more revision in the proposed legislation would make it possible to broker a compromise and allow for more Republicans to vote for the final version of the stimulus package which is, as everyone seems to agree, the only game in town. In any case, there is little doubt that Mr Obama would succeed in gaining the backing of at least three Republicans in the Senate, where the Democrats' majority is slim (59).

There seems to be a wide consensus for pursuing this experiment in Keynesian economics that is supposed to produce growing consumer and business demand. But even the most enthusiastic supporters of the stimulus package admit that they cannot guarantee that pumping money into the economy through a mix of government spending and tax cuts (about a third of the package) would succeed in providing the needed jolt to the ailing economy; they also agree that even under the best-case scenario (economic recovery), the mounting government spending would raise the federal deficit to dangerous levels.

The debate among economists is over the 'multiplier effect' of the many elements in the stimulus - whether government spending on, say, construction of new roads would lead to a greater or lesser increase in the national income than spending on, say, social welfare programmes.

In any case, a Congressional Budget Office (CBO) analysis concluded that only 64 per cent of the bill's spending would be completed within 19 months. And in that context, much of the delay would actually affect programmes with higher multiplier effect.

If there are very few in Washington who are confident that this gigantic fiscal spending programme (with more and more spending expected to follow) will do the trick, there is really no one in this city who would vouch for a coherent plan to deal with the monetary side of the current economic crisis that would fix and bring back to life the broken financial system.

New Treasury Secretary Tim Geithner said that the administration was working on a comprehensive strategy to 'repair the financial system' but declined to provide details about the plan it was contemplating. Perhaps such a plan has yet to be devised or Mr Geithner and other top economic aides - like Lawrence Summers, head of the White House's National Economic Council - are worried that disclosing information about the course the administration was going to pursue would encourage investors to take steps that would undermine their plan's objectives.

Or, more likely, the Obama administration, like its predecessor, is improvising - using trial balloons to test the waters, without having any long-term strategy in mind (which makes sense since Mr Geithner was involved in drawing the outlines and implementing the earlier efforts to shore up the financial system during the last year of the Bush term).

The latest trial balloon released by the administration suggested that it was seriously considering the idea of creating a so-called 'bad bank' (which sounds like a lousy name for an institution that is supposed to help revive the financial system) that would flush out 'toxic assets' from the balance sheets of the many failing financial firms.

That some bank stoc`ks ended up soaring last week after the plan was leaked to the press may be an indication that bankers welcome the idea of a government- backed bad bank - as opposed to earlier suggestions that the American government would take steps to nationalise some leading financial institutions, in the same way it had already nationalised insurance giant American International Group (AIG) and mortgage banking institutions Fannie Mae and Freddie Mac.

'We have a financial system that is run by private shareholders, managed by private institutions, and we'd like to do our best to preserve that system,' Mr Geithner said in response to that speculation.

But buying the bad assets could cost the government up to US$4 trillion (yes, that's 'trillion'). At a time when lawmakers are still fuming over the chaotic fashion in which the US Treasury and the Federal Reserve handled the funds that Congress has already approved as part of the Troubled Asset Relief Program, or TARP, the notion that Congress would be asked to release more trillions of US dollars to assist the CEOs and shareholders of Citigroup and Merrill Lynch is mind-boggling. Indeed, officials are still discussing how to use the second US$350 billion slice of that bailout package.

So, lawmakers are bound to insist that President Obama take responsibility for selling the idea to the American people who are losing their wealth and drowning in debt.

And since the financial system would be doomed without a continuing infusion of money from Washington, Mr Obama will soon have to ask those who voted for him, as well as those who voted against him, to put their trust in him as he tries to lead the nation out of the economic mess - with even more debt.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.

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