Policymakers’ Risk Fiscal Cliff

The debt ceiling, which refers to how much the U.S. federal government may go into debt, has become a bargaining chip in the final round of debate over how to avoid the fiscal cliff. Republicans have promised not to agree to raise it until President Obama offers deeper spending cuts. In a recent message to Congress, the president told Republicans that there would be no negotiating for raising it later if they allow negotiations about the fiscal cliff to fail now, and many economists feel taking the debt ceiling off the table is a smart move for the White House, if only to ensure that if a recession is to result that it comes now instead of at the end of Obama’s second term. For more on this continue reading the following article from Economist’s View. 

One more from Tim Duy:

The Debt-Ceiling Gamble, by Tim Duy: Ezra Klein reports that the White House is drawing a line in the sand on the debt-ceiling, and they really, really mean it:

The Obama administration is utterly steadfast on this point: They will not suffer a repeat of 2011, when they conducted negotiations over whether the United States should default. If Republicans go over the cliff and try to open up talks for raising the debt ceiling, the White House will not hold a meeting, they will not return a phone call, they will not look at the e-mails.

The Administration is looking to take the debt ceiling off the table forever. This is good policy; that Congress should be able to pass laws authorizing spending but not authorizing the required debt is beyond ridiculous. Also ridiculous - and irresponsible - is the willingness of the Republicans to use the debt ceiling to hold the economy hostage. Ending this travesty should be a priority for the White House.
Klein adds that the White House is ready for the fight now while their strength is up:

Boehner and the Republicans don’t want to give up the leverage of the debt ceiling forever, or for 10 years, or even, as John Engler, head of the Business Roundtable and a former Republican governor suggested, for five years. But the White House isn’t very interested in compromising on this issue, as they figure that if there needs to be a final showdown over the debt ceiling, it’s better to do it now, when they’re at peak strength, then delay it till 2014 or 2015, when their own vantage might have ebbed.

I would add another advantage. Better - from a political point of view - to have a recession at the beginning of President Obama's second term that can be blamed entirely on the Republicans. A recession in the first half of 2013 means that, most likely, the Democratic presidential nominee can run on the back of an improving economy by 2016. Alternatively, they run the risk that this recovery, anemic as it is, gets long in the tooth by 2016. Even worse would be that they agree to let the Republicans once again hold the economy hostage two years from now. Politically, if I had to pick between a recession now or closer to the next election, I would pick now.

 This blog post was republished with permission from Economist's View.

Obama Seeks Chinese Currency Changes

President Barack Obama addressed China’s role in the global economy during the Asia-Pacific Economic Cooperation summit in Hawaii. The president urged Chinese policymakers to allow the country’s currency to appreciate at a faster pace so as to rebalance mutual benefits in trade and industrial contracting between China and other countries. Chinese president Hu Jintao argued, however, that China had no significant part in crafting global economic policy and felt little need to abide by its rules, and intimated he hoped his country would have a larger role in shaping policy moving forward. For more on this continue reading the following article from Tim Iacono.

You’d think that there’s at least a little bit of a “Good Cop, Bad Cop” dynamic going on right now when President Obama talks to the Chinese about letting their currency strengthen at a faster pace. Of course, Obama is the good cop here with just about every GOP presidential hopeful playing the alternate role and one can easily imagine Chinese President Hu Jintao being told over the weekend, “Hey, I’m about the best friend you’re ever going to have in Washington. How about a little appreciation, currency-wise?”

As Hu made clear yesterday, from the perspective of the Chinese, they had no part in making any of the rules in the current global monetary system and feel little compulsion to play by them. Mindful of the Japan experience in the late-1980s when strong currency appreciation led to massive asset bubbles and two lost decades, they’re not likely to simply comply with the wishes of the West when it comes to their currency.

This blog post was republished with permission from Tim Iacono.

Rick Perry’s Absent Economic Staff

More details emerge about GOP candidates as the field of contenders gets tighter, with focus finally beginning to shift from the individuals’ sound bites to their planned policies and the staff they are assembling to carry them out. Economist Tim Iacono notes that GOP frontrunner Rick Perry does not have one economist on his staff and relies on the economic successes of Texas to support his proposed performance in the White House, meaning to suggest he does not have anyone to help him craft the economic policy he will use to replace the one currently being used by the Obama Administration – a plan for which Perry and Republicans have no shortage of criticism. For more on this continue reading the following article from Tim Iacono.

There’s a lot not to like about Texas Governor and GOP candidate Rick Perry, but, clearly, two of his redeeming qualities are his disdain for the Bernanke Fed and, based on the fact that his campaign team is, so far, devoid of economists, a seeming dislike for the entire dismal set. Prior to last night’s GOP debate, this story in Fortune discussed the latter.

The governor relies on the Lone Star State’s economic performance under his leadership over the last decade to make his case. But where is his economic plan for the nation? Or, at least, where is the economic team that will help him craft it?

So far, apparently, neither exists.
…
As he stands up his campaign, there is evidence Perry is reaching out to private-sector leaders for economic advice. He brought a handful of Washington hands who lead small business trade associations down to Austin last month for a lunch meeting that one participant described as a “pure policy session” on job growth.

And it may be that Perry would like to hold off on hiring economic eggheads for as long as he can. The governor has cultivated an anti-elitist image, distancing himself from his predecessor in the Texas governor’s mansion, George W. Bush, by noting the 43rd president went to Yale, while Perry was a Texas A&M man. On Fox News, he recently blasted Obama for surrounding himself with academics who claim prestigious degrees and no real-world experience. “They are intellectually very, very smart but he does not have wise men and women around him,” Perry said.

As for Tuesday night’s debate, according to this Housing Wire story, the nation’s chief economist – Fed Chairman Ben Bernanke – isn’t too popular with this crowd, both Newt Gingrich and Mitt Romney saying they would not reappoint Bernanke to another term as the Fed chief if they were elected president, Gingrich saying he’d “fire him tomorrow”.

Based on Newt’s position in polls, Bernanke can rest easy until the end of his term.

This post was republished with permission from Tim Iacono.

Advice for Obama

Economist Brad DeLong has some suggestions for President Obama regarding how he should handle the country’s current economic crisis without expecting any help from Congress, because they can’t agree on anything. This means that regulatory reform is a non-starter and the president will have to result in putting pressure on the Federal Reserve to increase quantitative easing, close the spending gap and be willing to invest government dollars in infrastructure projects. It would also help, he argues, if the Treasury Secretary spoke on the benefits of a weak U.S. dollar to help exports and give a boost to the struggling European economy. For more on this continue reading the following article from Economist’s View.

Brad DeLong:

...What in most important is not just what Obama proposes on Thursday (because nothing will get done by congress), but rather what he does in the weeks and months afterwards to actually tune the economy so that it creates more jobs. I think Obama should:

1. Apply a full-court press to the Federal Reserve to get it to target nominal GDP to close the spending gap, for it is fear of risk that nobody will spend to buy what you make and confidence that your purchasing power is safe in cash that is holding back businesses from spending money to hire people.

2. Apply a full-court press to the Federal Reserve to get it to engage in more quantitative easing--into taking more risk onto its own balance sheet, for it is an unwillingness on the part of Wall Street to hold the risk currently out there that is making it very difficult for a wide range of risky spending projects to get financing.

3. Quantitative easing does not have to be done by the Fed: the Treasury can use residual TARP authority to take tail risk onto its own books as well, and should be doing so as much as possible.

4. Expansion does not require that the federal government spend: using Treasury (and Fed!) money to grease the financing of infrastructure and other investments by states would pay enormous dividends.

5. For the Treasury Secretary to announce that a weak dollar is in America's interest right now would not only boost exports, but it would immediately lead to a shift in monetary policy in Europe toward a much more expansionary profile--which would be good for the world.

None of these is first-best. All of these are likely to do some good. All should be tried.

What's discouraging is that there doesn't seem to be any sense of urgency about the employment crisis itself. It's more of a reluctant and begrudging response driven by a shift in the political winds. If the polls weren't falling, I doubt we'd even be hearing a speech on job creation. So I hope there's follow-through as well -- these things should be happening already -- but we'll see.

This article was republished with permission from Economist's View.

Choices Few in US Economic Fix

Economist Tim Duy provides a broad overview of the current state of U.S. economic affairs by examining the Federal Reserve’s role and options in supporting a turnaround. Duy’s guess is that monetary policy is the only card left to play as the administration’s plans for an economic boost will likely fall short and new legislation seems out of the question given policymakers’ inability to find consensus. This makes the Fed and its choices on quantitative easing, mortgage-backed securities and long-term policy positions as the deciding factors in whether the country will experience another recession. For more on this continue reading the following article from Economist’s View.

Tim Duy:

Questions and Answers, by Tim Duy: I thought this might be an easier way to get back into the game after an extended hiatus.

Does the economy need more stimulus?

Always good to start with a softball question - YES! The US economy is two years into an economic expansion, and yet the unemployment rate remains above 9 percent. National output growth averaged just 0.7 percent in the first two quarters of the year. Job growth was zero in August, albeit with some downward pressure from the Verizon strike. Output is $1 trillion below CBO potential – and the gap is expanding. The 30-year inflation indexed Treasury bond just traded at 90 basis points. None of which should be happening two years into an expansion. Yet here we are.

Will the private sector provide the needed stimulus?

Federal Reserve President Dennis Lockhart summarizes the situation:

It is necessary that the process of deleveraging plays itself out, which may take several more years. When economies are deleveraging they cannot grow as rapidly as they might otherwise. It is obvious that as consumers reduce spending they divert more of their incomes to paying off debt. This shift in consumer behavior increases the amount of capital available for financing investment. But higher rates of business investment are not likely to fully offset weakness in consumer spending for some time, as businesses continue to grapple with uncertainties about the future.

Lacking the equity wealth provided by the housing bubble, households are simply unable to sustain the debt loads of years past. Hence, deleveraging continues. Without anyone else to pick up the slack, it is tough to see how we eek out anything other than subpar growth, trend growth (2.5 - 3.0%) at best. Not enough to quickly lift the economy back to trend output.

Will the government provide the needed stimulus?

On the fiscal side, the answer is no, or at least not yet. As Paul Krugman points out, fiscal policy is already contractionary, while the recently passed budget deal promises only more austerity. And, via Brad DeLong, Macroadvisors predicts that President Barack Obama’s impending jobs plan is not likely to provide much if any of an economic boost. That leaves monetary policy as the only game in town. And here we can anticipate that more easing is coming. But will it be enough to pull the economy from its slump? At this point, almost certainly not.

Why will monetary policy fall short?

Here again it is useful to refer back to Lockhart’s recent speech:

Given the weak data we've seen recently and considering the rising concern about chronic slow growth or worse, I don't think any policy option can be ruled out at the moment. However, it is important that monetary policy not be seen as a panacea. The kinds of structural adjustments I've been discussing today take time, and I am acutely aware that pushing beyond what monetary policy can plausibly deliver runs the risk of creating new distortions and imbalances.

Lockhart is not ruling out additional policy responses, but makes obvious his view the Fed is nearly, if not already, out of bullets to deal with a balance-sheet recession. Moreover, he shows his sympathy with the camp, I think best identified with the views of Kansas City Federal Reserve President Thomas Hoenig, that the Fed at this point risks doing more harm than good. This, I believe, represents the center of FOMC thought at the moment. This group is simply not inclined to initiate a new large scale easing in the absence of clear deflationary pressures. The five and ten-year TIPS breakevens are 1.81 and 2.05 percent, respectively. Combined, I believe they argue, at least from the Federal Reserve point of view, for more easing, but nothing dramatic.

But didn’t the most recent FOMC minutes reveal a more dovish constituency?

Yes. From the minutes:

A few members felt that recent economic developments justified a more substantial move at this meeting, but they were willing to accept the stronger forward guidance as a step in the direction of additional accommodation

Chicago Federal Reserve Bank President Charles Evans is a good example of this group. Via a recent CNBC interview:

In his view, QE needs to stay in place until unemployment plunges to 7 percent or if inflation gets past 3 percent. Core inflation, which strips out food and transportation, is about 1.8 percent, though the number is 3.6 percent including the more volatile measures.

Evans is a voting member on the fed Open Market Committee and traditionally has been among its more dovish members when it comes to interest rates and inflation.

"Strong accommodation needs to be in place for a substantial period of time," he said. "If we could sort of make everybody understand that this is going to be in place for a longer period of time, we could knock out some of that restraint that comes about when people talk about premature tightening."

As far as I am concerned, he is preaching to the choir. There has been a remarkably irresponsible tendency of Fed policymakers to turn hawkish at the slightest hint of economic improvement. I think this belies their discomfort with the expansion of the balance sheet, and renders the rest of us unsure of their commitment to the dual mandate. And I believe the Fed needs to accept the possibility of higher inflation.

What can the Fed do at this point?

The usual suspects: Reduce the interest paid on reserves, extend the maturity of the Fed’s portfolio, expand the balance sheet further, shift the portfolio in favor of mortgage-backed securities to support the housing market, make a firm commitment to zero interest rates regardless of the inflation outcome, or raise the inflation target from 2 percent to 3 or 4 percent. I suspect the first three are most likely in play, although the magnitude of an additional balance sheet expansion will likely fall short of what is needed.

Wait a second. Didn’t the Fed already commit to zero interest rates until 2013?

No – they just said that given current forecasts, they anticipated an extended period on low interest rates. This does have some value in marginalizing the hawks. That said, the minutes make clear this is only a soft commitment:

Most members, however, agreed that stating a conditional expectation for the level of the federal funds rate through mid-2013 provided useful guidance to the public, with some noting that such an indication did not remove the Committee's flexibility to adjust the policy rate earlier or later if economic conditions do not evolve as the Committee currently expects.

What we really need is a hard commitment that can weather a period of higher inflation.

Where is Federal Reserve Chairman Ben Bernanke is this mix?

It appears that Bernanke is right of the dovish contingent revealed in the most recent FOMC minutes. I think this first became evident in his June press conference, when he made clear the bar to QE3 was high. The bar was high because inflation expectations had rebounded, and inflation was the only clear target the Fed had control over. This basic idea was evident in Bernanke’s Jackson Hole speech:

The Federal Reserve has a role in promoting the longer-term performance of the economy. Most importantly, monetary policy that ensures that inflation remains low and stable over time contributes to long-run macroeconomic and financial stability. Low and stable inflation improves the functioning of markets, making them more effective at allocating resources; and it allows households and businesses to plan for the future without having to be unduly concerned with unpredictable movements in the general level of prices.

Once inflation is close to the Federal Reserve’s target, Bernanke apparently sees little else monetary policy can do to relieve the cyclical pressures on the economy:

Notwithstanding this observation, which adds urgency to the need to achieve a cyclical recovery in employment, most of the economic policies that support robust economic growth in the long run are outside the province of the central bank.

I think the Bernanke’s focus on the 2 percent inflation target will severely limit the magnitude of additional easing to support job growth. It is increasingly my opinion that to lift the economy beyond the zero bound, we need a commitment by the Fed to lift inflation above 2 percent to allow nominal spending to return to the pre-recession trend. This is policy the Fed Chair appears dead set against, leaving only half-measures.

Note, however, the above only applies when inflation and inflation expectations are near the Fed’s target. I do believe Bernanke will press for more dramatic action should deflationary pressures become evident. I just don’t think we are there yet.

Would a shift to additional mortgage-backed assets help?

It wouldn’t hurt, and could push mortgage rates down further and thus encourage additional refinancing. Back in the day I would have been worried that the Fed risked looking like it was trying to sustain bubble-level prices, but I think we are beyond that. Still, note the problem in mortgage markets is deeper than interest rates – the problem is the inability to finance due to tougher underwriting standards and underwater mortgages. I am not confident that lower rates would alleviate these challenges. This seems more like the purview of the US Treasury, which could push for all federally guaranteed mortgages to be refinanced at a lower interest rate, regardless of the loan to value ratio.

Are we headed for recession?

I would not discount the possibility of recession given the US economy was clearly operating near stall-speed in the first half of the year. That said, it would be easier to embrace the recession story had the US economy ever returned to trend output during the recovery. As noted earlier, the economy is operating well below trend, and typical sources of strong downdrafts in demand – housing and autos – remain below pre-recession levels. Indeed, the absence of any rebound in housing is striking. Under these circumstances, I find it easier to embrace the “Japan” scenario, a sustained period of choppy and low growth. Recession or not, a tragedy by any measure.

What’s going on in Europe?

The Europeans are vexed with a political establishment that is not conducive to maintaining a single currency (of course, we too in the US are vexed with a dysfunctional political establishment, just a different one). In particular, they lack a mechanism to make sizable fiscal transfers within the Euro area. This is simply an important element of running a “one size fits all” monetary policy. As it stands, Euro-policymakers are attempting to enforce IMF-style austerity packages on troubled economies without the usual currency depreciation that helps offset the resulting fiscal contraction. It is obvious this approach is not working – Greek two-year debt is trading at 50 percent and the spread on Italian and Spanish debt widens. Paul Krugman asks where is the ECB? Where indeed? Perhaps they see their earlier debt-buying efforts as a failure, thus concluding the problem is a solvency problem, not a liquidity problem. And there is no European solution for a solvency problem, other than more austerity for troubled economies. Where does this end? Either the Euro-area comes together as a strong fiscal union or the periphery is jettisoned from the Euro. It really looks like the smart money is on the latter outcome. Drachmas anyone?

Update: 10:09PM PST

I see the ECB was not completely asleep at the wheel and was buying bonds. From the Wall Street Journal:

The ECB purchased Italian and Spanish government bonds Monday in a bid to keep 10-year borrowing costs from rising further above 5%—a threshold analysts say is key to their ability to finance their high debt loads. The ECB has purchased over €50 billion in bonds since reactivating the program four weeks ago.

This post was republished with permission from Economist's View.

Has Obama Given Up On Economic Stimulus?

Based on recent statements, the Obama Administration appears to be pulling back efforts for fiscal stimulus and is instead aiming to sell the idea that the US is in recovery. Timothy Geithner says that it is time to transition to "a recovery led by private investment" to the chagrin of many economists who think that the economy is too weak and requires additional help. See the following post from Economist's View.

Instead of a series of op-eds by Christina Romer, Larry Summers, Jared Bernstein and other members of the administration making a strong, strong case for more stimulus -- particularly that devoted to job creation -- along with the president himself making the case to the nation, the appearance of key administration officials on Sunday talk shows to bolster the effort, and so on, the administration has decided to try and sell a recovery that hasn't yet taken hold.

Thus, instead of a much needed and impressive effort to move Congress to action, or at least make clear to voters who is and who isn't trying to help those struggling with the recession, here's Timothy Geithner saying it's time for the government to back off because a solid recovery is underway:

Treasury Secretary Timothy Geithner said the economy has now recovered sufficiently for government to begin to make way for private business investment.... Mr. Geithner’s comments on Sunday, which echo previous sentiments expressed by President Barack Obama, reflect a turning point in the government response to the worst economic downturn since the Great Depression, a period marked by deep federal intervention in the financial, housing, auto and other industries...

The message is that the administration is pulling back, and maybe even starting to balance the budget because good times are just around the corner:

“We need to make that transition now to a recovery led by private investment,” Mr. Geithner said Sunday on NBC’s “Meet the Press.” Mr. Geithner hit two Sunday talk shows, delivering the Obama administration’s message that the economy was recovering...

I don't understand this strategy. The election is not that far way. If unemployment continues to be a problem, and it looks like it will, saying that things are fine and recovery is just around the corner will backfire.

Update: I meant to make this point, but forgot, so I'm glad Calculated Risk noted this (and I likely would have relied on his evidence in any case):

The WSJ is quoting Treasury Secretary Timothy Geithner as saying it is time for private investment to take over from government stimulus:

“We need to make that transition now to a recovery led by private investment,” Mr. Geithner said Sunday on NBC’s “Meet the Press.”
...
“I think the most likely thing is you’ll see an economy that gradually strengthens over the next year or two, you’ll see job growth start to come back, investments expanding ... but we’ve got a long way to go still,” Mr. Geithner said.

I discussed this last week - in most sectors of the economy there is over capacity or too much supply (housing), so there is no reason for significant new private investment.

(Also, in response to comments, maybe I should also add that, despite the poorly chosen title, I wasn't serious about the reverse psychology part.)

Update: Brad DeLong follows up.

I would put it much less politely: have Tim Geithner and Barack Obama lost their minds? The Administration's mid-session review--released last week--projects that the unemployment rate will rise in the next several months and will be at 9.3% in February 2011. It projects that Q4/Q4 real GDP growth will be 2.9% this year--and I don't see how we are going to get there with a 2.7% growth rate in the first quarter, a likely 2.0% growth rate in the second quarter, and with the tracking third-quarter growth aret at 2.9%. We would need 4.0% growth in the fourth quarter of this year. Nor do I understand where the 1.7% decline in unemployment over 2011 is supposed to come from: a simple Okun's Law coefficient of 2 would suggest that we need 2 x 1.7 + 2.6 = 6% real GDP growth to generate such a decline.

According to Mark Zandi, in the fourth quarter of this year the phase-out of the ARRA is likely to shave 0.3% off the real GDP growth rate. in 2011, the contractionary effects of the ARRA phase-out on the quarterly growth rates are likely to be -0.8%, -1.2%, -0.7%, and -0.2%.

It sure ain't morning in America. Maybe I need to go back and read Geithner's transcripts from this morning to see if the MSM is misrepresenting what he said...

This post has been republished from Moses Kim's blog, Economist's View.

Are Obama's Policies Hurting The US Economy?

Maryland Professor Peter Morici writes in The Street that the Obama administration's policies are resulting in fewer dollars in consumer's pockets and more jobs going overseas. Additionally, the allocation of bailout funds was disproportionately spent on large financial institutions, leaving the small business friendly community banks out to dry. See the following post from The Street.

Americans have the economy scoped. Polls indicate they sense the economy growing again, but many more believe the job market is getting worse than see it improving.

Over the next three years, the economy must create nearly 13 million jobs to bring unemployment down to 5% -- still higher than pre-recession levels. That requires 360,000 jobs every month and economic growth at 5% a year.

After a deep recession, robust growth is possible if businesses have enough customers and capital, but President Obama's policies don't address the underlying causes of the Great Recession. Neither enough demand, nor financing, is forthcoming.

Domestic demand--consumer, business spending, etc--will accelerate to 3.5% a year, but much is tapped off by a rising trade deficit--Chinese imports benefiting from an undervalued yuan and pricey imported oil. Troubles in Greece and elsewhere in Europe dampen markets for U.S. exports.

President Obama won't back up talk with China about its protectionism with concrete actions. The Chinese sense in Obama weakness, and in America, decay.

The President talks tough on the speaking circuit, but hasn't the stomach to stand up to China any more than he confronted tort lawyers and drug manufacturers in his health care reforms.

The BP oil spill is a terrible national tragedy, but the hard reality is costly imported oil is depriving U.S. businesses of customers. Much money that leaves the country to pay for oil doesn't return to buy exports.

Obama tongue-lashing Big Oil makes it more unlikely the US will drill a lot more, either offshore or onshore. His bold talk notwithstanding, promises to build out domestic alternatives, like nuclear and wind, are not backed up by the comprehensive actions possible given technologies available right now.

The President talks a good game but hardly plays--a fisherman boasting in the tavern who owns no boat.

Add the troubles of the 8000 regional banks.

Obama spent the TARP to bail out Wall Street banks, GM and his pals at the United Autoworkers, but left the 8000 regional banks to sink or swim. Cash strapped, those banks can't lend enough to small- and medium-sized businesses, which create most new jobs.

Add the new health care law--with huge costs to employers and higher premiums for individuals and the cost overruns the Congressional Budget Office now admits. Voilà, even fewer dollars for consumers to spend on U.S. goods and more businesses offshoring jobs.

Now Obama wants to jack up taxes--repeal the Bush tax cuts, add a hefty interest and dividend tax, and the mother of all confiscatory taxes, a value added tax.

I have an expensive education in economics. Nowhere do the textbooks state raising taxes creates jobs.

President Obama reminds me of New York City before Mayor Giuliani. Mayors Koch and Dinkins were always scrounging for new taxes rather than addressing the dysfunctions of a broken government.

Democrats assume wealth and tax it to paint over problems.

Smart people cultivate wealth knowing tax revenues to solve problems will follow.

Professor Peter Morici, of the Robert H. Smith School of Business at the University of Maryland, is a recognized expert on economic policy and international economics.

This post has been republished from The Street, an investment news and analysis site.

Obama Pits Main Street Against Wall Street

President Obama employed populist rhetoric over substantive discussion to cast banks and Wall Street as the primary villains as he worked to ramp up support for the Democrats proposed bank reform and regulation bill. Glenn Hall from The Street states that by turning the financial industry's profits into greedy indictments, the President overstated his case that Wall Street and Main Street are at odds with one another; on the contrary, the bullish market has created value for numerous IRAs and 401Ks held by the citizens of Main Street. See the following post from The Street.


President Obama is totally overstating the MainStreet vs Wall Street conflict to scare Congress into passing new banking regulations.

"Some on Wall Street forgot that behind every dollar traded or leveraged, there is family looking to buy a house, pay for an education, open a business, or save for retirement," Obama said Thursday in New York.

That's got a nice populist ring to it, but it's not that simple. What about the value to MainStreet from all the money flowing into 401Ks and IRAs courtesy of a bank-led bull run in the markets?

I'm sure Obama understands the nuances, but they aren't politically expedient. It's far more effective in Washington to have clear villains.

So Obama's SEC delivered Goldman Sachs' (GS) head on a platter with its fraud charges last week.

It doesn't matter that the SEC's case against Goldman is lame, the public has been put on notice that banks can't be trusted.

With the stage set, Obama is now in New York today, taking the fight straight to Wall Street. Just when it looked like Congress might waste a good crisis (as Rahm Emanuel, Hillary Clinton and other Obamanistas have become fond of saying), Obama is putting on a full-court press against banks.

IMF Bank Proposals Face Hurdles (Forbes)

Obama's timing is deliberate, arriving in New York just after the banks started getting good press with headlines like "Morgan Stanley's (MS) Trading Business Delivers" and "JPMorgan's (JPM) Success Raises Stakes".

Even the oft-maligned poster child for the financial crisis, Citigroup (C), posted a surprise profit.

Obama took the opportunity to turn those profits into indictments, saying that "until this progress is felt not just on Wall Street but Main Street we cannot be satisfied. Until the millions of our neighbors who are looking for work can find jobs, and wages are growing at a meaningful pace, we may be able to claim a recovery - but we will not have recovered."

Sure, Obama offered a few bones to the bankers and struck the occasional conciliatory note such as his concluding remarks that "ultimately, there is no dividing line between Main Street and Wall Street. We rise or we fall together as one nation."

But Wall Street really served as the backdrop for Obama's populist appeal to rally MainStreet and remind members of Congress that an election is coming and they don't want to be on the wrong side of this debate.

Obama knows how to work a crowd -- and after today's speech in New York, he has put bank reform back on America's agenda.

This article has been republished from The Street, an investment news and analysis site.

Obama Refuses To Take Necessary Steps To Fix Economy

The US stock market has continued to adjust downwards in the face of the government's inability to reduce the country's economic woes, including the effective 17% unemployment rate. Peter Morici from The Street says the best solution to the situation would be growth in exports, but the government has neither provided appropriate programs nor provided appropriate pressure on China to bring down the United States' trade deficit. See the following post from The Street.

Stocks are tumbling as investors realize President Obama is simply not offering policies that will fix the U.S. and global economies.

Each week, more than 450,000 Americans apply for new unemployment benefits, and 17% of adults can't find a full-time job or have quit looking for work altogether.

Since Massachusetts voters sent Democrats a vote of no confidence, Obama has been doubling down on bigger government and class warfare as the road to prosperity.

Meanwhile, the two biggest problems that block economic recovery go unaddressed -- most businesses lack enough customers and access to bank credit to create jobs.

Just about everyone recognizes consumer spending won't come roaring back. Those few businesses that can increase sales often can't borrow from banks to expand.

Not surprisingly, the 5.7% growth in gross domestic product recorded in the fourth quarter was mostly an accounting adjustment, reflecting a slower pace of inventory depletion.

Domestic consumption and investment contributed a tepid 1.8% to growth, and that pace is simply not enough to sustain a recovery.

The government is all tapped out. Deficits, if pushed any higher, could cause an international run on the dollar and a financial calamity even Federal Reserve Chairman Ben Bernanke's printing press couldn't fix. Not surprisingly, the government added zero to fourth-quarter growth.

Salvation must come from bringing down the $440 billion trade deficit, and, in particular, the huge trade imbalance with China. Cutting that deficit in half would boost GDP by 3%, resurrect manufacturing and high wage jobs, and it's then off to the races -- healthy growth rivaling the Clinton years.

The president's new export promotion program and small businesses incentives are too little too late.

Obama needs to stop talking about Chinese mercantilism and do something about it. Instead, he whines America won't turn to protectionism.

Currency manipulation makes China the most protectionist bully on the planet, robbing growth and jobs from the United States and Europe and increasing the risk that troubled governments like Greece may default.

Meanwhile, after taking $2 trillion in government aid, the banks are doling out $150 billion in bonuses but are unwilling to loan most businesses the capital they need.

It is high time to separate the commercial banks that enjoy a government guarantee from investment banks like Goldman Sachs(GS Quote). Limit aid to commercial banks for the purposes of making loans, as opposed to trading currency, energy futures and other complex financial instruments.

The president expresses outrage about Chinese trade practices and bank bonuses but refuses to take substantive actions -- for example, countering Chinese protectionism with a tax on dollar-yuan conversions to raise the effective price of the yuan, and imposing a 50% tax on bank bonuses as Britain has done.

The markets have figured it out. Obama is a charismatic campaigner and eloquent speaker, but he simply doesn't have a grasp of the facts or lacks the courage to fix what is broken in the American economy.

Folly in Washington begets panic on Wall Street.

This post has been republished from The Street, an investment news and analysis site.

Growing Faction Of Angry Americans Making Meaningful Economic Policy Difficult

The high unemployment, bailouts, and bonuses have angered people from a wide range of political affiliations which Robert Reich calls the "I’m Mad As Hell" Party. This faction of Americans are creating a political climate that discourages policies that would accelerate the economy. See the following post from Economist's View.

Robert Reich defends Obama's economic policies:

Obamanomics one year out, by Robert Reich , Commentary, Salon: Obamanomics suffers from a misunderstanding of what the President is trying to achieve and what he’s up against. Into the breach come Republicans, Tea Partiers, nay-sayers, deficit vultures, and Raging-Dog Democrats, all viewing Obamanomics as more taxes and more spending. That’s nonsense. ...

You don’t have to be an orthodox Keynesian to understand that as long as the private sector is deleveraging, the public sector has to borrow and spend in order to keep the economy moving forward. ...

Obama needs to spend more. Just look at projected unemployment. ... The Council of Economic Advisors foresees 10 percent unemployment through the rest of 2010, falling only to 9.2 percent in 2011. ... High unemployment ... allows firms to keep wages low. That’s good for corporate profits but not for ... employees. ...

The federal budget deficit is a huge problem, to be sure. But you need to distinguish between deficits occurring this year and next when the economy is still trying to climb out of a hole, and deficits five to ten years from now. ... The public doesn’t quite get this distinction, which is probably why the President thought it necessary to freeze discretionary nonmilitary spending. ...

The economic stresses of continued high unemployment and low wages are contributing to the growth of the "I’m Mad As Hell" Party -- a rag-tag collection of Tea Partiers furious at establishment Republicans, left-wing Democrats angry at what they consider lily-livered Democrats in Washington, and Independents disgusted with everybody inside the Beltway.

Mad-as-hellers on the right hate government; mad-as-hellers on the left hate big business. Both share a growing sense that the economic game is rigged against them. The two are also united by how much they detest Wall Street and its bailout, and their contempt for any cozy relationship between big business and government. They distrust the Fed, and have no particular fondness for international trade, either. Mad-as-hellers are likely to be a formidable force in the upcoming midterms and beyond.

Obama is responding. That’s one way to view his newly-proposed crackdown on Wall Street... It also explains why the President is making another attempt to increase taxes on the overseas earnings of multinational corporations, and reduce tax breaks for hedge-fund managers and oil and gas companies. And why he feels it’s a good time to let the Bush tax cuts expire on higher-income individuals..., although not on the middle class. ...

They're still mad. That won't change for some members of this group no matter what. For the rest, the anger will persist until economic conditions improve, labor markets in particular, and there is some sense that justice has prevailed.

I think it will take a long time for labor markets to improve, policy has not been adequate to change that, and there's no sign that the help that is needed will be forthcoming. The political climate won't allow it.

I also think it will be far, far longer, if ever, before there is any general sense that the actions that were taken during the crisis served the needs of middle and lower class households rather than the needs of bankers. Charging banks for the cost of the bailout and other such proposals from the administration is an attempt to change this perception, but the perception of unfairness will be difficult to overcome.

This article has been republished from Mark Thoma's blog, Economist's View.

Can Obama Get Banks To Loosen Lending?

Obama met with top financial institutions to encourage them to loosen lending to help the economy recover in reciprocation of receiving significant help from American taxpayers during the financial crisis. However this encouragement may not be enough to overcome the higher risk of lending in a poor economic environment. See the following from Economist's View.

Obama tells bankers they should lend more to small businesses and homeowners:

Obama Tells Bankers That Lending Can Spur Economy, by Helene Cooper and Javier Hernandez, NY Times: President Obama pressured the heads of the nation’s biggest banks on Monday to take “extraordinary” steps to revive lending for small businesses and homeowners, drawing a firm commitment from one large bank to make more loans and vaguer assurances from others.

Meeting with executives from 13 financial institutions, Mr. Obama sent a clear message that the industry had a responsibility to help nurse the economy back to health and do more to create jobs in return for the bailout last year that kept Wall Street and the banking system afloat.

But ... Mr. Obama also confronted the limits of his power to jawbone the industry. ... The heads of three of the biggest firms — Goldman Sachs, Morgan Stanley and Citigroup — did not even make it to the White House meeting in person, having waited until Monday morning to travel to Washington and then being held up by fog.

“America’s banks received extraordinary assistance from American taxpayers to rebuild their industry,” Mr. Obama said in remarks after a midday meeting with bankers at the White House. “Now that they’re back on their feet we expect an extraordinary commitment from them to help rebuild our economy.” ...

Bank of America said after the meeting that it would increase lending to small and mid-sized businesses by $5 billion next year over what it lent to them in 2009.

Speaking outside the White House, Richard K. Davis, the chief executive of U.S. Bancorp,... said financial institutions would re-examine small business loans that had been denied, but he cautioned that banks had a responsibility to carefully evaluate the qualifications of each client. “We simply want to assure that we make qualified loans,” he said. ...

The tone for the White House meeting with the bankers was set Sunday night when CBS’s “60 Minutes” broadcast an interview in which Mr. Obama said “I did not run for office to be helping out a bunch of fat cat bankers on Wall Street.” ...

“We have to get them off the sidelines and get them to play a more active role in our economic recovery,” Rahm Emanuel, the White House chief of staff, said on Sunday. “They play an essential role in helping the economy grow.”

There are hurdles to get over on both the demand and supply side of the equation. Because of the recession, the demand for loans for new investment and for other purposes is down, but when firms do apply for credit, they are less likely to get it because banks assess credit worthiness partly based upon current economic conditions. The poor state of the economy has led them to conclude that many loans that might be made in better times are too risky to make right now

On the demand side, tax cuts and other incentives would help, but the supply of credit has to be addressed too. Yes, there's plenty of liquidity available, bank vaults are overrun with funds, but banks are reluctant to lend in this environment (particularly small and medium sized banks who face lots of uncertainty over their exposure to commercial real estate loans that may or may not be paid off). A solution to this is for the government to insure the loans in some way through tax write-offs, direct loss sharing, subsides, etc., there are lots of ways to do this, but it's hard to imagine anything like this happening in the present political environment, and the desirability of encouraging risky loans as a solution to our problems is questionable in any case (the money may be better spent on public projects with a high social return). However, if the government wants to encourage more lending in the private sector, something along these lines will need to be done. I don't see how speeches and meetings with bank executives asking them to lend more will do much to solve the problems, particularly the problems at smaller banks.

This post has been republished from Mark Thoma's blog, Economist's View.

Does TARP Savings Justify More Spending?

Glenn Hall from the Street discusses Obama's new proposal for another round of stimulus spending that would focus on jobs. Despite the estimated $200 billion savings on TARP, there are objections to spending a similar amount, especially since the government has been so inefficient at creating jobs so far. See the following article from The Street.

President Obama, having already stretched his authority to spend taxpayer money on the banking bailout, is now embarking on a TARP-for-Jobs program.

That's the tone he set with his jobs speech yesterday and the various other commentary from administration officials sent out to talk up the plan. Obama said the U.S. needs to spend its way out of recession and can afford to do so because recent estimates showed the Troubled Asset Relief Program, aka TARP, will cost $200 billion less than previously thought.

Conveniently, estimates for the cost of this next round of stimulus spending are also $200 billion. The plan, described as a "Grab-bag Approach," prescribes more infrastructure spending, tax credits and tax breaks for small businesses and extensions of other programs included in his previous stimulus package.

The TARP-for-jobs concept is already causing a stir among Congressional leaders, in particular Republicans, who are chafing at the growing federal deficit and the big-government agenda of the Obama administration.

Of course, we know that Obama is politically savvy enough not to simply redeploy TARP funds - though we've seen that he's perfectly willing to stretch the authorized uses of those funds by investing directly in banks and adding automakers to the dole.

Most likely, the president will use the lower TARP costs as a political balance against new spending he asks Congress to approve. It will be classic political slight of hand -- the TARP money will go to reducing the deficit so that more money can be spent on jobs without increasing the deficit.

So far, we've not seen great results from government spending on the job front, so the skepticism may be justified. The Obama administration's own accounting of its first stimulus package showed that stimulus jobs don't come cheap.

Obama argues that the first round of spending worked because the U.S. skirted a depression and the economy stabilized, so the second round is the booster shot that leads to full recovery. It's going to be a tough sell.

If you believe Obama can still work his magic, then we may start seeing the government-induced benefit that many major banks have been enjoying spread to other sectors as well. Whether or not Obama spends TARP funds directly, this could be like TARP for industrials.

If Obama sticks to the focus on big, publicly traded players like he did with the bank bailout, it could be a boon for the likes of Caterpillar (CAT Quote), United Technologies (UTX Quote) and Deere(DE Quote).

We could also start seeing industrials like GE(GE Quote) and Fluor(FLR Quote) reporting outsize profit similar to Goldman Sachs (GS Quote) and JPMorgan(JPM Quote).

Eventually, those profits will translate into growth and when the big companies start hiring, it will have a trickle down effect on all the smaller companies that orbit them.

I'm sure we'll be seeing massive job creation in the banking industry any day now.

If that doesn't work, then maybe the government should try just getting out of the way and letting the private sector do its thing.

This post has been republished from The Street, an investment news and analysis site.

Obama Changes His Tune On Deficit

After campaigning for and signing into effect more than $800 billion in federal stimulus, President Obama now is worried that too much debt could create a double-dip recession and recently spoke out against deficit spending. Although the federal stimulus package delivered limited and underwhelming job growth results, Democrats in Congress are already at work on a second package targeted at spurring job growth – one that will likely result in more deficit spending. See the following from The Street.

President Obama, the champion of stimulus spending, is suddenly worried about an overload of government debt.

After pressing Congress to approve an $800 billion package of infrastructure projects, unemployment benefits and tax cuts during his first month in office, Obama is now warning that too much debt could cause a double-dip recession.

Even more intriguing about this shift in rhetoric is that he chose to deliver the new message to Fox News, News Corp. (NWS Quote) network with which Obama has been feuding over a perceived conservative bias.

One can only assume that the detente with Fox and the decision to talk about debt issues is a politically calculated move to assuage Republicans who have been making deficit spending a centerpiece of their resistance to Obama's many initiatives, in particular health care reform.

Obama also acknowledged that he's in a precarious position in terms of boosting job creation to keep the recovery going while reinstating some fiscal discipline.

In the same interview with Fox, Obama talked about the need for new measures to spur companies to create jobs. Obama's Democratic Party chiefs in Congress are in fact working on new legislation they hope will bring down the unemployment rate from the staggering 10.2% level. Any government-sponsored initiatives along those lines will add to the deficit one way or another.

It's essentially an admission of failure that Democrats are now working on a second job-creation package.

So far, the stimulus spending isn't showing great results. At the end of October, the Obama administration released a report showing that about 650,000 jobs had been saved or created at a cost of $150 billion. That's about $230,000 per job.

I'm not knocking Obama or the Democrats for trying to stoke the economic recovery, for the trillions of dollars spent to bailout the financial industry or for realizing that they may need to do more to help the 15 million unemployed Americans find new jobs.

It's just the idea that Obama is now critical of deficit spending that I find so ironic.

This post has been republished from The Street, an investment news and analysis site.

Obama Wrong About Deficits Causing A Double-Dip Recession

Mark Thoma discusses why Obama is wrong about the deficit causing a double-dip recession. While he may be trying to reassure China about their US dollar concerns, a premature attempt to balance the budget before the economy is fully recovered is more likely to lead to a second recession. See the following post from Economist's View.

Edward Harrison catches this quote from Obama:

The president is in Beijing as part of his tour through several Asian countries to address economic challenges. He spoke candidly about the precarious balancing act his administration is trying to perform. He wants to spend money to kick-start the economy, but at the same time is in danger of creating too much red ink.

Obama warned the United States' climbing national debt could drag the country into a "double-dip recession," though he said he's still considering additional tax incentives for businesses to reverse the rising unemployment rate.

"There may be some tax provisions that can encourage businesses to hire sooner rather than sitting on the sidelines. So we're taking a look at those," Obama told Fox News' Major Garrett.

"I think it is important, though, to recognize if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the U.S. economy in a way that could actually lead to a double-dip recession."

I hope his economic advisers set him straight, though I suppose there's a chance that this nonsense is coming from them. We needed a larger stimulus package to begin with, and the economy could still use more help, labor markets in particular.

Let's hope that this doesn't turn into a call to actually start balancing the budget before the economy has fully recovered as that would increase the chances of the double dip recession that he is so worried about (something we should have learned from the 1937-38 experience where an attempt to balance the budget prematurely plunged the economy back into recession).

These comments also make it sound like any jobs program, if we get one at all, will be limited to (right-wing approved) tax cuts which is, in my opinion, inferior to direct job creation strategies. Tax cuts can be part of the mix, but by themselves are unlikely to do enough to solve the employment problem.

This post has been republished from Mark Thoma's blog, Economist's View.

Obama's Report Card On The Economy

After only nine months in office, some may question whether President Obama’s administration has achieved much in changing the lives of Americans. NY Times commentator Alan Blinder believes that while any substantial achievements have yet to be seen, President Obama has been instrumental in pushing forward several macroeconomic and banking policies that may well create positive long-term changes in the future. See the following post from Economist's View.

Alan Blinder grades the administration's accomplishments on macroeconomic and banking issues:

Comedy Aside, an Obama Report Card, by Alan Blinder, Commentary, NY Times: First, “Saturday Night Live” parodies President Obama’s “achievements.” Then Mr. Obama wins the Nobel Peace Prize, bringing yet more head-scratching. Clearly, the nation’s attention is focused squarely on a question few presidents want to answer just nine months into their term: What has your administration accomplished?

I’ll leave foreign and military affairs to the Oslo Five and concentrate on domestic economics. ...

Stopping the Slide Let’s remember that the new president was dealt a dreadful hand on Inauguration Day — including a shattered financial system and a national economy teetering on the brink of disaster. The administration’s chief accomplishment to date surely is devising and executing — with huge assists from the Federal Reserve — a comprehensive program to pull us back from the abyss. ... Thus Job No. 1 — stopping the train wreck — appears to have been done rather well.

Enacting the Stimulus Package The much-maligned fiscal stimulus has been criticized from both the left (as too small) and from the right (as too big, especially the spending parts). My own judgment is that both its magnitude and composition were reasonable, though not perfect. But ... speed of enactment merits substantial weight in the overall grade. By that standard, the stimulus package scores well — especially considering that Republican obstructionism... Give it a B or B+.

Rescuing Banks ...[T]he Treasury secretary ... wisely resisted the siren songs coming from both the left (“nationalize the banks”) and the right (“let ’em fail”), opting instead for the high-risk “stress tests” of 19 big financial institutions. Today, all 19 are alive and breathing. None have been nationalized. ... Most are not just showing a pulse but also actually have pink in their cheeks. ... (In fairness, the Fed and other regulators deserve great credit for executing this delicate task so skillfully.)

So give the bank rescue plan an A–. The minus comes from being too soft on many banks and bankers, who failed us and then benefited from public largess.

Reducing Foreclosures Mr. Obama’s efforts to mitigate foreclosures have been more modest — and less successful. ... Give them a C.

Trying for Regulatory Reform While it is still only a set of proposals,... the Treasury worked at breakneck speed ... to produce an intelligent and comprehensive set of financial regulatory reforms after just five months in office. The ... proposals ... are not perfect. ... And I continue to be distressed that the president, having overloaded his plate, has been unable to devote enough time and effort to pushing the proposals through Congress — leaving the lobbyists far too much running room.

At this point, we can’t even guess what may pass. So give this policy an “incomplete,” noting, however, that the first draft shows promise.

Etc. In addition to these efforts on the macroeconomic and financial fronts, the president appears to be making some headway on health care reform... By contrast, the betting is against getting through Congress a cap-and-trade system for reducing carbon emissions.

On balance, then, this assessment leads to a Nobel-like verdict in the areas of financial regulation, health care and energy: the ideas have great merit, but any real achievements are hopes for the future. They don’t award prizes for that in Washington, even if they do so in Oslo.

Yet on the crucial macroeconomic and banking issues,... Mr. Obama’s accomplishments in just nine months are palpable and were very much needed. ...

Let me add one more category, how the benefits from the stimulus package and the bank bailout package have been distributed. With so many of the benefits of the financial bailout accruing to the same people and institutions that helped to cause the problems, with employment still lagging, and with social insurance programs to help those who cannot find employment coming under increased budgetary pressures, particularly at the state and local levels, it seems evident that the distribution could have been much better without compromising (and perhaps even enhancing) the speed of recovery.

This post has been republished from Mark Thoma's blog, Economist's View. Photo courtesy of Wikipedia Commons.

Should Obama Bring Bernanke Back?

There is widespread debate on whether Bernanke should be reappointed. While Bernanke receives his share of criticism, Economist Mark Thoma explains why it would be in the country's best interest for Obama to bring him back for a second term. See the following post from Economist's View to learn why.

Nouriel Roubini says:

Ben Bernanke ... deserves to be reappointed. Both the conventional and unconventional decisions made by this scholar of the Great Depression prevented the Great Recession of 2008-2009 from turning into the Great Depression 2.0.

Anna Schwartz has a different perspective:

As Federal Reserve chairman, Ben Bernanke has committed serious sins of commission and omission — and for those many sins, he does not deserve reappointment.

Here's how I see it. It's true that we failed to notice that the patient was getting sick. The signs of disease were there, but we either didn't see the signs or they were misdiagnosed. In fact, there's a case to be made that we saw some of the changes in the patient as signs of improving health. Had we made the correct diagnosis early enough, maybe we could have prevented the patient from getting sick (though it's not clear the patient would have taken our advice, so stronger measures than mere advice may have been required).

And once the patient showed up in the office and was clearly sick, we didn't get it right initially either. We thought the patient needed fluids - liquidity as they say - and the patient did need some of that, but we didn't immediately see that there were also some key nutrient deficiencies and chemical imbalances that were threatening to cause further problems.

Bu we kept at it with tests and other diagnostics, and eventually got a handle on the problem. Once we did, we began to administer the medicine the patient needed. The patient will get better, the deterioration was rapid and turning it around will be difficult - it won't happen fast enough to suit any of us - but what has been done prevented a complete collapse, and is helping to move the patient towards recovery.

So I'm with Nouriel, Bernanke should be reappointed. It's true that the progression of the underlying disease was largely missed, but that's pretty much true across the board, all the doctors missed it. It's also true that there was some dispute over how to interpret the initial symptoms and test results, and what to do to cure the patient. But again that was largely true across the board in the tumultuous period just after the patient began to exhibit clear and serious problems. It's not like everyone except the patient's doctors knew exactly what to do. The uncertainty in that initial period created fear, and the fear made the patient - who needed calm above all else - even worse off.

But as just noted, the doctors who were put in charge - Bernanke in particular - persevered and began to understand more precisely what was going wrong and what was needed, and that allowed them to save the patient from a much, much worse fate. They deserve credit for that. The patient will live, and that wasn't always so clear. In the initial confusion they did what you need to do - they administered wide spectrum drugs and other procedures that were known to abate the symptoms they were observing, and these did help, and that gave them time to find more targeted remedies. They used the time wisely to find and structure better remedies, and once those remedies were ready they used them to attack the various ways in which the disease was shutting down vital systems (not everything they tried worked, but the things that did work helped quite a bit).

There was one scary point, however, and that was when they thought the patient had become strong enough to go without the medicine, and they withdrew it too soon (the Lehman episode). The result was that they almost lost the patient completely, and only quick action saved the day. That's the one point where I think the doctors could have done better. I understand the concerns over the side effects of this medicine, but it was too soon and it created too much unnecessary uncertainty and fear.

But overall, they did the things that needed to be done to make sure the patient did not suffer an even worse, prolonged, debilitating collapse, and those efforts were successful. Failing to diagnose a disease is different from not knowing what to do once you figure it out. The disease was a difficult one to diagnose or it wouldn't have missed so widely, and it wasn't clear at first precisely what was wrong, but in every case, once they understood the problem, they took the proper course of action.

Here's the question I ask myself. If I were to suddenly come down with the same disease, would I want the current group with it's current leadership in charge of bringing me back to health, or would I want a different group led by someone new who thinks they know what to do, but has never actually been through it? I'd want this group, the one with experience. They're likely to have learned enough to spot the disease the next time and head it off all together, one hopes so. But if not and I get the disease, they are also likely to know just what to do - while avoiding the missteps they took the first time - to get me back on my feet as fast as possible (and please don't let politicians second guess them).

This post was originally published on Mark Thoma's blog, Economist's View.

Obama's Proposal For Requiring Bank "Funeral Plans"

An arguably much needed change outlined in the Obama administration's financial regulation overhaul proposal is the requirement of a "rapid resolution plan". This would provide the government with important information in the event that a systemically important financial institution faces collapse. For more, see the following post by economist Mark Thoma, author of Economist's View.

No disagreement with this. The failure to have dissolution plans for systemically important institutions on the shelf and ready to go turned out to be costly, so credible dissolution plans are certainly needed. However, the argument seems to assume that too big and too interconnected firms cannot be avoided, something I'm not ready to concede:

A sound funeral plan can prolong a bank’s life, by Anil Kashyap, Commentary, Financial Times: Buried within the 88-page Obama administration proposal to overhaul financial regulation is an overlooked option called a “rapid resolution plan”. It mandates that systemically important financial companies be required regularly to file a “funeral plan”: a set of instructions for how the institution could be quickly dismantled should the need to do so arise. ... It could be implemented now, without the need for legislative action. Regulators should do so immediately.

The first benefit is that regulators would gain a stronger negotiating position with a dying institution. Throughout this crisis the authorities have had to intervene without knowing exactly what hidden traps might emerge if a bank were to be closed down. The bankers know this and can exploit the fear of the unknown to press for bail-outs.

It is remarkable that such rules do not already exist. ... The crisis has shown us that the sudden unwinding of a large, complex financial institution is terrifying for the financial system. ...

A second immediate benefit would be to force bank managers to think much more carefully about the complex financial structures they have created. If bankers had to explain every single step needed (and the associated consequences) to shut down their subsidiaries in all the various jurisdictions in which they operate, they would have a big incentive to simplify their organisations. ...

Over the medium term, there would be additional benefits. The headline component of the plan would be the requirement for banks to estimate the number of days it would take to shut down. Banks that require longer to close would have to hold more capital. This would place management under serious pressure to improve their plans...

Senior members of the management team and the board would have to understand the funeral plan. Crucially, they would be forced to sign off on its accuracy. This might also lead to closer scrutiny of new products or lines of business if they jeopardised an orderly unwinding. ...

This proposal is far from a cure-all. One big problem is that resolution rules themselves, especially when multiple legal systems are involved, are quite complicated. But the plan has an extremely high benefit-to-cost ratio and could be put in place right away. ...

This post was republished from Mark Thoma's blog, Economist's View.

Who Should Be Blamed For Big Bonuses

Many Americans are outraged right now of the report that Goldman Sachs is planning to pay out record bonuses. Although Goldman Sachs denies the report, many are asking how this could possibly happen. Martin Hutchinson from Money Morning explains who deserves the blame.

It’s been in the news the last couple of days. Goldman Sachs Group Inc. (NYSE: GS) bankers are headed for record bonuses. The Financial Times reports that bankers’ pay in the London market is already right back to 2007 levels and going higher. Banks are poaching each others’ best staff, and are offering huge pay packages to staffers willing to make the leap.

It’s enough to make you succumb to the Two Minutes’ Hate.

But let’s face the truth. As egregious as salary escalation seems - coming as it does on the tail of the worst U.S. banking crisis since the Great Depression - the reality is that this is the U.S. government’s fault. After all, it was the U.S. Federal Reserve and the Obama administration that created all the bailouts and the special-loan-subsidy schemes for banks that would otherwise have been on their last legs.

In a truly free market, ex-Citibankers (NYSE: C) would be on every street corner of Manhattan - selling apples - and that would properly hold down the pay of those bankers still lucky enough to have a job.

The sudden rebound in demand for bankers is a symptom of overall market conditions right now. The U.S. stock market is way up from its lows, there are three Chinese initial public offerings (IPOs) due to come to market this week (one of them for a company with no earnings), the volume of home mortgage refinancing has been running at record levels, the FHA index of home prices has dropped only 0.3% this year and the volume of new corporate debt issuance is also high. Commodity prices are well off their lows, and oil prices are again close to $70 a barrel, which would have been considered an excessively high level only three years ago. That’s not a picture of a financial market - or a global economy - in deep recession.

Far from it.

To some extent, this is good news. A revival of the financial system and its ability to finance businesses and home purchases is exactly what the huge monetary and fiscal stimulus was meant to produce. A modest revival in world trade, as inventories cease being wound down and Chinese production ramps up again, is also a necessary precondition for economic recovery.

As the banking bonus news suggests, however, much of the activity is coming in some pretty funny places, where the excesses of the past decade were concentrated and where you wouldn’t expect to see such a quick revival.

That gives us a clear indication of just what the problem is. Because bankruptcies weren’t allowed to happen back in September and October - as they would have in a free market - there are more institutions in the market than there should be, Citigroup and Merrill Lynch most notable among them.

Moreover, in a true free market, the entire credit-default-swap (CDS) business - a product that caused $180 billion of losses to the financial system through American International Group Inc. (NYSE: AIG) - would be nothing but a smoking ruin. But in the market we are living in, those $180 billion worth of losses have been transferred to the tab of the taxpayers of America.

With Citigroup and Merrill Lynch bankers mooching around on street corners, financial sector salaries would be forced down to a more reasonable level. As it is, the few unemployed unfortunates who worked at Lehman Brothers are not enough to depress the market. Likewise, credit default swaps have caused huge pain to the unfortunate employees of Abitibi-Bowater Inc. (NYSE: ABH), General Growth Properties (OTC: GGWPQ), and Six Flags Inc. (OTC: SIXFQ), each of which went bust partly because their creditors were playing in the CDS market and had no incentive to find an alternative to bankruptcy. Had CDS caused the pain they should have to financiers, the product would no longer exist, to the considerable benefit of the rest of us.

Inevitably, we are going to have to pay the price for all the bailouts. The financial sector will eventually shrink to its proper size, as will its members’ earnings. CDS will eventually be sharply restricted, to prevent their holders from forcing random companies into Chapter 11. Interest rates will have to rise, to accommodate the huge debt-funding needs the government has incurred. Money will have to be kept tight, to pay for the indulgences that Fed Chairman Ben S. Bernanke granted during the bubble, as well as for the even greater-indulgences of the bust.

Which is probably why you don’t want to hold U.S. stocks right now.

This article was reposted from Money Morning. You can also view this article at Money Morning's investment news site.

Why Are Republicans Attacking The Republican Fed Chairman?

Why would Republican law makers want to attack Bernanke, a Republican appointed by President Bush? If Bernanke resigns, Obama could appoint a Democrat as Fed Chairman. Economist Mark Thoma from Economist's View, attempts to explain this counter-intuitive strategy.

The GOP is targeting Bernanke as "a champion of government intrusion and an ally of President Obama":

G.O.P. to Paint Bernanke as Ally of Big Government, by Edmund L. Andrews and Louise Story, NY Times: In a peculiar role reversal, Republican lawmakers are mounting a ferocious attack on the Republican chairman of the Federal Reserve, while Democrats are coming to his defense.

Ben S. Bernanke ... will be grilled on Thursday by the House Oversight and Government Reform Committee about his role in orchestrating Bank of America’s controversial takeover of Merrill Lynch late last year.

The House investigation is heavily colored by partisanship. President Obama is proposing to give the Federal Reserve formidable new powers to regulate giant institutions, including Bank of America, that could pose risks to the financial system.

Republicans, along with some Democrats, argue that the Fed already has too much power.

Unhappy about the huge bank bailouts that the Fed arranged with the Treasury Department during the Bush administration, many Republicans are even more displeased that Mr. Bernanke is now working hand-in-glove with the Obama administration.

The result is a set of dueling narratives and agendas, all of which will be on full display when Mr. Bernanke testifies on Thursday. ...

Despite Mr. Bernanke’s Republican roots, and the fact that President Bush nominated him to be Fed chairman, the Republican memo prepared for the hearing on Thursday describes Mr. Bernanke as a champion of government intrusion and an ally of President Obama. ...

I don't think this is an attempt to negatively influence Obama's decision on Bernanke's reappointment as Fed chair as some have been hinting because that would not be in the GOP's best interest. There are open positions on the Federal Reserve Board, so even if Bernanke didn't resign as is customary in the event he was not reappointed - and nothing says he must - Obama would still be free to appoint a new Fed Chair from outside the present Board membership.

Obama would certainly appoint someone who shares his regulatory vision, and that person would likely be confirmed (e.g. someone like Janet Yellen would likely be confirmed even if there was lots of grumbling), so I don't see how the appointment of a new Fed chair would do anything but strengthen the support for the type of regulatory oversight the administration envisions. That's not what the GOP wants.

Instead, this looks much more like an attempt to by the GOP to maintain its usual anti-regulatory, anti-government stance by arguing that the Fed should not to be trusted with the powers envisioned in the proposed regulatory reform legislation. So the real goal is the Fed as an institution, Bernanke is simply the target being used to make that the point. E.g.:

The vast extent of the Fed’s actions in the past two years to commit trillions of dollars in government money to support the economy has raised significant concerns on Capitol Hill, some of which will be aired on Thursday when Bernanke testifies before the House Committee on Oversight and Government Reform.

Congressional investigators have been looking into the Fed’s role in encouraging Bank of America to purchase Merrill Lynch... Rep. Darrell Issa (R-Calif.), ranking member on the Oversight Committee, said on Wednesday that the Fed engaged in a “cover-up” and hid details about the merger, completed in January 2009, from other federal agencies.

Meanwhile, lawmakers from both parties are raising questions about Obama’s proposal to grant the Fed broad new powers to prevent another crisis.

Those concerns could make the next confirmation process far more contentious than the six that have occurred in the last two decades.

And:

Sen. Jim DeMint (R-S.C.) said, “It won’t be my decision whether he is held over or not, but right now I’m concerned that they have lost their independence and are too cozy with Treasury.”

It looks like we are going to get some version of a strategy that has the GOP saying that given what happened to the financial system, of course we need more oversight and regulation of the financial system. But any particular piece of legislation that is proposed will be fought tooth and nail by the GOP as being far too intrusive, granting the government too much power, and generally going far beyond what is needed to solve the problem. The fact that the will for reform will diminish with time works in their favor, and if they can string things out long enough with this strategy, the result will be that the legislation eventually passes in a much weaker form, or it won't ever pass at all.

Just ignore them. Altering a few words:

The Republicans, with a few possible exceptions, have decided to do all they can to make the Obama administration a failure. Their role in the financial regulation debate is purely that of spoilers who keep shouting the old slogan — Government is always the problem, never the solution! — hoping that someone still cares.

This article was reposted from Mark Thoma's blog, Economist's View.