Stimulus for the Long Run

David Roche in the FT tomorrow:

When Volker walked into the Fed 30 years ago, the US national savings rate had been relatively static for decades at around 20 per cent of GDP and total US debt to GDP was about 160 per cent. Household debt was 47 per cent of national income. When the credit bubble burst in August 2007, the national savings ratio had fallen to 14 per cent of GDP and debt had risen to 350 per cent with household debt at just under 100 per cent of GDP. Even today, household debt in the US, although now contracting, still exceeds the level at the beginning of this crisis.

The disinflationary forces that drove the switch from thrift to leverage are over. This means the next decade will be one of replacing leverage with thrift. That will hurt retail spending.

The latest increase in the savings rate may be a positive trend in itself. But so far it has only been possible because of the Obama stimulus package. That has accounted for all the 5 per cent growth in household income so far this year. All that has happened is the consumer has saved and not spent the fiscal handouts financed by the Obama debt splurge. From now on, the impact of the stimulus measures will slowly wane and that means any rise in household savings will hit consumption directly.

This will set off feedback loops between the real economy and financial one, in the opposite direction to that we have been experiencing. It will cause consumer incomes and employment to deteriorate, along with the real economy, giving rise to increased defaults on consumer credit, commercial real estate and other loans, as well as, of course, housing mortgages. The default ratio on prime mortgages is already well above the US treasury’s stress test limit set for the banks. And the default rates on consumer debt, including credits, are rising very fast. The credit crisis hit to banks’ balance sheets is far from over.

I am still not yet on the economist optimist's bandwagon.  At the core of so much now is understanding how weak this decade was for the average consumer in America before the Great Recession kicked in.

In a post a few weeks ago I argued that policymakers were going to have to attack our core economic challenges we face with much more creativity and vigor than we have seen so far.   The Times today has an excellent op-ed by Daniel Alpert which offers up some such next generation thinking about how to get out of the mortgage mess - a critical part of any emerging national economic strategy - equal in size and scope to the problem itself.   

It begins: 

BY providing financial institutions with enough capital to survive (and even thrive) over the past year, the federal government prevented the global economy from grinding to a halt. But it may also have unwittingly encouraged banks to slow the resolution of delinquent, defaulted and underwater loans secured by homes and commercial real estate. Such “extend and pretend” behavior does little except delay losses — which helps explain the recent crop of prediction-beating, market-rallying bank earnings reports — while prolonging and worsening the damage done by bad loans.

Just this week, the White House met with a gaggle of mortgage company executives to discuss why their loan modification programs have been so ineffective. In fact, a recent study by the National Bureau of Economic Research illustrates that these programs haven’t been ineffective so much as unused: only 8 percent of seriously delinquent borrowers have received any form of mortgage modification and fewer than 3 percent of such borrowers received a concession on principal or interest payments from their lender. By contrast, about 50 percent of those seriously delinquent loans had foreclosure proceedings initiated against them. That’s a record rate of 1.9 million foreclosure filings in the first half of this year.

Banks, of course, typically lose more money by foreclosing on a home than by renegotiating the principal of a loan — but, as foreclosure timelines often run 12 to 18 months, that loss takes far longer to show up on their balance sheets. As a result, banks are pushing the mess (and the attendant additional losses) well into 2010 while they maintain the fiction that borrowers will be able to repay severely underwater loans in full. Banks are even beginning to turn down borrower requests for immediate “short sales,” in which homeowners sell for whatever they can get and then give all proceeds to the lender, because this, too, means that the bank must record a principal loss at once, rather than down the road.

The sheer magnitude of the debt bubble — doubling to $11 trillion in home loans and adding tens of trillions in total American debt in the past decade — along with the collapse of real estate prices, make it extremely unlikely that any of these houses will recover their value soon enough to mitigate the losses embedded in banks’ balance sheets. And by stretching out the time over which banks will continue to have their capitalization hit by losses, banks cannot soon fulfill their mission of providing new capital for the recovery and growth of the economy. Fearing for their own solvency, banks are instead salting away enormous, record-setting reserves.

To put the bubble behind us, we need to place mortgage lenders on a path to settling up with underwater homeowners. One of the few viable ways to do this is for banks to accept the voluntary surrender of deeds and then lease the homes back to their former owners. The former homeowners should then retain a right to purchase their homes back at fair market value, after, say, five years, during which time they would need to get their financial affairs in order.

Congress could pass legislation, within the bounds of constitutional protection of contracts, that would require lenders to provide such a lease-back arrangement to any borrower who wants one. The former homeowners would pay rents set in accordance with local rates (which in almost all cases would be considerably lower than the total of their former bubble-era mortgage payments, taxes and insurance premiums).

Count me as one of those who believe that for the national to see broad-based prosperity in the years ahead the banks will have to take some kind of "haircut" on consumer debt. Restructuring, deleveraging, or whatever we are going to call the process of lessening the debt load of consumers will at some point become seen as a requirement for the future success of the American economy and not some malevolent form of "moral hazard."  Until American consumers can get back in the economic game "recovery" will be more wish than reality. 

Having worked in Washington for 16 years now, I've learned a bit about how an idea moves from the periphery of the debate here to its center.  And this week you could feel that happen for the rising concern about our economy.  Despite the President's emphasis on health care and climate change of late, there is a new and growing sense of urgency here about the worsening economy and whether the government's response so far has been adequate or effective.  

Unemployment in Michigan is over 15 percent now, and the US unemployment rate is now higher than the EU's.  In a Senate hearing on Thursday Chris Dodd publically criticized the President's mortgage foreclosure plan as not having delivered on its promise.  A new study finds dramatic drops in state government revenues, which foreshadow both what will happen at the federal level later this year and significant troubles again with state governments themselves.   While there was what appeared to be good news with the financial sector, a deeper analysis predicts significant troubles ahead even for banks who showed profits in the 2nd quarter.   Twice as many banks have failed this year already as failed in all of 2007 and 2008 combined.   Many friends of ours have talked in alarming terms about what is likely to happen to the commercial real estate market later this year, a coming crisis which could also devastate local and regional banks who have escaped the worst of the financial crisis so far.  Add to that what could our first national flu pandemic in a generation, which if it is virulent as some predict, could slow economic activity and productivity even further.

The President is clearly paying attention to all this, and has begun to address these growing concerns head on.  Last Saturday he devoted his weekly address to the economy.  On Sunday he offered up a thoughtful op-ed on the economy in the Washington Post.  On Tuesday the President proposed a compelling new community college plan which spoke directly to the struggle of existing American workers.   On Friday NEC chief Larry Summers gave a speech reviewing the Administration's economic progress so far, and where it hopes to go in the months ahead.   And next Wednesday night the President will hold a prime time press conference where one can be certain he will address the growing concerns about the economy to a national audience.  

As he prepares for his remarks next Wednesday, he would be wise to heed the warning from a new letter offered up by 21 freshman Democratic House members this week.  The NYTimes provides this summary: 

Representative Jared Polis, a freshman Democrat from Colorado who voted against the bill approved Friday in the Education and Labor Committee, said he worried that the new taxes “could cost jobs in a recession.”

To help finance coverage of the uninsured, the House bill would impose a surtax on high-income people and a payroll tax — as much as 8 percent of wages — on employers who do not provide health insurance to workers.

Mr. Polis said these taxes, combined with the scheduled increase in tax rates resulting from the expiration of Bush-era tax cuts, would have a perverse effect. “Some successful family-owned businesses would be taxed at higher rates than multinational corporations,” he said.

In a letter to the House speaker, Nancy Pelosi, Mr. Polis and 20 other freshman Democrats said they were “extremely concerned that the proposed method of paying for health care reform will negatively impact small businesses, the backbone of the American economy.”

There have been calls from some quarters for a 2nd stimulus plan, an acknowledgement that what the first stimulus has not done enough to stop the current economic deterioration.  This may be necessary, but I think what will need to be done is much more comprehensive than just a new stimulus plan.  Future action could include a much more aggressive action against foreclosures, a more honest assessment of the health of our financial sector, an immediate capping of credit card rates and a rollback of actions taken by credit card issuers in the last few months, a speeding up of the 2010 stimulus spending, a completion of the Doha trade round and a much more aggressive G20 effort to produce a more successful global approach to the global recession, the quick passage of the President's community college proposal, enacting comprehensive immigration reform which will bring new revenues into the federal and state governments while removing some of the downward pressure on wages at the low end of the workforce, and recasting both the President's climate and health care initiatives as efforts which will help stop our downward slide and create future growth.

The worsening economy has become the nation's number one problem.   We will need a new language to talk about it, moving beyond the words stimulus and recovery which no longer seem to speak to the gravity of the economic moment we are in.  This is the most important work in front of the government now, and I look forward to hearing the President on Wednesday night about his plans for the remainder of the year.

For more on this be sure to read this excellent Thursday essay from Rob Shapiro.

Over the past few days the Obama Administration has begun a new effort to re-engage on what is the most important subject for the American people today, the economy.  This is a welcome development from where we sit, and have been pleased at both the language and proposals coming from the White House.  As the President gears up for a sustained discussion on the economy, two issues will need to be woven into his evolving narrative - the role of both immigration and global trade flows in creating broad-based prosperity here at home and a more prosperous and safer world aboard.

We've written extensively on how immigration reform should be better woven into the core Obama economic argument (see here for a recent video presentation of our argument).  The NYTimes this weekend did a very good job at reminding us of the opportunity the nearly completed Doha trade round offers the President to reassert America's role as the main advocate for a global economic liberalization, and why it also matters to American workers here at home.  A quick excerpt:

There are few things that could do more damage to the already battered global economy than an old-fashioned trade war. So we have been increasingly worried by the protectionist rhetoric and policies being espoused by politicians across the globe and in this country.

Against this bleak backdrop, it is especially good news that the world’s leading developed and developing nations have committed to complete a stalled global trade agreement (the so-called Doha Round) by next year. For that to happen, leaders — especially in the United States, Europe, India, China and Brazil — are going to have to muster real sense and political courage.

The World Trade Organization forecasts that exports from developed countries will fall 14 percent this year, while exports from developing nations will contract 7 percent. The collapse is particularly damaging for poor countries that are heavily dependent on exports. But it is also intensifying the downturn in many rich countries. Reviving trade is essential for economic recovery.

The talks, begun in Doha, Qatar, in 2001, had long been in limbo. They broke down last year after big developing countries — China and India, in particular — rejected demands from the wealthy nations that they lower tariffs on imports of agricultural and manufactured goods and open service sectors to more competition.

But there are signs that the collapse in trade and the rising protectionist rhetoric have awoken many leaders to the advantages of strong international rules to keep trade channels open. This is particularly true of China, which has suddenly found its exports on the receiving end of tariff increases and antidumping suits.

There is no guarantee that a deal can be pulled off. President Obama will have to provide lots of leadership to convince developing countries to make serious offers on market access, and to convince reluctant members of the United States Congress — notably those within his own party — that they will have to make concessions, too.

Even while he was abroad this week the President started a new and important message track, once again putting the focus on where it needs to be right now - on the economy itself and the increasingly difficult struggle of every day people.   His weekly address spoke to it yesterday, and today the President offered up an economically focused op-ed in the Washington Post, Rebuilding Something Better.  

I offered my thoughts on the need for the President to more forthrightly engage the economy in this recent essay, Not Taking the Presidential Eye of the Economic Ball.  And of particular interest to NDNers today is the new emphasis the President puts on our nation's community colleges as a key part of a 21st century economic strategy.  This spring NDN was proud to partner with Rep. John Larson in offering a bill, HR 2060, which would do just that.

You can find the text itself here, and be sure to read this recent essay I offered on the challenges of the current economic moment, Not Taking the Presidential Eye Off the Economic Ball.   You can find more of our recent economic work here.

On Wednesday I went on Fox News to talk about the stimulus.  Or so I thought.  Fox anchor Neil Cavuto ended up spending more time talking about cannoli and weight loss than the struggle of every day people and the American economy.  Check it out:

Despite the bumps in the road over the last few weeks, there can be no doubt that President Obama and the new Congress have acted decisively, quickly and with great force in passing the Recovery and Reinvestment Act so quickly.  After years of politics and dithering, the nation should be relieved they have leaders in place willing to take on the hard challenges of our day. 

Speaking for the NDN team we are very pleased with where the new bill has ended up.  Many of its core ideas - investments in health IT, clean and traditional infrastructure including greening federal buildings, 21st century schools and uiversal broadband access, support for unemployment insurance and backstopping the states, weatherization - are ideas NDN championed publically and privately before the President-elect outlined his original stimulus plan in early December.   Consider this passage from an essay, A Stimulus for the Long Run, Rob Shapiro and I released in Mid-November originally on the Huffington Post: 

When Congress goes back to work next week, its first job should be another stimulus package for the sinking economy. President-elect Obama also has said he wants another stimulus of his own design after he is sworn in. We know that more stimulus is necessary, because the ongoing financial and housing market crises will very likely produce an unusually long and deep recession. We also need additional stimulus as insurance against the possibility of another economic shock that would worsen the downturn, such as a run on the dollar that drives up interest rates, or worsening housing foreclosures that trigger more failures in financial institutions and further drive down consumer and business confidence.

The path of least resistance to deliver that stimulus is another round of tax rebates for American families, which in theory families would spend to jumpstart demand and, ultimately, the business investments and jobs to meet that demand. However, the catch is that approach is very unlikely to work this time. Most of the rebates from the spring 2008 stimulus were saved rather than spent; and given the recent, sharp decline in confidence, even a greater share of another round would be saved and so provide little stimulus. Moreover, President Obama and Congress can put those billions of dollars to uses that will stimulate long-term growth and income gains much more effectively.

Instead of tax rebates, congressional leaders and President-to-be Obama should look to targeted tax changes and targeted spending increases, with the lion's share going in a new direction: investments in the basic elements of growth for a 21st century economy. The stimulus should and will include traditional measures such as aid to the states facing serious revenue shortfalls and an extension of unemployment insurance. But for its major thrust, President-elect Obama should use the stimulus to drive policy reforms that will affect the shape and strength of the economy for the next decade, rather than simply affecting the timing of the next recovery. The stimulus should be first steps toward delivering on the change that President-elect Obama has pledged to bring to America.

This change should be directed toward creating a 21st century, low-carbon, innovation-driven economy, as the development, spread and efficient use of economic innovations will continue to be the most important factors driving all our future progress in growth, productivity, and incomes. For example, productivity gains are increasingly tied to an employee's capacity to operate effectively in workplaces dense with information and telecommunications technologies. Within a decade, workers who cannot perform in such work environments will be marginalized economically. Therefore, the stimulus should help businesses and workers prepare for the ideas-based economy, through grants to community colleges to keep their computer labs open and staffed in the evenings and on weekends for any adult to walk in and receive free computer training, a plan Obama endorsed as Senator. The stimulus also could include an innovative program to provide inexpensive laptops to every sixth-grader in America and spread broadband installation to schools, local libraries, and human services offices that currently lack it.

There is already a broad consensus on the need to include infrastructure investment in the stimulus, but instead of addressing only roads and bridges, America can also take this opportunity to invest in a new generation of clean infrastructure. The federal government can lead the way, through greening its buildings and vehicle fleets and putting 1,000 megawatts of solar power on its roofs. It also can provide funding to help modernize the electrical grid and build a new generation of light rail systems for urban areas, as well as greater support for research and deployment in renewable energy and energy efficiency technologies, and tax credits and other incentives for greening America's homes and private buildings.

Aside from energy, the other rapidly rising business cost squeezing wages and jobs is health care. To help hold down these costs for the long haul, the stimulus can provide support for hospitals, clinics and physicians to purchase and install the hardware and software for standardized electronic medical records systems. This will serve as a first down payment for 21st century health care reform, and will ultimately reduce costs and promote best-practices at the nation's hospitals.

These are all investments we know we have to make if we intend to make the U.S. economy more efficient, innovative and sustainable. They also are all investments that will ultimate pay for themselves several times over. Congress and President-elect Obama can use this opportunity not only to create more jobs, but to do so in ways that will help drive the development of a real, 21st century workforce and genuine 21st century economic infrastructure. And taking this course by passing a stimulus for change could be an early and important opportunity for him to practice both his new politics and a new form of economic leadership.

Or this passage from Michael Moynihan's excellent October essay, Accelerating the Development of a 21st Century Economy: Investing in Clean Infrastructure: 

Below are six proposals NDN offers to accelerate the building of clean infrastructure now. Each of these will help get money onto the street quickly to stimulate demand, help American families solve problems related to high energy costs and build the clean infrastructure America needs to compete effectively in the 21st century. Congress should pass legislation to:

 Fund the National Infrastructure Bank to leverage federal resources to fund
worthy, approved clean infrastructure projects (which would not only increase
funds available to infrastructure, but also represent a vast improvement over the
earmark system).

 Modernize the electrical grid through use of smart computer technology and
more transmission capacity, both to manage demand and move America's
tremendous wealth of wind and solar power to where it is needed.

 Provide tax credits for Americans to winterize their homes as the cold weather
approaches.

 Provide tax credits for the purchase of Energy Star appliances to reduce
demand for electricity.

 Provide aid to states and cities to expand mass transportation service and
perform maintenance on overburdened systems.

 Provide a tax credit to people who buy a new, fuel efficient car and take an old gas guzzling jalopy off the road, which has the added bonus of aiding the
weakened automobile industry.

There are other ways for Congress to promote clean infrastructure going forward -- through funding rail, promoting green national building standards and updating our electricity regulation regime to promote distributed generation of renewable power, among other approaches. But these six proposals can help us move toward clean infrastructure now as we get the economy moving again.  

So in other words NDN is very invested in this new legislation, and will be working hard with our Congressional leaders and all of you to ensure that as the plan moves from bill to implementation it is done in a way consistent with the opportunties presented to us and the nation.  More on this historic piece of legislation in the days ahead. 

And again Congratulations to your new President and Congress for stepping up, standing tall and doing the right thing for a nation in need.

Update - Jake Berliner did a comprehensive summary of our recent economic essays on Friday.  You can find it here. 

From his column today:

And I don't know about you, but I've got a sick feeling in the pit of my stomach - a feeling that America just isn't rising to the greatest economic challenge in 70 years. The best may not lack all conviction, but they seem alarmingly willing to settle for half-measures. And the worst are, as ever, full of passionate intensity, oblivious to the grotesque failure of their doctrine in practice.

There's still time to turn this around. But Mr. Obama has to be stronger looking forward. Otherwise, the verdict on this crisis might be that no, we can't.