What Obama Needs to Do to Correct His Economic Vision

This is the post I have dreaded writing.

Now that my inauguration hangover has worn off, I have to start treating the new Obama administration with some degree of objectivity. The truth is that I like Obama and I certainly see him as a welcome change from George W. Bush for a host of reasons. However, I have not been particularly impressed by the economic policy vision his team has cooked up. Let me tell you why.

I come at this from a Libertarian's point of view. Now, despite what you might hear in the American media, Libertarians are the true liberals in the classical sense. That makes Libertarians so-called cultural 'liberals,' but economic 'conservatives.' This means a belief in the primacy of individual liberty and limited government. Now, I am not going to tell you that anyone should be able to own AK-47s or that the government is the problem or that the free market always works and we don't need regulation. I don't believe any of those things.

But, what I do believe is that government policy must be well-crafted in order to avoid negative unintended consequences that arise when the government inserts itself into the private sector. And this is where I am having a problem with the Obama Administration.

Recently, Tim Geithner's comments about currency manipulation put me over the top; I felt compelled to give you my seven reasons to be skeptical about the policy course now being charted.

• Obama has no comprehensive game plan
• Obama needs to put teeth in the bailout packages
• Obama is silent on prosecuting financial industry villains
• Obama must re-regulate, but not go overboard
• Obama should know that the mortgage buy-up solution will be a disaster
• Obama must beat back the protectionists
• Obama must provide more stimulus if he provides any at all

Take this as constructive criticism of an administration of which I expect great things, mindful that it has been in office for all of one week. Nevertheless, it is critical that we adjust the economic course now as time is at a premium.

Obama has no comprehensive game plan

You have probably seen some of my posts on the need for a comprehensive solution to the banking crisis in the U.S. and globally.

• The global economy has crashed: we need a comprehensive credit crisis plan
• The Swedish banking crisis response - a model for the future?
• Lehman's bankruptcy: putting the cart before the horse?

However, the Obama Administration has offered zero along these lines. For all intents and purposes, we are continuing with the ad hoc approach crafted by Henry Paulson. This creates uncertainty for equity investors, bondholders, and management. Who is going to be bailed out and under what terms? Anyone managing capital is likely to husband it in an environment of fear and doubt. This is not a recipe for increased lending, as Yves Smith has demonstrated quite well.

The bailouts do not have enough strings attached

If Obama's team is not going to present a comprehensive solution, it needs to create well-crafted bailout structures. But, the recent Citigroup (C) and Bank of America (BAC) bailouts demonstrate the opposite. No management was let go. There were no real pay caps. The government has no board control. The government is getting a dividend, but one that is at once insufficient and destructive to banks' need to recapitalize.

Moreover, these institutions will need far more money than is presently acknowledged. They have not written down the tidal wave of Leveraged, Credit Card, Auto and Construction, and Commercial Real Estate Loans that are going to go sour. Are we to believe that they will not need more funds? What contingency plan does the Obama team have for distress amongst the large banks? What about large regional banks?

And don't get me started on the auto bailouts. They have already created a competitive bailout response in France, the UK, Germany and Sweden.

I have heard nothing — either during the presidential campaign, after the election, or since the confirmation hearings that gives me comfort regarding these bailout issues.

Obama promises greater oversight. Start with prosecuting

We have the recent flap over expenses at Merrill Lynch, huge bonuses going out to staff at this failed institution, massive bailouts of Citi and BofA, and more money expected for Fannie (FNM) and Freddie (FRE). Yet, Angelo Mozilo is living high on the hog. Dick Fuld is selling his Florida mansion to his wife for $100 to avoid potential confiscation, and no one at Citi has been dismissed or indicted. I'm sorry, but Bernie Madoff is the tip of the iceberg here. There is much more impropriety lurking underneath. These issues need to be addressed in a way that leaves people with a sense that the rich and powerful are subject to the same laws as everyone else.

Oversight begins with legislation

I was heartened to hear Timothy Geithner claim that the Obama Administration is planning to straighten out a number of regulatory issues. But, I was also a bit frightened when he claimed this would be the biggest overhaul of financial regulation since the 1930s. I fear unintended consequences will result.

Nevertheless, I have heard nothing substantive from Obama's team decrying these egregious examples of the broken financial system or specifics on legislation which I support as yet. (See naked capitalism's post to see what I mean) Whilst Obama has promised an end to crony capitalism, the proof is in the pudding. There remains much legislation to be proposed on rating agencies, OTC derivatives, hedge funds, off-balance sheet assets, predatory lending, and more. Let's see what we get. I remain skeptical.

Buying mortgage paper at inflated prices props up prices artificially

Then there's the Fed proposal to spend TARP money on buying distressed mortgage debt. This was the original Paulson plan. I find it admirable regarding the need for price discovery. However, I fear the Fed is going to end up propping up house prices artificially. Caroline Baum has said similar things in her column Tuesday:

Now that we're here, with more homes for sale than buyers at the current price, what's the government's solution? Why, make it easier — and cheaper — to buy homes. The Fed has embarked on a program to buy $500 billion of mortgage bonds in the first half of 2009 in an attempt to lower actual mortgage lending rates, which fell to an all-time low of 5 percent earlier this month.

Rather than let the market "clear" — or let prices seek their own level — policy makers are stimulating artificial demand for housing to prevent prices from falling.

Buying Mortgage-backed securities lowers the interest rate for those securities. Does the resultant interest rate reflect the 'true' rate if market liquidity were normal? Or do they reflect easy money, re-creating the problem that got us here to begin with? I think you know the answer.

Protectionism is a likely outcome

This is my biggest beef. If Tim Geithner continues to explicitly label China a currency manipulator, we will end up in a trade war, irrespective of his motives. To be sure, his motives are not clear; he may be playing to the Democrats in Congress in order to assuage their protectionist wing. But, he is playing a very dangerous game which feeds into a whole protectionist line of argument that is gaining momentum. (See my last post "The Blame Asia Meme")

Not enough stimulus

Whilst I am no fan of government deficits as far as the eye can see, I have become convinced that government stimulus will be necessary to mitigate a downward spiral of reduced consumption, reduced production, layoffs, bankruptcy, writedowns, reduced lending and more reduced consumption. Government can replace some of the lost private sector consumption temporarily. But much more stimulus is needed if government spending is to be effective.

For whatever reason, Obama has started off by compromising with Republicans and Democrats on core issues of stimulus and spending. To my mind, he is negotiating from a position of weakness instead of strength. If you start the discussion with a position hedged toward your negotiating partner, you will be beaten back to an even worse compromise position. It is much better to begin with a reasonable best-case position — one that is not likely to be dismissed out of hand — and be beaten back from there if at all. Obama needs to go big on stimulus if he goes at all.

The worst-case scenario is one in which Obama tries to stimulate the economy,fails and then, sees this failure shown as prima facie evidence that stimulus never works. This is where we seem to be headed.

Conclusion

Obama has an enormous number of things to sort through. So it is somewhat unfair and premature to attack him just as he gets into office Nevertheless, I raise these issues not as an attack, but as a reminder of what is at stake here. As with the Bush Administration, we need to keep Obama's team honest about the task at hand.

And you thought I had gone soft.

Comments

[AlexS:]

I don't know many Libertarians who would say Obama should provide more stimulus, especially since what he calls "stimulus" doesn't seem like stimulus at all. Libertarian stimulus would be towards smaller government: less regulation, or lower taxes. Those would be stimulus. What Obama wants is just more and more government spending, oriented towards construction unions and teachers unions. His "tax cuts" are just limited redistribution schemes, as he promised during the campaign. Take from the rich and give to the poor. The libertarian position would be that government has no business taking from any group of people to give to another. That's what kings and dictators do.

Jan 28 07:42 AM

[Paul Price:]

Virtually nothing in Obama's plan would create jobs.

Almost everything he proposes is just to advance liberal ideology without debate. It is financial heroin that will addict the states and educational instituions permanently.

This is some of the worst garbage ever proposed!!!!

Barrack is seeking to do decades of damage by invoking 'emergency' needs to get huge deficit spending thateven the Democrats would never propose under normal circumstances.

Let's hope the congress is not as stupid as they have been in the past.
I doubt they will do the right thing, however. In the end they will just 'horse trade' amongst themselves until everyone gets some pork to take back to his own district.

Jan 28 08:13 AM

[kennyB:]

Lib/Whig/Dig: what difference does it make. It's not like there's some master catchall plan which will magically rescue the universe. Deregulation brought Trillions of dollars north to the richest 1% through systematic deconstruction
of rational regulation over 30 years. Since Gov't is a true redistribution force, shouldn't it spread the wealth? Absolutely. For people who have money, it's easy to lay claim to mythology of capitalism. Trust-fund babies
made it the old fashion way, didn't they? Maybe Money's false nature should be replaced with barter? Regardless of whatever system is put in place, unless there's adequate safeguards to spread the wealth, slaves, indentured servants, workers will not willingly support and trust it. They'll rip it off, just as the "true-believers" in "dog-eat-dog" do. So recapitalise, but pass down the favors, otherwise the house will have to fold its cards, too.

Jan 28 08:30 AM

[auggie:]

obama is in over his head--he is lost--his confusion will lay this economy prostrate--as was done in hte 1930's; stimulus did nothing--i should think a lebertarian should already understand this insight intuitively

Jan 28 08:48 AM

[Ferdinand E...:]

Everything is relative in this old world, and until they change the system, there are only two political parties in the US. In the other one, the one that lost, the candidate was a man with health issues who talked about a hundred years of war, and despite his status as a veteran, his choice of a vice presidential candidate left me wondering about his stability. In the circumstances it was easy for intelligent persons to endorse Mr Obama.

Jan 28 09:10 AM

[axelrod608:]

Re strings attached, The gummint should impose the federal salary schedule on bailout recipients. The CEO can be paid no more than the Prez. All others go to the GS rating levels.

At these levels, their costs should be slashed enough to return them to solvency fairly quickly. Then when they pay back the taxpayers in full, they can pay themselves however much they want.

Jan 28 09:54 AM

[Old Turk:]

A terrific post! There is a chance that Obama can stop the transfer of funds from the working public into the hands of the annointed few at the top of our political and financial spectrum. To me there is only one political party in the U.S.A.: the ruling elite. The two sides of the ruling elite put up a wonderful charade to make us workers feel that we are being represented, but don't be fooled. The taxpayer's money has so far gone straight into the coffers of the very people at the top who created this mess in the first place, with pitifully little restriction on behavior or responsibility for deployment.

Jan 28 10:00 AM

[kelm:]

This is a terrific post. I too want this administration to succeed but there is clearly no game plan and the changing plans are now creating additional moral hazard. Let's look at the stimulus. I spent some time this past weekend looking at the details of the $825 billion plan. I concluded that very little of this has anything to do with job creation at least of a form that gives the nation some solid "thing" at the end of the expenditure. Far too much of it is merely handouts and funding for programs that will have no impact on job creation. What is alarming though is that we then hear that no, it's not $825 billion, it will actually ed up being $1.2 trillion. In a few days we have gone up 50%. This is the kind of nonsense I have grown to expect from GM's management. It says plain and clear that the new administration has no handle on the problem.

The dearth of prosecutions is astounding but so too is the lack of uproar over it. No one apparently is accountable for the near collapse of the system. No politicians, bankers,traders, executives, civil servants - no one. And Bernie is still living at home.

Jan 28 10:30 AM

[AlexS:]

I think it's ridiculous to think that Obama is not part of the ruling elite. Look at his history as a go-along member of the Chicago Democratic Party machine. Look at who he's been appointing (Goldman Sachs, anybody?). Look at the fact that the first program he's concentrating on is equivalent to $3000 in new debt for every man, woman, and child in the U.S. Do you think somebody else is going to pay for that?

Jan 28 12:22 PM

[gordon:]

Obama is a LIAR. He said any economoc plan would be based on IRAQ WITHDRAWL COST SAVINGS! He said we needed 7,000 more Afganastan troops, NOW ITS a 30,000 ESCALATION! He says we are fighting the Taliban now, not Al-Queda, just like the British and Russians got sucked in!
And his appointees are stacking Goldman Sachs cronies in, which will control America, as they are the 5th largest shareholder in the Federal Reserve.
This isn't change.

Jan 28 12:41 PM

[austrian63:]

I am sure this is a silly question but explain to me how government stimulus packages, massive deficit spending and government price fixing of interest rates are libertarian policies. If they are then I am definitely NOT a libertarian.

Jan 28 01:29 PM

[OldLimey:]

"I fear the Fed is going to end up propping up house prices artificially."

All the English-speaking economies rely on artificially high house prices to fuel overconsumption and to keep people hooked up to the system through overbearing mortgage debt.

Jan 28 01:58 PM

[DiggerUK:]

I am accepting from following your articles you have an understanding of the classical economists theories of wealth creation from "labour creating value". This doesn't seem at the front of your proposals for the way forward.

Only in your paragraph "Not enough stimulus" do you mention the problem of "reduced production".

Is not the crux of the crisis the collapse of the productive base in society, should this not be put first.

If we are not producing wealth we can only expect poverty.

Jan 28 02:49 PM

[phaf:]

Mr. Harrison, I enjoyed your article. I especially like your tone, and I agree with most of your points.

Regarding China and the potential for a trade war, I disagree with your assessment of where Obama's position is likely to lead. I'm more in line with other SA posters who feel that his more aggressive posturing on China currency and trade is more political positioning than substantive; it's as more a move designed to appeal to congressional Republicans than it is a signal of where specific policy is headed.

Jan 28 03:02 PM