A few comments about Tuesday’s election’s impact on the economy
I have been meaning to put together a few comments about the election on Tuesday but I haven’t had the time to string anything together. But an enlightening video from Tech Ticker with Jamie Galbraith provides some good fodder. So let me say a few lot of words now.
Here’s the story: Obamanomics is a failure. There are a lot of differing views as to why –most of them politically-motivated. Let me tell you why Obamanomics is failed.
Obama’s economic policy failed for one simple reason: his team has fought a bank solvency crisis as if it was a liquidity crisis. You can see the difference in perspective based on two posts I wrote at exactly this time last year
- The wildly optimistic view of Treasury’s handling of the crisis
- The less optimistic view of Treasury’s handling of the crisis
The simple fact of the matter is that Barack Obama put two individuals in Larry Summers and Tim Geithner who were complicit in the errors leading up to the crisis in charge of his economic policy. You only need a basic understanding of human psychology to know that they would have no interest in future policies which highlighted those past errors. So you knew as soon as he made his cabinet selection of Washington insiders, particularly of Geithner and Summers what was going to happen.
And here’s what happened. Let’s look at it from Summers’ or Geithner’s perspective. I imagine their thinking something like this:
"Wow, this crisis has been more severe than anyone could have imagined. Obviously, none of this was foreseeable because the U.S. banking system is basically sound. We have the most robust and competitive institutions in the world. So my calls for gutting regulation in the past [Summers as Treasury Sec.] and my looking the other way as leverage built up all around me in the lead up to crisis [Geithner at the NY Fed] cannot be faulted. Certainly, if some government watchdogs had picked up on an epidemic of financial fraud being perpetrated, that would be another story.
So, what do we do now that this 100-year flood has come our way?
We’ll probably be forced to do deeply unpopular, deeply hard to understand things like bailing out the banks. It’s not like we want to do this. But we have to because the banks are suffering a liquidity crisis; we can’t just put them into receivership like the obviously insolvent Fannie and Freddie. They just need a little push, some stress tests and we can get through this. Anyway, people would panic if we took a big bank into receivership. They couldn’t open for business.
The question is what to do about the economy in the meantime. Since this is a liquidity crisis, after we do our quick fixes on the banks and throw some stimulus money into the mix, things will be off to the races by the mid-terms. The key is how much stimulus. Let’s run with $800 billion. That will be plenty. Anyway, it better be enough because we’d never get more through the Democratically-controlled Congress even if we pulled some fear-mongering ploy like Hank Paulson did when he got his TARP money.
So, let’s make a decently aggressive economic forecast – albeit one we can actually meet – and tell people that unemployment will be down to a still high 8% due to our stimulus. Afterwards, we can focus on healthcare and our social agenda with the mandate we received from voters.
Here’s the thing though. This has not been a liquidity crisis, it is a solvency crisis. Changing accounting rules and pumping insolvent companies full of money isn’t going to get it done. You run into the information asymmetry problem, which can only be overcome by some serious "talk soft, big stick" kind of action. So when the Obama people covered up their prior ineptitude by treating a solvency crisis like a liquidity crisis, it created an expectations gap that they simply couldn’t talk their way out of. And it poisoned the well on his other initiatives.
Unemployment was 10%, not 8% And the $3 trillion output gap was not closed by a $800 billion stimulus. Clearly the President didn’t know this was going to happen any more than George Bush knew that Iraq and Afghanistan would be quagmires that would ruin his legacy. He’s not an economic policy expert. But like Bush, his administration was defined by a terrain in which he was unfamiliar. So the President had to rely on the counsel of Summers and Geithner as Bush did on Cheney and Rumsfeld.
In the end, banks were not lending. But bankers were getting huge bonuses off of government-sponsored trading profits and loans to the Federal government when they were borrowing against their depreciated collateral for zero percent interest. Barack Obama never in his wildest dreams imagined that Wall Street would stab him in the back this way after he bailed them out. He thought they would be grateful and show discretion instead of flaunting their government-acquired wealth amidst record foreclosures and 10% unemployment.
All of this was entirely predictable because you can’t solve a solvency crisis the way the Obama Administration has tried. And – also predictably – the consequences have been a drubbing in the mid-terms. The question now is: what next?
In the US, the Obama Administration will soldier on at least through 2012. In all likelihood, Congress will become more Republican [it has done already. I wrote this before the mid-terms]. This means that after the mid-term elections, Congress will often want to demonstrate how terrible a job the Obama Administration has done in fixing the economy. It can only do this by focusing on policies which exaggerate differences: stimulus, bailouts, health care (correct me if there are other areas you think I missed).
So this will mean Republicans will show extreme opposition to any stimulus, any bailouts and may look to rescind the healthcare bill already passed by whatever means necessary. Likely, stimulus is out for good now. The Obama Administration clearly understands it made a tactical error in predicting a more robust economic outcome while bailing out the financial sector. This has left it in a bind because they are trying to argue that the stimulus prevented depression when (the U-6 measure of)underemployment is still 17%. I anticipate the Obama people will change tack because the Republicans will beat them over this. It is not clear yet what they will do in order to demonstrate their ‘for and by the people’ stature. However, I have speculated that the Administration will become even more conciliatory toward the financial sector (which feels aggrieved because of populist rhetoric) in order to deflect Republican criticism about being anti-business and to protect their previous policy decisions. This necessarily means being somewhat more aligned with the banks in the foreclosure crisis. The Obama Administration cannot possibly take a hard line via foreclosure moratoria or a bank holiday because the outcome would simultaneously reflect poorly on previous policy decisions and risk the technical recovery. Remember the Obama Administration needs to convince us that more bailouts were necessary in 2009 in order to be successful in a 2012 match-up. The only way it can do so is both through a sustained recovery and keeping the banks from being exposed to another systemic crisis.
The Federal Reserve will also need to protect previous policy choices since the actors are the same. This means more quantitative easing. I have speculated what form this would take – not because I think QE is a good policy choice but because we need to understand what is likely to occur. Buying mortgage paper has been broached. If you want to do QE, this is a good way to get some extra kick. But it opens the Fed up to charges of politicizing its function and doing fiscal policy. So assume it will float the idea to let it gain legitimacy and then only if the economy is in really dire straits might it proceed.
The key here is that it does no good for the Republicans politically to compromise with President Obama. His policies are rightfully seen as failed. The right thing to do politically (but not morally) is to try and strike as much contrast to the President as you can, especially if it makes him look more failed. So that means favouring gridlock and pushing deficit reduction, looking for spending cuts and so on – even if it leads to a government shutdown stare-down as it did under Clinton. Is this the right thing to do? I don’t think so, if only because it reduces the number of potential positive economic outcomes. But I am speaking now more from a forecasting perspective than one of advocacy.
Anyway, that’s my piece. Here is what Dr. Galbraith thinks in the video below. Enjoy
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