Per Capital Government Spending Chat Draws Fire

Economist Mark Thoma, spurred by commentary from Paul Krugman regarding President Obama’s real government spending, created a graph to compare Obama’s annualized growth in real per capita government spending with that of the last six presidencies. The result, which reflects the Obama Administration’s comparatively low spending, created a small storm among partisan and non-partisan economists regarding the breakdown of the numbers and Obama’s perceived austerity in the face of economic crises. For more on this continue reading the following article from Economist’s View. 

Via email:

Seeing the Krugman commentary comparing real government spending under Obama and Reagan made me curious about what it looks like if you express it in per capita terms?  In particular, how does the Obama period compare with other presidencies in terms of penury/austerity versus spendthriftness?

To compare presidencies, I did the calculation two ways.  One starts in the quarter before the president was elected (e.g., 2008Q4), the other starts in the first quarter of the presidency (e.g., 2009Q1).  (The ARRA probably had some effect in Q1, but most of the change was simply economic conditions that the incoming president had nothing to do with, so I think I prefer the Q1 to Q1 method). Ranking since Johnson (starting in 1968), and using the first-quarter comparisons, and calculating growth under Obama through 2011Q4, Clinton is the most austere, followed by Obama.  The most spendthrift are (1) Nixon-Ford, (2) Reagan, and (3) Bush II.   The figure is pasted below:

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

Fiscal Cliff Deal Inadequate

The simple fact is that the deal that was reached to avoid the so-called “fiscal cliff” is nothing more than a postponement of the real negotiation, which will have to bear results if the country is to avoid across-the-board spending cuts in the form of sequestration. The March deadline looms larger than that of the cliff and Republicans and Democrats have already drawn lines in the sand. The GOP will refuse to vote for an increase in the debt ceiling unless Democrats agree to cuts to entitlement programs, and the entire drama will be played out again, although this time experts feel there is less chance of positive resolution. For more on this continue reading the following article from Iacono Research. 

My takeaways from the recent fiscal cliff deal.


First, thank God people will now stop talking about “going over the fiscal cliff”.  Fed Chief Ben Bernanke has done many terrible things at the central bank, but coining the phrase “fiscal cliff” was clearly one of the worst.

Second, anyone thinking that this is somehow the end of the story when it comes to the U.S. budget difficulties should be immediately absolved of that notion since, before you know it, there will be another catchy phrase to describe what is about to happen over the next two months.

Based on what I’ve been reading, it will be termed an “abyss” of some sort – the debt ceiling abyss, the sequestration abyss, the government funding abyss, or, my personal favorite appearing in the title above, sans the “abyss” moniker. This Bloomberg report summarizes what lies ahead:

If anything, the U.S. faces an even more ominous deadline in a few months. The debt ceiling was hit as of New Year’s Eve. The U.S. Treasury will dip into its tool bag to keep the country’s borrowing ability going, but that will last only about two months. Also in early March, the sequestration — $110 billion in across-the-board spending cuts, half in defense and half in domestic programs – springs back, unless Congress finds a way to offset it with other spending cuts. Weeks later, the law that keeps the government funded expires. It all means that, in late February and early March, Congress will face a sequestration, a government default and a government shutdown. Republicans say they’ll use the leverage created by the debt ceiling to force Obama to accept spending cuts, particularly in entitlement programs. Obama resisted that notion on Dec. 31, saying he wants more tax increases and won’t accept Republican plans to “shove” spending cuts past him. “If they think that’s going to be the formula for how we solve this thing, then they’ve got another thing coming,” he said.

Per this story at The Hill, the duo of Simpson and Bowles probably best characterized the result as follows:

“We have all known for over a year that this fiscal cliff was coming. In fact Washington politicians set it up to force themselves to seriously deal with our Nation’s long term fiscal problems,” Simpson and Bowles added. “Yet even after taking the Country to the brink of economic disaster, Washington still could not forge a common sense bipartisan consensus on a plan that stabilizes the debt.”

What does this mean for financial markets in general and precious metals in particular? These thoughts from the Bank of Nova Scotia appearing in this Globe & Mail report today provide a good summary:

The U.S. budget agreement is likely to prove [U.S. dollar] negative in the medium term as it averts the fiscal cliff today but fails to provide a credible medium-term fiscal plan and instead forces major issues, like the debt ceiling and $110-billion in spending cuts, out to March 1, and highlights how challenged the U.S. political system has become. In addition, it potentially lays the foundation for a rating agency downgrade.

Anyone who grew tired and angry about the fiscal cliff debate over the last couple months should enjoy the current reprieve while they can because it will be just days (maybe only hours) before we start hearing about the much more difficult (and dangerous) debate that lies ahead.

This post was republished with permission from Tim Iacono.

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.

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.

Focus on Reducing Deficit Risky, Analysts Say

President Barack Obama made recent comments that have some economists questioning the administration’s plan to maintain fiscal responsibility without endangering an already fragile economy. President Obama reiterated the need for deficit reduction, which could mean an increase in taxes, cuts in federal spending or both, and many believe either of these moves could jeopardize economic growth. Political pundits argue Republicans may support a U.S. default if it means a boost in polls during election time, which is a cause for concern if it increases the chances the administration may be forced into a position that makes avoiding default impossible. For more on this continue reading the following article from Economist’s View.

This is in the mid-range of the Brad DeLong Shrill-O-Meter, but I think it's safe to conclude that he's not happy with the president's remarks in yesterday's press conference:

This Is Very Bad: Barack Obama Fail Department, by Brad DeLong: Can't anybody in the White House play this game?

Barack Obama:

Transcripts: There are a lot of folks out there who are still struggling with the effects of the recession. Many people are still looking for work or looking for a job that pays more. ...

But there are ... steps that we can take right now that would help...

Of course, one of the most important and urgent things we can do for the economy is something that both parties are working on right now, and that's reducing our nation's deficit...

No. No. No. No. No. No. NO. NO!!!!!!!!!

Absolutely the last thing, the last thing, the country needs is to cut federal spending or raise taxes in fiscal 2011, 2012, and it is now looking like fiscal 2013 as well.

Absolutely the last thing the country needs.

It gets worse. Obama:

[B]ecause of the work that's been done, I think we can actually bridge our differences. ... Nobody wants to put the creditworthiness of the United States in jeopardy. Nobody wants to see the United States default. ...

Does Obama read? There are some people who are looking forward to a default. And some of them are in the Republican legislative caucus--or so John Bresnehan and Jake Sherman claim:

"Who has egg on their face if there is a sovereign debt crisis, House Republicans or the president?" said another senior GOP lawmaker.

We have Republicans threatening to default on the debt and blow up the economy if they aren't allowed to put the economy at risk in another way -- through immediate deficit reduction -- and a president selling the demands from the other side as a jobs package. To make it worse, some Republicans seem eager for default to happen based upon the false belief that they'll somehow gain political advantage for wrecking the economy. No wonder the economic outlook is so grim.

With the economy struggling to get back on its feet, "Absolutely the last thing, the last thing" we should be doing right now is making threats or enacting policies that increase the risks of an economic setback. I think it's important to realize that the threat to default on the debt puts the economy at risk even if it is never acted upon, especially as the critical date to lift the debt ceiling draws closer. Republicans aren't just threatening to put the economy at risk in the future if they don't get their way, they are already doing so. If this continues there will likely come a point when markets get the jitters, and if that happens, watch out.

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

President Obama On Government Regulation

Since President Obama took office there has been a lot of discussion around how the governement should or shouldn't regulate certain aspects of the financial markets, among other things. Economist, Mark Thoma, takes a look at a recent article published by Obama, and offers his thoughts below:

President Obama on regulation:

Toward a 21st-Century Regulatory System, by Barak Obama: For two centuries, America's free market has ... been the greatest force for prosperity the world has ever known. ...

But throughout our history, one of the reasons the free market has worked is that we have sought the proper balance. We have preserved freedom of commerce while applying those rules and regulations necessary to protect the public against threats to our health and safety and to safeguard people and businesses from abuse.

From child labor laws to the Clean Air Act to our most recent strictures against hidden fees and penalties by credit card companies, we have, from time to time, embraced common sense rules of the road that strengthen our country without unduly interfering with the pursuit of progress and the growth of our economy.

Sometimes, those rules have gotten out of balance, placing unreasonable burdens on business... At other times, we have failed to meet our basic responsibility to protect the public interest, leading to disastrous consequences. Such was the case in the run-up to the financial crisis...

There, a lack of proper oversight and transparency nearly led to the collapse of the financial markets and a full-scale Depression.

Over the past two years, the goal of my administration has been to strike the right balance. And today, I am signing an executive order that makes clear that this is the operating principle of our government.

This order requires that federal agencies ensure that regulations protect our safety, health and environment while promoting economic growth. And it orders a government-wide review of the rules already on the books to remove outdated regulations that stifle job creation and make our economy less competitive. ...

Where necessary, we won't shy away from addressing obvious gaps: new safety rules for infant formula;... efforts to target chronic violators of workplace safety laws. But we are also making it our mission to root out regulations that conflict, that are not worth the cost, or that are just plain dumb. ...

And finally, today I am directing federal agencies to do more to account for—and reduce—the burdens regulations may place on small businesses. ...

Despite a lot of heated rhetoric, our efforts over the past two years to modernize our regulations have led to smarter—and in some cases tougher—rules to protect our health, safety and environment. Yet according to current estimates of their economic impact, the benefits of these regulations exceed their costs by billions of dollars. ...

Regulations do have costs; often, as a country, we have to make tough decisions about whether those costs are necessary. But what is clear is that we can strike the right balance. ...

There will now be a rush of lobbyists explaining to Congress and agency heads that the regulations the industries they represent face are excessive and need to be removed. There will be no shortage of effort in this direction. At the same time, a similar effort will be devoted to opposing any new regulation.

We need tougher, better regulation in many areas, and I'm sure there's a bad regulation to be found as well. But if the administration is going to move in this direction, it had better be prepared to match the effort it is up against. If it doesn't -- if special interests succeed in swaying the process in their direction -- we"ll end up as far from the "the right "balance" as ever. I hope the administration realizes that this is not an effort it can take lightly with a sweeping proclamation for action that attempts to straddle the political fence. To make this work, the administration will need to do the hard work needed to lead this process forward and guide it to a satisfactory end.

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

Did Obama Leak Information To Move Financial Reform Forward?

Dan Freed discusses whether the latest news of bank investigations was leaked by the Obama administration to move financial reform forward. Several major banks may be investigated for passing misleading or false information to get favorable ratings for their securities. See the following post from The Street.

For those innocents who think it is just a coincidence that The Wall Street Journal has once again topped its front page with stories about criminal investigations of Wall Street banks, allow me to inject a dose of reality into that cream-filled donut you are about to swallow.

Sweeping regulatory reform is making its way through Congress, and the Obama administration has clearly decided that leaking news about investigations of Wall Street banks is the way to get the legislation it wants.

Rochdale Securities analyst Dick Bove, a veteran who has seen a few Wall Street crackdowns in his day, argues that the fact that the Securities and Exchange Commission is working together with the U.S. Justice Department on the investigation suggests the hand of the Obama administration is behind it.

"The President has demonstrated with the health care bill that he doesn't back off until gets what he's attempting to achieve," Bove says. "With the financial regulation bill he's showing the same level of tenacity. We're getting almost a programmed set of announcements every couple of days concerning something that was done wrong on Wall Street."

Bove made these comments to me Wednesday, following Journal's report that Morgan Stanley(MS) had joined Goldman Sachs(GS) as reportedly being the subject of a criminal inquiry into its disclosures regarding collateralized debt obligations it helped create.

The analyst looked especially smart when I opened the same newspaper Thursday to read that JPMorgan Chase(JPM), Citigroup(C), Deutsche Bank (DB) and UBS(UBS) are also reportedly being investigated.

The New York Times, meanwhile, despite the fact that its owners and editors appear far more sympathetic to the idea of a Wall Street crackdown than those at The Wall Street Journal, has to settle for a leak from New York Attorney General Andrew Cuomo for its page. Cuomo, the newspaper reports, is looking into whether banks passed false or misleading information to bond ratings agencies to get higher ratings for securities they created.

If I were Obama, I'd leak to the Journal too. He knows the Times will bash Wall Street on its own, while the Journal has regularly demonstrated its willingness to go after Congress instead, with articles detailing questionable expenses, or short selling by elected officials. Give them a few leaks, and they may lay off those stories a bit, or feature them somewhat less prominently.

Still, clever public relations strategies can easily backfire. Wall Street can only hope this one will.

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

Is Deficit Myopia Leading To A Longer Recession

The outcry about the deficit is making it difficult for government to use fiscal tools to help pull the economy and jobs out of its weakened state. The right fiscal stimulus will reduce the deficit if spending efficiently creates jobs. See the following post from Economist's View.

Joseph Stiglitz:

Obama must resist 'deficit fetish', by Joseph E. Stiglitz: ...Don’t give into deficit fetishism. ... The real risk for America right now is a prolonged weak economy - something that a mindless focus on deficits can help ensure.

The deficit hawks from the banking system went on vacation from the fall of 2008 through the spring of 2009, while they demanded money be doled out freely - to themselves. But now that the public clearly won’t stand for another free lunch at its expense, the deficit hawks are back at work, more vocal than ever about the need to cut government spending.

They say it was necessary to the health of the economy to dole out money to the banks; but not necessary to the health of our society to make sure everyone has access to health care. It was not acceptable to alter the contracts of the AIG personnel, even those “key” and irreplaceable personnel who made the mistakes that led to a $180 billion bailout, but acceptable to break the social contract between America’s elderly and the rest of society, by cutting back on Social Security.

The bankers were short sighted when getting the country into the mess. But deficit fetishism is equally short sighted. ...

Worrying about the deficit can be good, if it focuses attention on four big issues:

(a) What kind of spending yields high returns?

(b) What kind of spending has the largest multipliers? We can increase spending that stimulates the economy a lot, decrease other spending, and still have a stronger economy.

(c) Are there tax increases that will not hurt output and employment, or at least not much? Increasing the progressivity of the tax structure and closing some corporate tax loopholes can, for example, raise revenue and lower the deficit, as employment increases.

(d) Are there other ways of stimulating the economy, e.g. by eliminating some of the problems in access to credit, or inducing banks to lend more for job creation, rather than helping create bubbles? The answer is clearly yes, but that means being a little tougher on the banks than we have been. ...

There are no easy ways out of the mess that the financial sector has created. But giving into mindless deficit fetishism risks higher unemployment...

Deficit fetishism is alive and well, but I'm not sure it is being driven mainly by the financial sector. People like Pete Peterson -- Chairman and CEO of Lehman Brothers from 1973 to 1984 -- are certainly behind some of it, so they aren't blameless either, but it seems broader than that.

The long-run trend line for the deficit is being driven mainly by health care costs. That needs to be kept separate from variations around the trend designed to stabilize the economy through the business cycle. Stabilization policies -- what we need more of right now but won't get due to deficit fetishness -- have little to do with the long-run trend for the budget.

There are two problems that we need to fix. One is the employment problem that exists right now, and we are not doing enough to fight that problem. The last line in the Stiglitz piece above is "The economy needs another stimulus, and it needs it now." I fully agree.

The second problem is the long-run imbalance in the budget, and that can only be solved by health care reform that brings the growth in costs down to a sustainable level. Whether we spend more or less to fight the employment problem that exists right now has little to do with solving this problem, and there's no reason at all for concern about the long-run problem to stop us from doing more now. No reason except deficit fetishness that refuses to separate the long-run health care cost problem from the largely independent short-run needs of those who are struggling to find employment in an economy that is still losing jobs.

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

Should Obama Be Blamed For The Record Deficit?

Glenn Hall from The Street argues that the blame for the record budget deficit of $1.56 trillion in 2010 should fall to both the democrats and republicans. While Obama will shoulder a lot of the blame for the record deficit, much of the spending is an extension of actions were initiated before he took office. See the following post from The Street.

President Barack Obama sent his proposed $3.83 trillion budget to Congress today, showing deficit spending that goes well beyond the levels set by the previous administration of President George W. Bush.

The Obama budget shows the government spending $1.56 trillion more than it earns from taxes, an increase from $1.4 trillion in 2009. The new deficit projection would be 10.6% of GDP -- almost double the level during the Reagan years.

This will stoke a lot of heated debate about policy choices, stimulus spending, banking bailouts and pork-barrel politics. In large measure, the blame will fall on Obama. This is already being labeled as Obama's deficit (just like it was Bush's deficit before).

The reality is that this is everyone's deficit.

The budget will include billions of dollars to fund the ongoing war efforts in Afghanistan and Iraq -- wars that were started by the previous administration and gladly financed by the Republicans in Congress during their period of control. It will also include the costs of the banking bailout, also initiated under the previous regime but expanded by Obama. And the budget includes stimulus spending that both parties of Congress quickly passed amid the panic of the financial collapse and economic downturn when Obama took office a year ago.

While I'm not inclined to be Obama's apologist, I think we have to recognize that he's only been in office for one year and it took much longer than that for this deficit to grow to this historic level.

That said, Obama's new-found religion about reining in government excess is just words at this point. He's starting to preach but is he practicing? In the state of the union address, Obama said belt-tightening will be needed - just not this year because of the need to create jobs and nurture an economic recovery that remains tentative.

Obama didn't mention the mid-term elections coming up, but it must be on his mind. He can't afford to lose any more Democratic allies in Congress after Republican Scott Brown broke the Democrat's filibuster-proof majority in the Senate when he won the special election to replace the late Democratic icon Ted Kennedy.

We've seen Obama embracing the populist rhetoric with his vilification of the big banks and the big bonuses paid out by the likes of Goldman Sachs (GS Quote), JPMorgan Chase (JPM Quote) and yes, even Citigroup (C Quote). Tapping into that anger may help overcome the growing Republican focus on the deficit as the election rallying point for their party -- at least as far as the tea party faction is concerned.

It will be easy to pan the Obama budget, but the inconvenient truth is that this is more than Obama's problem - it is our nation's problem and both Republicans and Democrats share in the blame and the responsibility for fixing it.

This post has been republished from The Street.

Obama Makes Safe Bet With Bernanke Reappointment

President Obama chose to go with the status quo and not shake things up at the Fed by reappointing Ben Bernanke. Despite widespread criticism, Obama praised Bernanke for helping the US avoid another Great Depression. Tim Iacono discusses how investors can be take advantage of from this latest development.

President Obama made it official this morning by nominating Federal Reserve Chairman Ben Bernanke to a second four-year term as reported by MarketWatch.

In a short statement in Martha's Vineyard with Bernanke standing at his side, Obama said Bernanke's background, temperament, courage and creativity helped to prevent another Great Depression.

"Ben approached a financial system on the verge of collapse with calm and wisdom; with bold action and outside-the-box thinking that has helped put the brakes on our economic free fall," Obama said.
...
In a brief statement, Bernanke said the goals of his second term at the central bank will be fostering stable economic conditions and financial markets. "We have been bold or deliberate as circumstances demanded, but our objective remains constant: to restore a more stable economic and financial environment in which opportunity can again flourish," Bernanke said.

"Mr. President, I commit today to you and to the American people that, if confirmed by the Senate, I will work to the utmost of my abilities -- with my colleagues at the Federal Reserve and alongside the Congress and the Administration -- to help provide a solid foundation for growth and prosperity in an environment of price stability."

While Bernanke may face some testy questioning during his confirmation hearings this fall, a result of last year's bait-and-switch bank rescue package and other questionable dealings with giant Wall Street firms while standing at the side of former Goldman Sachs CEO Hank Paulson at the Treasury Department, approval for a second term is a virtual lock.

This is good news for financial markets in general and will likely spur even higher prices for many commodities, one commodity in particular.

You see, Ben Bernanke has been a veritable one-man gold price appreciation machine.

References to the government's printing press earlier in the decade and his eagerness to use it as Fed chairman apparently have a way pushing the gold price higher.

Since his initial nomination in 2005, when gold was trading at only about $465 an ounce, the yellow metal has more than doubled, besting just about any other asset class during that time, so gold bugs should welcome today's news.

Let's just hope that the next four years are as good as the last four - $2,000 an ounce gold in the year 2013 when it comes time for his next re-nomination sounds about right to me.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Obama's Mortgage Aid Plan Will Pay Homeowners To Pay Their Mortgage

The latest mortgage aid plan proposed by the Obama administration seeks to encourage underwater homeowners to keep making mortgage payments by paying down a portion of their principal. This could prevent many homeowners from walking away from their mortgages when they owe much more than what their home is currently worth. The following article from Blown Mortgage, explains more details of the plan.

Home mortgage aid plans are hard to design. Because of how the ideologies behind open market and social responsibility are polarized no matter what you do with a mortgage aid plan pretty much half the nation is going to disagree with you.

Obama’s new mortgage plan is not perfect, not even his closest aides will say that. Its strongest opponents will point out that the new mortgage plan does not really cover for homes that have seriously dropped in value in the last months/years. Most of the families in trouble live in homes that have lost serious value, so there is a question mark in how effective this mortgage modification plan is going to be.

However the new plan has managed to incentivize the payment of mortgages and their previous modification so that it is worthwhile for banks and borrowers. This might not be enough to tip the scales on the millions of households that are at risk of losing their home this year but then again, it might.

If anything does help to tip the scales on the current crisis is to make it attractive for homeowners to pay their mortgage as well as reducing it’s principal and making it affordable on a monthly basis. Let’s face it, if your home is under water (it is worth less than what you owe on it) and there is no prospect of prices going up and you are struggling to pay the mortgage you might be inclined to cut your losses, give up and let the home go. Of course if someone is willing to give you some extra incentive to pay your mortgage and make it affordable, you might just give it a try.

What incentives does the Obama Mortgage Plan offer?
There are two main benefits or incentives homeowners that are in the red can take advantage of.

1. Once their mortgage has been modified and monthly payments begin the Treasury will pay an incentive for every mortgage payment a borrower pays on time that goes to pay the principal balance of the loan(The cash you actually borrowed, not the interest). This is interesting because it will help reduce the length of the loan and the amount of interest paid on it. Over a five year period this “incentive” could help reduce the principal on the loan by $5,000. Reducing the principal of the mortgage has of course even greater repercussions as years go by. If you have a 15 year mortgage and you reduce your principal by $5,000 in the first five years you will be actually saving yourself over $3,000 in interest by the end of your mortgage.

2.There is a trial period of three months before any modification is permanent. During those three months the homeowner must pay his mortgage on time. If he does he gets $1,000 from the government every year for next three years. If the mortgage isn’t paid on time there is no deal.

These are not huge benefits but they are something and they might just help people start thinking in a different way and help people dig themselves out of financial trouble.

This article has been republished from Blown Mortgage.

Can Obama Convince The World To Buy US Debt?

As the government plans to sell $65 billion in notes and bonds this week, we will see whether Obama, Geithner, and Bernanke were able to renew the confidence of overseas investors in America's ability to repay debt. Will countries like China and Saudi Arabia continue to buy US debt? Peter Schiff from Money Morning discusses this in the following post.

Just last week, Team Obama took its financial-crisis dog-and-pony show on the road. U.S. Treasury Secretary Timothy F. Geithner went to China. Federal Reserve Chairman Ben S. Bernanke visited Capitol Hill. And President Barack Obama, himself, embarked on a Mideast tour that started in Saudi Arabia.

This full-court press is not coincidental, and comes just as the federal government began unloading trillions of dollars in new U.S. Treasury obligations. The coordinated charm offensive is meant to assure the world-at-large that the United States can repay these obligations - without destroying the dollar.

Given the renewed weakness in the dollar and the recent expressions of concern from China-our largest creditor-about the safety of its current holdings, this is no easy sell. Not only must our leaders convince holders of our debt not to sell what they already own, U.S. officials must persuade these same foreign investors to back up the truck and buy a whole lot more. The hope is that a Dream Team - consisting of a charismatic politician, a skilled Wall Street banker with longstanding ties to China, and a respected Fed chairman - can close the deal. However, no matter how slick the sales pitch, no amount of lipstick can dress up this pig.

The most obvious fear the trio must address is that oversized deficits will persist indefinitely. Reading from a carefully scripted rebuttal book, all three proclaim that as soon as the stimulus revives our economy, the government will take all necessary steps to reign in the deficits that result. Bernanke’s testimony showcases this rhetorical shift. The Fed chairman claimed that catastrophe has been averted and that the recession is nearly over. As a result, he advised Congress to now focus on debt management. How he expects U.S. lawmakers to do that was left unexamined.

Setting aside the fact that the recession is far from over and that the stimulus will actually weaken the economy in the long run, Bernanke’s words were less a practical guide to Congress than a bromide for our foreign creditors. Meanwhile, President Obama carefully peppers his speeches with calls for Americans to live within their means, to save more and spend less, to produce more and consume less. But nothing in the government’s current fiscal or monetary policy will encourage such behavior. In fact, the objective of economic stimulus is to prevent such changes from taking place!

The laughter of Chinese students that greeted Secretary Geithner at Peking University shows how ridiculous this spiel sounds overseas. Actions speak louder than words, and the actions of the Obama administration are deafening. Multi-trillion-dollar deficits, bailouts, nationalizations, quantitative easing, and grandiose plans for government-provided healthcare, education, and alternative energy, render all of the administration’s claims of future prudence meaningless. If our leaders will not make tough choices now, why should anyone believe they will do so later, when those choices will be even harder to make?

Of course, it’s not just major holders - such as China and Saudi Arabia - that need to be convinced. Since the largest holders are already in so deep, they have the greatest short-term incentive to play ball. While throwing good money after bad is certainly a lousy investment strategy, it is politically expedient as it delays the need to officially acknowledge losses.

The spin is designed to keep all the smaller, more nimble holders from dumping their U.S. Treasury securities. The major holders can publicly pledge their commitment to Treasuries, while they privately planning their exit strategies, as long as they feel that the smaller holders won’t spook the market by front-running their trades.

However, once the psychology turns, there is no way to stop the rush for the exits. Remember how quickly the secondary market for subprime mortgages collapsed? One day, investors were lining up to buy; the next day, the stuff couldn’t be given away.

Make no mistake about it, we are issuing subprime paper and no amount of political spin can alter that reality. Bogus credit ratings aside, I think the world already knows this and it’s just a matter of time before someone admits it.

In the meantime, by continuing to lend, our creditors merely supply us the shovels to dig ourselves into an even deeper economic hole. Their credit enables our government to grow when it needs to shrink, finances bailouts of companies that should be allowed to fail, and enables a nation that should be saving and producing to continue borrowing and spending. As a result, the more money the world loans us, the less capable we are of paying it back. I really wish the world would stop doing us favors, as neither party can afford the consequences.

For a timely example, just look at California. With an unmanageable $20 billion deficit, California recently asked Washington for a bailout. With none immediately forthcoming, California was forced to make real and needed budget cuts. The hard choices, which will benefit California in the long run, would not have been made if federal funds had been committed. We all should be so lucky.

This article has been reposted from Money Morning. You can view the article on Money Morning's investment news website here.

Is The Obama Administration Covering Up What Really Happened In Treasury Meeting?

One watchdog group is accusing President Obama's administration of covering up what really went down during the major Treasury meeting that ended with 9 major banks selling equity stakes in their companies to the government for $250 billion. The Treasury originally stated that it had no documentation from the meeting, however, some documents were later obtained. The watchdog group insists some documents — potentially implicating current Treasury secretary Timothy Geitner — are being withheld. Who knows what is true and not in all this, but it will certainly be interesting to see how it all plays out. For more details about the meeting, along with what the watchdog group thinks happened, read the following article from Money Morning.

Despite promises of open government, the Obama administration tried to “cover up the very existence of smoking-gun documents” prepared for a meeting in which former U.S. Treasury Secretary Henry M. Paulson allegedly coerced major banks to allow the government to take equity stakes, according to conservative watchdog group Judicial Watch.

Judicial Watch said the Treasury initially said it had no records about the meeting. It didn’t release a transcript of discussions between government officials and bankers.

However, documents obtained under a Freedom of Information Act request confirm that Paulson and other Treasury officials gave nine major banks no options other than allowing the government to take $250 billion in equity.

Judicial Watch said on its Web site that after it made inquiries, the Treasury insisted on Feb. 4 it had no documents about the historic meeting.

Furthermore, “the cover-up continues, as the Obama administration protects Timothy Geithner by withholding a key document about his role in this infamous bankers meeting,” Judicial Watch president Tom Fitton said in a statement.

The group says suggested edits of the “talking points” for the meeting by Treasury Secretary Tim Geithner, then President of the New York Federal Reserve are being withheld by the Obama administration.

Saying the nine U.S. banks were “central to any solution” of the credit crisis, Paulson told their leaders in the meeting in Washington on October 13, 2008, to take the government aid voluntarily or be forced to by regulators.

“We don’t believe it is tenable to opt out because doing so would leave you vulnerable and exposed,” the document said, citing Paulson talking points. “If a capital infusion is not appealing, you should be aware your regulator will require it in any circumstance.”

Within four hours of the start of the meeting the CEOs wrote by hand the names of their institution and multibillion dollar amounts of “preferred shares” to be issued to the government, the documents show.

“These documents show our government exercising unrestrained power over the private sector,” Fitton said in a statement.

The banks were represented by Vikram Pandit of Citigroup Inc. (NYSE: C), Kenneth Lewis of Bank of America Corp. (NYSE: BAC), John Thain of Merrill Lynch & Co., now part of BofA, Jaime Dimon of JP Morgan & Co. (NYSE: JPM), Richard Kovacevich of Wells Fargo (NYSE: WFC), John Mack of Morgan Stanley (NYSE: MS), Lloyd Blankfein of Goldman Sachs Group Inc. (NYSE: GS), Robert Kelly of Bank of New York Mellon Corp (NYSE: BK), and Ronald Logue of State Street Corp. (NYSE: STT).

A spokesman for the Treasury, Andrew Williams, didn’t return calls seeking comment from Bloomberg News.

The Treasury has invested $199.1 billion in the bank-preferred share program, with $1.2 billion since returned by 12 institutions, according to government data, Bloomberg reported.

Despite his heavy-handed nature, Paulson succeeded at stabilizing the financial services industry, J.P. O’Sullivan, an SNL Financial bank analyst in Charlottesville, Va., told Bloomberg.

“It was a calming mechanism,” O’Sullivan said.

This isn’t the first time Paulson has been accused of strong-arming bankers to bend to his will.

As previously reported in Money Morning, Bank of America CEO Kenneth Lewis said in testimony before New York’s attorney general that Paulson and Federal Reserve Chairman Ben S. Bernanke pressured him not only to move ahead with a merger with Merrill Lynch despite reservations, but also to stay quiet about the mounting losses at the crumbling investment bank.

Lewis went on to testify that he felt Paulson threatened him with losing his job if he didn’t go along with completing the Merrill Lynch deal.

“I can’t recall if he said, ‘We would remove the board and management if you called it [off]‘ or if he said ‘we would do it if you intended to.’ I don’t remember which one it was,” Mr. Lewis said.

This article can also be viewed on moneymorning.com.

What Is The Likelihood Of The U.S. Losing Its AAA Credit Rating?

A few months back — after Moody's issued a warning — there was a lot of talk about the possibility of America losing it's AAA credit rating. Of course that never materialized. Now after a recent report on the health of Social Security and Medicare, the talk is resuming. The question still remains though of whether all this talk, is just talk, or if there is any merit to it. Kathy Lien looks closer at the question in her blog post below.

In today’s Financial Times, there is an op-ed article by David Walker, the CEO of the Peter G. Peterson Foundation pondering the possibility of the U.S. losing its prized AAA credit rating. The paper focuses on a warning that was issued by rating agency Moody’s months ago. Moody’s has not issued a new warning, yet Walker and in turn, the FT has decided to re-inject uncertainty into the financial markets by resurrecting this fear. What has prompted this article is most likely the recent comments about the insolvency of the Social Security and Medicare systems. According to the trustees for the systems, the Social Security trust fund could be depleted by 2037 while Medicare could be insolvent by 2017. These dates of insolvency have been pushed up as the weak labor market reduces contributions. The Obama Administration has pressed the importance of gaining control of the growth in Medicare costs and their desire to tackle Social Security insolvency once health care reform is passed.

According to Walker, if the health care reforms strains finances further or if the federal government fails to monitor spending, tax or budget control, rating agencies could strip the U.S. of its credit rating.

Is Losing AAA Rating that Big of a Deal?

But is losing the AAA rating that big of a deal? Yes. A credit rating reflects the risk of default. Therefore a lower credit rating means that a country is at greater risk of defaulting on their debt. Some global funds are mandated to invest only in AAA debt and therefore if the U.S. loses its AAA rating, we could see a massive outflow of foreign investment. Also, a credit rating downgrade is the perfect excuse to push through an alternative reserve currency to replace the dollar because it would strip the confidence of sovereign funds like China that have been buying dollars to prop up the U.S. economy. Yes, investors will still buy U.S. Treasuries, but their purchases will be less. It could also have a spillover effect on corporate debt and will raise the cost of borrowing for the U.S. government.

How Real is the Risk?

Now with the risk in mind, I think that ratings agencies talk a good game but they will face problems following through. The consequences of downgrading U.S. sovereign debt is huge both politically and economically. Therefore Moody’s or any rating agency for that matter may be reluctant to the first to pull the trigger. Downgrading the U.S. is very different from downgrading Ireland. Based upon how the rating agencies have handled the credit derivatives bubble, chances are they will be behind the curve once again.

With that in mind, U.S. finances are deteriorating significantly, raising the concern of Asian nations. However if President Obama is successful at turning around the U.S. economy, America will be well equipped to meet its debt obligations.

This post can also be viewed on kathylien.com.

Obama Pushes For $17 Billion In Budget Cuts...That's It?

In what seems like joke, President Obama has sent lawmakers a proposal that aims to cut over a hundred programs, and save us $17 billion. When you look at the fact our deficit this year will be a projected $1.85 trillion, you can start to see that $17 billion in cuts is next to nothing. It's almost as if Obama is simply trying to appear like he is making an effort to trim spending. The worst part is that it appears Obama will be fought tooth and nail to get these cuts through. If he can't manage to get $17 billion cut off the budget, what hope does this country really have forbalanced budget? For more on this, read the following article from Money Morning.

President Barack Obama sent lawmakers a budget package today (Thursday) that proposes to shrink or eliminate 121 federal programs and save almost $17 billion in the fiscal year that begins Oct. 1. But the budget plan contains cuts that will face vigorous opposition in Congress and fierce resistance from special interest groups.

The package of proposed reductions fills in the fine print of a $3.55 trillion budget outline approved by lawmakers in April that contains Obama’s top agenda items, including a health care overhaul, a push for renewable, clean-energy sources and changes in education funding.

The President wants to cut or end a number of programs that he feels are wasteful or ineffective to take the first toward getting spending under control. But the administration’s attempt at bringing fiscal discipline to Washington has already been met with skepticism by analysts.

“Every government program - no matter how wasteful - will be defended by its recipients and congressional champions,” Brian Riedl, a budget expert at the Heritage Foundation, a Washington-based research group told Bloomberg News. “Unless Obama puts the weight of the White House behind his spending cuts, Congress will ignore them.”

The cuts are miniscule compared to the overall budget package and deficits that will be ushered in the next few years. The $787 billion stimulus package Obama pushed through Congress combined with the $700 billion Troubled Asset Relief Program (TARP) bank bailout will come on top of the $1 trillion deficit the administration inherited when he took office in January.

Total savings from the cuts, even if they were accepted by Congress in their entirety, would represent a paltry 0.4% of the overall budget. The Congressional Budget Office projects the deficit will be $1.85 trillion this year, about four times the previous record, and $1.38 trillion in fiscal 2010.

“Even if you got all of those things, it would be saving pennies, not dollars. And you’re not going to begin to get all of them,” Isabel Sawhill, a Brookings Institution economist who waged her own battles with Congress as a senior official in the Clinton White House budget office, told the Washington Post. “This is a good government exercise without much prospect of putting a significant dent in spending.”

Only about 80 of the proposed cuts are new - the others had been previously revealed. And most of the cuts will be from the “discretionary” budget, avoiding the so-called untouchable “third-rail” entitlement programs of Social Security and Medicare.

Those two programs account for more than 40% of government spending, meaning the more difficult work on deficit reductions has been left for another day.
“More serious efforts at deficit reduction are going to require entitlement and tax reform - that’s where most of the money is.” Marc Goldwein, policy director of the bipartisan Committee for a Responsible Budget, a Washington-based research group, told Bloomberg. “To really get the deficit under control, we’re going to have to start thinking bigger,” he said.

But some in Congress defended the administration’s approach, saying the list of program reductions is just the start of a more comprehensive effort to cut spending and pull the reins on the skyrocketing deficit.

“It depends on what it means over the scope of five and 10 years.” Representative John Larson (D-Conn.) told Bloomberg. It’s a “deep, cavernous hole where we have been left, we’re looking a long way up but it’s a steady climb” using the budget plan agreed to by Obama and Congress, he said.

This post can also be viewed on moneymorning.com.

How Is The Economic Medicine Working?

The government has been injecting trillions of dollars into the economy, but how has it been working so far? James Picerno looks at recent events and attempts to answer that question in his blog post below. In addition Picerno takes a look at what lies ahead for the U.S. economy, and offers some words of wisdom for investors.

In late-March, we asked: Is the medicine working? By medicine we meant the massive injection of liquidity into the economy as a cure for fending off deflation and laying the groundwork for recovery. At the time, we were mildly encouraged, in part due to the rising inflation forecast as derived from the spread between the nominal and inflation-indexed 10-year Treasuries.

More than a month later, there's still reason for optimism, perhaps more so, thanks to the so-called green shoots that suggest better days ahead. Yet the rate spread, which is to say the market's inflation outlook, hasn't changed much since late-March. The current forecast is for inflation of 1.4% for the next 10 years, just barely up from around 1.3% from the end of the first quarter. In both cases, that's a healthy change from expecting flat pricing, as was the case at the end of 2008. Low inflation as far as the eye can see would be nice, but is that a reasonable expectation?

In the months ahead there will be a thin line between a healthy rise in inflation expectations and the potential for burdensome pricing pressures later on. Deflation is a hazard to be avoided for a number of reasons. Although we can't quite shut the book on the danger, the odds look increasingly in favor of mild inflation for the foreseeable future, as the chart above suggests. Behind this reasoning is the growing sentiment that the recession is at or near a bottom. Is it time for the Fed to begin tightening? Or are the green shoots still too tentative?

"We're seeing more indications of perhaps a bottoming in the economy," Bill O'Neill of LOGIC Advisors tells Dow Jones. "So there is an increasing—and it will continue to increase—concern surrounding inflation potential."

Gold, the perennial inflation hedge, seems to be considering the possibility, although this market hasn't quite made up its mind. The price of the metal has been hovering around $900 for much of this year, just below its all-time high of $1,033, set back in March 2008. The 10-year Treasury yield, meanwhile, has been climbing, recently bumping up against 3.2% on renewed worries that inflation may now be the bigger risk. Even so, a 10-year yield of 3.2% is still quite low.

None of the inflation anxiety is worrying the stock market, which has now reversed the selloff in the first quarter. Indeed, the S&P 500 is now marginally up on the year, as of last night's close, on expectations that by the end of this year the economy will be sitting up and prepared to get out of bed.

The big question is whether all the renewed hope that the worst is over is really just the byproduct of a bear market bounce in markets and inflation expectations? Given the extreme waves of selling last year and into March, a rebound was all but assured if the world economy didn't collapse. As we now know, it didn't. There are still lots of problems, but we'll all be here next year and so it was time to reprice assets upwards to reflect a humbled but otherwise enduring economic climate.

Investors have cheered the signs that the U.S. economy no longer seems to be contracting at an accelerating pace. Given the fears of what could have happened, that's certainly a reasonable response. Deciding that you're not going to fall into the abyss is always encouraging. But that's still a long way from arguing that growth is imminent, or that the economy won't tread water for a year or two.

The first phase of the post-apocalyptic visions that prevailed six months ago may be over. If so, now we're faced with the more difficult chore of deciding how to repair and rebuild the economy to foster growth while containing inflation. The hardest days are yet to come. Unless you're expecting a seamless transition, keeping some cash at the ready still makes sense, albeit less so than in past months. Volatility isn't banished, it's only hibernating, which suggests another round of value-oriented pricing opportunities in the major asset classes.

This post can also be viewed on capitalspectator.com.

We Need A Root-And-Branch Reorganization Of The Financial System

Some people are open to the government handing over trillions of dollars to the banks, but no taxpayers want the money handed over without proper controls in place that will ensure it goes to good use. This has been one of the biggest issues the public has had with the bailout efforts thus far. For that reason Steve Waldman is calling for a root-and-branch reorganization of the financial system. For more on this, read the following blog post from Mark Thoma.

Steve Waldman says "we need a root-and-branch reorganization of the financial system":

Value for value, Steve Waldman: Would it have been better if Timothy Geithner had had the power to guarantee all bank debt early on? As James Surowiecki reminds us, that was part of the Swedish solution. Justin Fox plausibly suggests that we might have avoided a lot of pain with a fast, full guarantee.

But that's not the point. The question isn't whether we could have avoided this crisis, if only we had cut a big check. We could have, and that was not lost to any of us debating these issues more than a year ago. (See e.g. me or Mark Thoma.) Had we done so, the near-to-medium term fiscal costs might have been less than they probably will be now. So, with 20/20 hindsight, would it have been a good idea?

How you answer that question depends upon how you view the crisis. Is it an aberration, a shock to a basically sound financial system, or is it a painful symptom of an even more dangerous condition? ...

If you think that our financial system just needs some tweaks, some consolidation of regulators' organizational charts and sterner supervision, then you should prefer that we had just cut a check, passed Sarbanes/Oxley Book II, and moved on. But that is not what I, or most proponents of temporary receivership for insolvent banks, believe.

If you believe, as I do, that we need a root-and-branch reorganization of the financial system, which must necessarily involve the dismemberment and intrusive restraint of deeply entrenched institutions, does that mean pain is the only way forward, "the worse the better" in the old revolutionary cliché? It need not mean that. But it does mean that palliative measures, like giving the banks money, would have to be attached to curative measures, like enacting capital requirements and imposing regulatory burdens that would force financial behemoths to break themselves up or become boring narrow banks. For almost two years, policymakers at the Fed and the Treasury, including Secretary Geithner, have offered bail-out after bail-out and asked for nothing serious in return.

Do I regret that Henry Paulson was not empowered to issue a blanket guarantee of bank assets early on, as the Swedes did? No, I don't regret that at all. Why not? Because I think that "Hank the Tank" was a crappy negotiator... He would have offered the financial system sugar without requiring it to make the medicine go down. He may believe, quite sincerely, that a cure would be worse than the disease. He may believe that, but he is wrong. ...

You may believe that we have learned our lesson, that if we can just get some stability and comfort for a while we are prepared to do what must be done. That's a respectable position. But I don't share it, and neither do the majority of Americans who are unwilling to allow their representatives to sign off on any more expensive aspirin. We want value for value, an ironclad commitment of root and branch reform in exchange for the unimaginable sums of money we are being asked to hand over. ... Congress would, because the public would, support large, explicit transfers, if they were attached to reforms sufficiently radical to prevent a recurrence, and suitably punitive towards the people who managed the system that brought us here. Value for value. ...

I ... would be willing to hold my nose and tolerate a Swedish-style guarantee of bank creditors. I'd acquiesce to that even without formal nationalization. Nationalization is ... a means to an end, and the desired end is a world in which too big to fail is too big to exist for any financial institution that originates or holds credit risk in any form. Secretary Geithner could send a bill to Congress today that would put all banks with a balance sheet of over $50B into run-off mode... I'd fax my Congressman and support a $2T on-budget buyout of bank creditors as part of that bill, as long as it had teeth. ("Teeth" would imply making sure that off-balance-sheet and derivative exposures were included in the size cap, etc.)

It's not that us pitchfork-totin' populists are unwilling to pay the bill. It's that we want to know that in exchange for writing a very, very large check, the people that we are paying will actually deliver the goods. Given the behavior of bankers before the crisis and of shifty policymakers during, we have every reason to watch warily and to insist upon every precaution while we hand over suitcase after suitcase of freshly printed Federal Reserve notes.

This post can also be found on economistsview.typepad.com.

Stress Tests Reveal Three Banks In Need Of Additional Funding

The controversial stress tests commissioned by the government on the 19 largest financial institutions have revealed at least 3 in need of additional funding. These stress tests were meant to ensure that banks have enough capital reserves to last through the recession. For more on this, read the following article from Housing Wire.

At least three of the 19 financial institutions with assets in excess of $100bn may face pressure to build up capital reserves after failing to meet desired operational projections through the government-mandated stress tests, unnamed sources told the Wall Street Journal. The identities of the three firms remained confidential at the time this story went to press, but analysts told the Journal they likely include regional banks with commercial real estate exposure in the Midwest and Southeast.

The stress tests aimed to determine whether major US banks retain enough capital to weather even the more adverse economic projections. Federal officials offered three alternatives to banks that lack sufficient reserves: raise private investor funds, receive additional government aid or convert the government’s existing preferred shares into common shares, effectively placing part of the firm in government ownership.

The Federal Reserve, in reporting stress test methods late Friday, say most banks retain enough capital to weather a longer, more severe recession, although deteriorating economic conditions affect the reserve capital held among some banks.

This article can also be found on housingwire.com.

Depression Looms Without More Stimulus

Do we really need more economic stimulus? We have already spent trillions of dollars attacking this financial crisis, and unfortunately we also have seen billions apparently wasted by poor policy decisions and implementation. All that aside, according to famed economist Robert Shiller, we need more economic stimulus or else we are likely facing another depression. For more on this, read the following blog post from Mark Thoma.

Robert Shiller says we need to continue with the monetary and fiscal policies we are pursuing, but both efforts need to be larger:

Depression Lurks Unless There’s More Stimulus, by Robert Shiller, Commentary, Bloomberg: In the Great Depression ... the U.S. government had a great deal of trouble maintaining its commitment to economic stimulus. “Pump- priming” was talked about and tried, but not consistently. The Depression could have been mostly prevented, but wasn’t. ...

In the face of a similar Depression-era psychology today, we are in need of massive pump-priming again. We appear to be in a much better situation due to the stronger efforts to date. Still, there is a danger that, because of a combination of faulty economic theory and inadequate appreciation of human psychology, as well as deep public anger, we will not continue with such stimulus on a high enough level. ...

In our analysis of the current economic crisis, we conclude that the government should have two targets. One would be a joint fiscal-monetary policy target. The same kind of expansionary policies embodied in the government expenditure stimulus and tax cuts that are already being tried have to be done on a big enough scale and for a long enough time in the future. ...

The government should also have a credit target. Once again, we are calling for more of the same kinds of existing policies... Achieving this requires new approaches, like those announced by the Bernanke Fed and the Obama administration, but on a continuing and even larger scale. ...

In this crisis, acceptance of these measures is being replaced with outrage. It is increasing the blood pressure of the public, and that can’t continue without damage to our system. ... It is time to face up to what needs to be done. The sticker shock involved will be large, but the costs in terms of lost output of not meeting either the credit target or the aggregate demand target will be yet larger.

It would be a shame if we are so overwhelmed by anger at the unfairness of it all that we do not take the positive measures needed to restore us to full employment. That would not just be unfair to the U.S. taxpayer. That would be unfair to those who are living in Hoovervilles...; it would be unfair to those who are being evicted from their homes, and can’t find new ones because they can’t find jobs. That would be unfair to those who have to drop out of school because they, or their parents, can’t find jobs.

It is now time to keep our eye on the ball and set clear targets to fix a system that broke when our animal spirits got out of bounds.

This post can also be viewed on economistsview.typepad.com.