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.
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.