What 'Partial Nationalization' Means for the Federal Budget

The financial rescue plan clarified by the Bush Administration yesterday was appropriately characterized as “partial nationalization” in the headline of yesterday’s Washington Post.  (A follow-up Washington Post story is available online here.) 

What makes it “nationalization” is that the federal government is effectively taking ownership of private equity. 

As Treasury Secretary Hank Paulson explained yesterday (emphasis added):

Today we are taking decisive actions to protect the US economy. We regret having to take these actions. Today’s actions are not what we ever wanted to do – but today’s actions are what we must do to restore confidence to our financial system.

Today I am announcing that the Treasury will purchase equity stakes in a wide array of banks and thrifts. Government owning a stake in any private U.S. company is objectionable to most Americans – me included. Yet the alternative of leaving businesses and consumers without access to financing is totally unacceptable. When financing isn’t available, consumers and businesses shrink their spending, which leads to businesses cutting jobs and even closing up shop…

…Treasury will make $250 billion in capital available to U.S. financial institutions in the form of preferred stock. Institutions that sell shares to the government will accept restrictions on executive compensation, including a clawback provision and a ban on golden parachutes during the period that Treasury holds equity issued through this program. In addition, taxpayers will not only own shares that should be paid back with a reasonable return, but also will receive warrants for common shares in participating institutions…

What does this new government ownership of pieces of the private sector mean for the federal budget?  It surely means that the government’s share of the economy will get bigger–but that was inevitable even before this equity-stake plan was announced.  And given that the government isn’t able to expand using saved money, this morning’s revelation doesn’t change the fact that the financial rescue will enlarge the federal debt.  

What the new equity-stake plan does is gives the American taxpayer a little more promise of getting something back for the $700 billion.  Instead of being told the $700 billion in additional public debt would “buy us” only “toxic assets” (bad debt), taxpayers can at least now find some comfort in receiving an ownership stake in more-tangible/measurable assets (decent equity).  So for current and (more likely) future taxpayers, this morning’s plan should be viewed as a clear improvement in terms.

Quantifying that improvement in terms won’t be easy for federal budget scorekeepers at CBO and OMB, however.  The effect on the federal budget deficit, the annual difference between outlays and revenues, won’t be as large as the initial impact on the federal debt (increase in outstanding Treasury bonds), because budget analysts are expected to “score” the impact of the rescue plan in a way that reflects the expected return on this federal “investment” in these private companies–a return that even now (with the equity stake) is still highly uncertain.

Meanwhile, Congress is focused on doing what they can to help, with both sides of the aisle talking about more deficit-financed fiscal stimulus, likely to be taken up in a lame duck session after the election.  And Senator Obama and Senator McCain are coming up with their own versions to talk about on the campaign trail.  

In a recent article, I pointed out that Obama’s new proposals for additional deficit-financed tax relief (about $60 billion worth) are aimed at improving cash flow into the economy (what I think of as “life support”), but are at least temporary in nature, recognizing that over the longer run, what our nation’s economy needs is to increase national saving, not decrease it (i.e., to start “living within our means”).

The McCain campaign doesn’t seem to understand this distinction between what might be justified as short-term fiscal stimulus and what is needed for longer-term economic growth.  In another Washington Post story, McCain economic advisor Doug Holtz-Eakin responds to the new Obama proposals:

On a conference call with reporters, Holtz-Eakin called Obama’s new ideas “hypocrisy.”

He accused the Democrat of supporting tax increases that would more than offset the tax credit he proposed Monday. And he said Monday’s proposals would “hardly undo” the damage to the economy created by Obama’s plan to boost the top marginal income tax rates.

“He pretends to offer a, quote, ‘rescue,’ ” he said of Obama. “But the rescue is simply from the threat of his own policies.”

But Doug, the “boosting” of the top marginal income tax rates under Obama’s economic plan is scheduled to take place under current law (without any new legislation) on January 1, 2011–hopefully well after we would need the stimulative effect of a temporary tax cut, and well into the time when we’d be getting back to fiscal policies that will improve long-term economic growth.

The McCain campaign yesterday proposed new deficit-financed “fiscal stimulus” tax cuts in response to the current economic crisis, and like Obama’s new proposals, McCain’s new proposals are likely to be temporary in nature–which is good.  (Here's a link to the McCain website description; cost of new proposals said to be $52 billion.)  But the McCain campaign will continue to dig their heels in about their longer-term plan to not only extend all of the Bush tax cuts, but to cut taxes (mostly those on the rich) even further.  So on the broader trouble facing the U.S. economy–the fact that the current crisis is just one symptom of the “living beyond our means” philosophy that has pervaded the entire economy–the McCain campaign just doesn’t seem to be looking in the mirror.  They don’t seem to realize that we have run out of money, we are just moving the debt around, and that it’s time for the government (and especially our next president) to better prioritize and to acknowledge that while we all love tax cuts, they don’t come for free.

And still, with all this and all the new proposals for more tax cuts (without taking any of his “old” tax cuts off the table), the New York Times reports that Senator McCain is still claiming (as of Monday, really!) that as president he would balance the federal budget by 2013.  (Remember, with all the tax cuts the McCain campaign was already proposing–before any new ones yesterday–this implies cutting federal spending down to 16 to 17 1/2 percent of GDP, from a current-policy-extended level of more than 21 percent of GDP.) 

Is it such a surprise that voters who are truly concerned about the economy are having more and more trouble taking Senator McCain seriously?

Comments

[Smarty_Pants:]

"taxpayers can at least now find some comfort in receiving an ownership stake in more-tangible/measurab... assets (decent equity)"

Ummm ... the ownership stake is in a corporation which still owns all that 'toxic debt' and has a negative shareholder equity on the balance sheet. Said corporation can only make more money by lending into a recessionary economy to businesses who are trying to cut costs while paying the large interest burden on those new preferred shares.

Not terribly comforting. If it works it will be a completely new business model.

2008 Oct 15 05:01 PM

[Joyful Alte...:]

But Smarty, that's still better than a pile of toxic debt!

2008 Oct 16 12:00 PM