Recession

Barack Obama's historic election as a new, national agent of change will face a daunting test as the economic crisis continues to accelerate, and the political pressures arising from what must now be called “The Great Recession” begin to reshape the response.

The latest evidence is today’s unemployment data: one million jobs lost in two months; the sharpest eight-month rise in the jobless rate since 1945, when tens of millions of soldiers and sailors were demobilized; and losses across every sector and every region. Jobs are in freefall along with the markets, investment, consumer spending and household wealth. And economists are now genuinely frightened by the course the Great Recession is taking, because there’s been nothing like it in anyone’s experience.

That’s why long-time advocates of fiscal probity now call for stimulus topping $1 trillion, and why every spending and tax idea floating around Congress for the last decade is back on the table again. The political pressures and real concerns are so overwhelming that there’s talk of large tax cuts, despite the consensus among economists that when people and businesses are as economically downcast as they are today, tax relief has little stimulus power. That’s not only politics at work; it also reflects a sense of grave foreboding among many of those same economists.

We do need unprecedented stimulus – but all of the stimulus in the world won’t change the course of this crisis until we also address its underlying forces. The wealth of American households and the portfolios of American financial institutions will continue to tank until the housing market stabilizes -- or at least until foreclosure rates return to normal. And the most aggressive, easy policy in our history won’t be enough, and financial institutions won’t begin normal lending again, until they’re more confident that the hundreds of billions of dollars in mortgage-backed securities and other derivatives they still own aren’t headed for the drain as well.

The new Administration can take on these challenges directly, as candidate Obama pledged to do with extraordinary foresight. For example, we can impose a 90-day moratorium on foreclosures and use the time to renegotiate the terms of tens of thousands of distressed mortgages held by Fannie Mae and Freddie Mac. One idea promoted by many economists is to convert those mortgages to 30-year fixed at 5.25 percent, which happens to be long-term mean rate for Fannie and Freddie mortgages. It won’t stop foreclosures, but it should bring down foreclosure rates to near-normal levels, which would do more to stabilize the financial system than the bailouts in the Bush Administration’s own Wall Street version of tsunami stimulus. And some tough love from the new Treasury Secretary could help restart the lending process: having done what we can to stabilize the value of their portfolios, we should consider requiring institutions receiving federal aid to use a real share of that assistance to restart their lending.

We need large-scale stimulus, but it will only work if we first address the underlying problems. Otherwise, 18 months from now, we could be $1 trillion poorer and have little to show for it.

On virtually everything economic, the Bush Administration and much of Congress have become the gang that can't shoot straight -- and their stray bullets could take down a good piece of the nation's economic prospects. They have directed hundreds of billions of taxpayer dollars to financial institutions (and soon, auto companies), and they're getting ready to direct several hundred billion more at the overall economy. In all of these instances, a political drive to display the will and capacity for large actions has overwhelmed deliberate thinking about the specific consequences of those actions. The Obama presidency and the country may pay a big price for this scattershot approach.

The latest example of this dangerous development is the ever-expanding size of the long-awaited next stimulus. We're in a deep and serious recession and a major stimulus was certainly needed -- mainly six months ago, when the Bush Administration and Congress provided tax rebates which were largely saved and had little stimulative effect. Now we know how bad the downturn is turning out to be, and Congress and the Administration-in-waiting is preparing another stimulus of a size commensurate with what's already unfolding, once again, as if this were six or eight months ago. A stimulus providing another $200 billion to $300 billion in new federal spending makes sense, mainly as insurance for another shock to the economy. But a $500 billion to $750 billion package like the one now under discussion will miss its target by many months and mainly indicates that the new rule is that anything goes when you win and damn the consequences.

Congress seems intent on responding to this recession as if everything known about how the business cycle works can be ignored, and the consequences could be serious. The Obama team is focused on long-term investments in 21^st century energy and transportation infrastructure, modernizing health care records, expanding training and education, and extending broadband and IT access for poor children. That's all good news for the long-term health of the economy and for the incomes of many households.  The catch is, long-term investments entail not a one-time boost in spending, but continued funding. So when we raise the ante on those investments from $100 billion or so to $300 billion, $400 billion or $500 billion, we're implicitly choosing either to foreswear any other commitments, such as health care, or to embrace another round of dangerously large, structural deficits.

Since the new politics seems to involve never saying no, the likely result of the current course, on top of the extraordinary infusions of credit by the Federal Reserve, is serious inflation once the downturn begins to resolve itself. This pattern is disturbingly similar to the short-sighted and cavalier approach to long-term risks that got the nation into this mess. And it continues to develop alongside the Treasury and Congress' continuing inability to address the rising foreclosures still driving the financial crisis and the credit freeze accelerating the downturn. Yet real responses are within reach: place a moratorium on foreclosures while Fannie Mae and Freddie Mac renegotiate the terms of millions of troubled mortgages and link financial bailout funds to a commitment to use them to extend credit to businesses. If we do that, the economy won't need so much fiscal or monetary stimulus. 

The current approach presents other serious risks. This pattern of fast-rising spending, on top of the bailouts already done and those to come, as well as more tax cuts, could push the U.S. deficit to levels that even the United States will have trouble financing. The Asian and Middle Eastern governments that provide much of our public financing could stop -- either because they'll see inflation coming, too, or because the global downturn and falling oil prices sharply reduce their savings and thus, their ability to lend them to us. The U.S. Treasury will always find the funds it needs, but it may have to pay a lot more to borrow them, which means higher interest rates. So the current approach risks an interest rate spike on top of everything else, which at best would lead to a substandard recovery. With all of its talent and broad public support, the Obama presidency should be able to do a lot better than that.