Sunday, March 8, 2009

The Economic Crisis: Build, Don't Just Bail

The American public is suffering from bailout fatigue. Last week's announcement of a mortgage bailout prompted more criticism than praise, as the fiscally responsible denounced having to prop up the irresponsible and reckless. The Federal Reserve's soon to be implemented TALF (Term Asset-Backed Securities Loan Facility) will provide hedge funds and other wealthy money managers the opportunity to greatly increase their net worth by investing in consumer, student and small business loans while taxpayers largely bear the risk of loss. It's hard for the smart money to turn away from a heads we win, tails the taxpayers lose bet. And that's what the Fed is offering them.

Then, there's AIG. Last week, Federal Reserve Vice Chairman Donald Kohn declined, in Congressional testimony, to identify the financial institutions that, as AIG counterparties, received billions of U.S. taxpayer monies through the bailout of AIG. This was like waving a red cape in front of Congress and the press. Congress made noise about withholding further bailout money. The press began running articles listing names of counterparties. The Wall Street weekend print edition ran a story, as did ( While the two lists aren't identical, you get the general picture that many of the world's largest banks transferred their AIG-related losses to the taxpayers, including a few that haven't previously been publicly identified as being in serious trouble.

Central bankers like to operate in secrecy, since they are afraid that the very fact of their doing their jobs--helping banks--can lead to runs that then push the banks under. That's not a trivial concern. But neither is the democratic nature of our government. The public is entitled to know what the government is up to, especially when it's spending hundreds of billions. In the absence of sunlight, government officials can make seriously bad decisions. Take a look at the Pentagon Papers case and what those documents say about the government's slide down the slippery slope in the Vietnam War. One important lesson from that case is that making important public policy in secret usually turns out badly.

The AIG bailout is turning out badly. With the Fed vigorously withholding information, Congress and the press now confidently assert that AIG has become a black hole. There is no public evidence to the contrary. Repeated assertions by government officials that all the bailout spending is, in the final analysis, of benefit to the public sound too much like "trust us." Perhaps more than is appreciated, the Bush 43 administration eviscerated public trust in the government. The M.I.A. WMDs used to justify the Iraq War, the disastrous response to Hurricane Katrina, the politicization of the Department of Justice, and, of course, the hear no evil, see no evil regulatory oversight of the financial markets combined to create a degree of voter mistrust that harks back to the post-Nixon 1970s. "Trust us" doesn't work any more.

It goes without saying that the smart move for the Fed would be to issue, at 8:30 a.m. on Monday, March 9, 2009, a press release publicly identifying the counterparties that benefited from the AIG bailout. We'll soon find out whether the Fed does the smart thing.

Perhaps equally, if not more, important is the need to spend more federal stimulus money to build the economy rather than bail out the undeserving. Just about all the bailout spending is devoted to short term measures designed to revive the flow of credit. Aside from the fact that they don't seem to be working, except to benefit wealthy and reckless bankers or reckless and irresponsible borrowers, these measures are boosting the federal deficit by quantum leaps. When the numbers get big enough (and they have), taxpayers worry about how they and their children will repay all this debt.

At the end of World War II, the U.S. had a much larger debt load, relative to GDP, than what it is currently expected to borrow for the economic crisis. The World War II public debt was more than 100% of GDP, while the current and likely federal stimulus and bailout programs may run the federal debt up to about 60% of GDP. The burden of World War II debt was reduced because the U.S. economy--and especially the productivity of U.S. workers--grew rapidly for the 25 years following the war. In other words, prosperity came from growth of the real economy and improvement of worker productivity. More efficiently building better cars, washing machines, computers, televisions and other goods created real wealth, so much so that the post-war American standard of living rose dramatically in spite of all the war debt.

To give the American taxpayer more of a stake in the government's current fiscal policy, the Obama administration should direct more money toward building and less toward bailing. The bailees are already in line for several trillion. Funding for building--measures that are explicitly aimed at fostering growth or improving worker productivity--may total around $212 billion. This includes $111 billion for infrastructure and scientific research, $53 billion for education and training, $43 billion for energy, and $5 billion for accelerated depreciation of new purchases of equipment. In other words, less than 10% of the spending now devoted to dealing with the financial and economic crises is aimed at boosting economic growth and improving worker productivity, the things that can make the future look bright to taxpayers. The remaining 90% plus is devoted to short term aid for the reckless, irresponsible and often wealthy that supposedly will provide trickle-down treats to taxpayers.

Trickle down doesn't sell in today's markets. Direct action is necessary. More fiscal spending should be devoted to strengthening the economy and improving worker productivity. Tax policy should encourage research and development, and new investment. Perhaps special attention could be given to fostering nationwide availability of high-speed wireless Internet access--a powerful information highway system could complement the concrete and pavement Interstate highway system begun in the 1950s. Given that the U.S. has an increasingly ideas-based economy, a robust communications system is essential.

Federal policy should enhance long term growth, and not just engage in short term pump priming. Without clear, concrete benefits for all, the government's fiscal and monetary policies may well lose legitimacy in the eyes of the electorate. If that happens, the groundhog will see a big, dark shadow and you should prepare for a long, cold winter.

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