Why I Prefer Obama's Economic Plan

The plan to create a "bad bank" to absorb financial firms' toxic assets will work.

It provides an effective "circuit breaker" in the vicious circle between housing and the rest of the economy and will ensure that a systematic collapse of the economy won't happen. I have discussed the concept of a circuit breaker in my earlier article on systematic risks.

The Republicans insisted that cutting taxes would be superior to greater spending. This "small government" hang-up is entirely misplaced today, because this is a confidence crisis, and tax relief will be saved rather than spent. Without an effective way to boost confidence and with the worry that the vicious circle would continue to run its full course the economy will wind down, eroding confidence further and generating much more unemployment. The crisis WILL INTENSIFY, and a repeat of 20%+ unemployment, as happened in the Great Depression, is NOT UNTHINKABLE.

The problems with the Bush Administration's approach in dealing with the crisis include procrastination, inconsistency, ideological hang-ups, and favoritism. It waited far too long to take action, and the actions were indecisive and inconsistent. Just as Richard Herring of the Wharton School pointed out, it is difficult to explain why the Bush Administration bailed out Bear Stearns but not Lehman Brothers (LEHMQ.PK).

It's very hard to argue the system was more vulnerable in March than it was in September. Bear was half the size of Lehman Brothers. It had half as big a dealer position. It had half as many assets.

It was wary of directly owning banks, obviously on ideological grounds, so it would not inject capital in the form of common stock, even though purchasing common stock is far more effective in reducing the effective leverage ratio. It wavered between buying toxic assets and injecting capital.

The Obama team in contrast is decisive and strategic in its approach toward a problem with gigantic proportions. It is using unconventional methods and is boldly going ahead despite criticisms and queries, because it knows the approach is right.

I am confident the economy will show clear signs of recovery before the year ends.

Comments

[tdillian:]

sorry.. but this has got to be one of the most vague, hopey filled articles I have read on SA.

This plan is HORRIBLE! a "bad" bank, with all these debts from risks they took... and it is going to be FDIC insured?!?!?

Heck, the 250000 FDIC insured gurantees for us mere mortal American is only for 1 year.

Again.. we are under the bus. Sorry, but this is a very ill-informed article!

Jan 29 07:43 AM

[Ferdinand E...:]

Personally, I'm not worried. If Obama's plan is bad he and his experts are smart enough to recognize its deficiencies at an early stage and drop or change it. The point is that if it works somebody will have to adjust to not just 4 years of a Democratic government, but 8 years. Probably more, because Obama's success will give Ms Clinton her chance. I think that I'm big-hearted enough to take a few Democratic governments.

Jan 29 08:00 AM

[DuffBeer:]

Change you can believe in---
Hope-----
Yes we can ------
Audacity of Hope-------
Our time for change has come----------------We are the ones we've been waiting for ------

I knew it would get all better after January 20 th !!!!
I got it from CNN PBS- MSNBC -- NY Times and Oprah

I just hope they do not screw up the brewing beer
Cheers, DuffBeer

Jan 29 09:33 AM

[ain't no fo...:]

For Republikans, these elephants sure have short memories. Bush's tax refunds last spring went straight into the bank or to pay bills for the most part, and that was BEFORE the economy really fell off the cliff... does anyone REALLY think that money will go to stimulate buying this time around?

No way in the world.

Of course, when Republikans say tax breaks for all, you know they mean tax breaks for the rich and a pittance for the rest.

Be very afraid when the words "tax break" and "Republikans" are put in the same sentence... be VERY afraid.

Jan 29 09:39 AM

[Timonomics:]

You need to think more clearly about why the Bush stimulus package didn't work. It was a good thing that people saved and paid off bills with it. That is exactly what they needed to do after a decade of no savings and credit card and other debt buildup.

A big part of getting the consumers to buy again [realizing they make up 70% of gdp] is for them to pay off existing credit and put away some savings. Then it will be time to begin spending again. If Republican tax cuts reveal that people have to pay off more bills and save more for an additional period of time, so be it. Ten years of poor personal financial management can't be undone in a few months.

The Democratic solution is incapable of righting what has gone wrong with the debt/savings relationship. All it will do is make the government an ever-larger "consumer", whose "income" is not earned, but only taken from the American people in taxes. More taxes will only further delay the real consumers from getting their personal balance sheets in order. The recession will only be prolonged.


On Jan 29 09:39 AM wpdragon wrote:

> For Republikans, these elephants sure have short memories. Bush's
> tax refunds last spring went straight into the bank or to pay bills
> for the most part, and that was BEFORE the economy really fell off
> the cliff... does anyone REALLY think that money will go to stimulate
> buying this time around?
>
> No way in the world.
>
> Of course, when Republikans say tax breaks for all, you know they
> mean tax breaks for the rich and a pittance for the rest.
>
> Be very afraid when the words "tax break" and "Republikans" are put
> in the same sentence... be VERY afraid.

Jan 29 11:24 AM

[One Eyed Guide:]

The bad bank might work if:
1. Banks are willing to give up bad (undervalued due to market action) assets.
2. .Banks have access to capital once they dump their bad assets.

Banks are not going to give up undervalued assets because, acting as prudent investors, they will hold them until they recover. Therefore only assets that are obviously bad will go the the bad bank and there will be no way to value them as anything but junk so banks will need more capital.

I don't know where capital will come from if not from the government unless the deal is so bad for tax payers that even a Republican can figure it out and then who will vote for it?

Bad Bank probably won't work unless direct gov. investment is part of it.

I also think the economy will be recovering by year end.

Jan 29 11:29 AM

[Timonomics:]

Your economic understanding is too narrowly focused. The fact that the Bush stimulus checks were saved and used to pay off bills tells us a lot about the condition of the American consumer, who generates 70% of gdp by their spending. They simply don't think it is wise to continue spending using credit and also not saving. They have to deal with their debt/savings imbalances and improve their personal balance sheets. No amount of spending on such idiotic things as the National Endowment of the Arts at this time will solve anything. Tax reductions on the corporate and personal level will give more money to businesses who do the hiring and to the consumers who can work on their personal balance sheet issues until they are satisfied and then begin spending again. That may take some months, but it is necessary for longer term sustained economic growth fueled by balanced consumer spending.

Jan 29 11:32 AM

[Lok Sang Ho:]

Breaking the vicious circle is a necessary condition for a recovery. But you are right that depending on credit to boost consumer spending is not sustainable. Still, consumer debt is concentrated among some people. There are many Americans whose balance sheets are strong but they are holding back their spending because of the uncertainty. Moreover, note that the Obama team also offers tax relief, but mainly to those whose balance sheets are in poor shape.

Jan 29 12:24 PM

[OldLimey:]

"The plan to create a "bad bank" to absorb financial firms' toxic assets will work."

A few questions:

1. What are the criteria we should use to evaluate whether or not it has 'worked'?

2. Who will decide what assets are to be acquired? Who will design the models used to price them? Must the assets be 'bad' as at some defined cut-off date, or will assets going bad at a future time (e.g., commercial RE) be encompassed?

3. By how much do the newly cleansed 'good banks' need to be recapitalised, who will provide this capital, how will it be priced, and what effect will its issuance have on other sectors also in need of recapitalisation? (The size of the capital requirement is of course intimately tied to the question of whether envisaged future write-downs can also be shifted to the 'bad bank'.)

4. What impact will the cleansing and recapitalisation of US money centre banks have on international financial flows given that many countries in Europe do not have the financial wherewithal (or ideological flexibility) to shift bank losses into the public sector on the scale required for their banks to remain competitive as counterparties or cross-border deposit-takers?

5. How much capital will the bad bank require and what will be its guesstimated recovery rate?

6. What implications for the future lie in the sidelining of moral hazard for, supposedly, the greater good?

7. What makes us so sure that the freezing of credit is purely a supply-side issue?

Mr. Ho, once we have answers to more of these questions (and doubtless others I have overlooked) we might be better able to judge whether the optimism embedded in your assertion is well-grounded.

Jan 29 01:13 PM

[user344210:]

wpdragon, if you look at the breakdown of taxes paid by income level, the reason you get back a pittance when there are tax cuts is because you pay in a pittance. Sorry, but that's just the facts, so keep that class-envy rhetoric to yourself please.

Jan 29 01:57 PM

[Old Rick:]

WP: I hope your other 235 comments here were a bit more pithy and accurate than this one. Under the Bush tax cuts (as under the Reagan ear cuts) the percentage of total income tax revenue paid by upper income brackets increased. In 2007, the top 10% of earners paid nearly 75% of income taxes. On the other end, the bottom 40% of earners paid a fat ZERO. In the Clinton era the top 10% paid around 60% of the total. As much as you and your MoveOn buddies disagree with tax RATE cuts, it has been proven over and over that tax RATE cuts increase tax collections and skew the % paid by the upper income group higher. You might do some real research next time.


On Jan 29 09:39 AM wpdragon wrote:

> For Republikans, these elephants sure have short memories. Bush's
> tax refunds last spring went straight into the bank or to pay bills
> for the most part, and that was BEFORE the economy really fell off
> the cliff... does anyone REALLY think that money will go to stimulate
> buying this time around?
>
> No way in the world.
>
> Of course, when Republikans say tax breaks for all, you know they
> mean tax breaks for the rich and a pittance for the rest.
>
> Be very afraid when the words "tax break" and "Republikans" are put
> in the same sentence... be VERY afraid.

Jan 29 01:59 PM

[Old Rick:]

I should also have added that it is instructive to read the comments of Democratic Icon, JFK, from 1960-1963 on the subject of tax rate cuts.

Jan 29 02:02 PM

[Tony Petroski:]

Change we can believe in? "The Obama team is decisive and strategic..." The Obama team is a bunch of retreads from the Clinton era. One thing I was looking forward to with the new administration was some new faces and voices. Instead we have the old crowd including Hillary Clinton! The Obama economic plan consists in taking the regular government spending that already wastes enormous amounts of resources under "normal" conditions and multiply it by 3 because we need "stimulus." Cut corporate taxes as that will help good companies that actually produce profits.

Jan 29 02:26 PM

[Whippet:]

"The Obama team in contrast is decisive and strategic in its approach toward a problem with gigantic proportions. It is using unconventional methods and is boldly going ahead despite criticisms and queries, because it knows the approach is right."

Mr. Author, I'm assuming you mean these elements of the pork-(ahem)-stimulus plan are the "right approach", "strategic", and "decisive":
$50 million for the NEA
$1 billion for global warming alarmist research at NOAA
$300 million for contraceptives
$1 billion for the National Park Service
Billions in wealth transfers from taxpaying Americans to welfare-(ahem) refundable-tax-credit-... Americans
Billions poured down economically non-viable alternative energy ratholes
New CAFE standards that will put the death blow on the American car industry

I would agree with you that they are "unconventional"...
The only stimulus plans that have EVER worked in this country are wars and tax cuts. Not tax refunds to people who don't pay taxes. TAX CUTS on producers, employers, capital investors, and spenders.

Jan 29 04:02 PM

[mediapro:]

So, it seems that we are still lining up on ideological, unwavering, unthinking positions rather than putting our shoulders to the plow.

This tax cut/stimulus debate is silly.

For all the wpdragon bashers, please consider the entire federal tax scheme:

1. Our effective cost per gallon of gas is ~$10.00 when one factors in the roughly $30 billion dollars in tax subsidies ANNUALLY provided to the oil and gas industry. This is the most egregious, downscale tax imaginable. Moreover, the oil and gas companies simly need to bid and secure future leases and INTENT to drill for the largess we reap upon them every year. This ponzi scheme against the American taxpayer is one of our dirtiest tax secrets.

2. Add to that tax subsidy the protectionist import rules on sugar, milk, etc. Removing sugar tariffs alone and replacing this supply with a much more efficient cane sugar ethanol source could end the corn producer/fertilizer manufacturers stranglehold on the taxpayer's neck. If one wants to make the small farmer argument, then set resdiency, gross receipts and size requirements on farm subsidies. This reward for planting inefficient crop supply and for NOT PLANTING crops drawfs even the oil subsidies.

3. For people who don't count the payroll, FICA, SUI, etc. automatic worker payroll contributions while conveniently ignoring the offshore accounts, shell businesses, and other manipulative uses of the tax code by those who can afford tax attorneys, don't be so quick to condemn the extra pittance put into the pockets of those who actually contribute a day's labor for a fair wage vs. the incredible sums paid to those who move money through the system. Look where that system of rewards has put us.

4. Finally, would someone please explain to me why there is a ~$100 K cap on wage contributions to Social Security? Are you considering that tax subsidy when you make the rate cut argument?

Kudos to Mr. Lo for opening the door to a different path than the predominant one we've been travelling for the past 28 years of supply side dogma.

For those who are still interested please recall...

Flash back to the neo-con's answer to 1970's stagflation and Milton Friedman's Shock Economics Theory he plied so well in South America for right wing fascists.

Roll tape a bit forward to the Gipper. Cut taxes, spend on defense out the wazoo, run record deficits, de-regulate markets and watch Uncle Milties' magic work.

While every right wing neo-con tape loop is buzzing with out-of-control GSEs, we all seem to conveniently ignore how all of this silly and frightening theoretical economic approach played out around the world through the likes of the IMF, World Bank, Halliburton, and their ilk.

Look at any country where this supply-side, trickle down, deregulated gambit has played and look at how eeiry is the similarity between those countries and this one:

1. The top 1% control 40% of all financial wealth in the U.S. The top 20% another 52%, leaving the rest of us (80%) America's financial wealth at a whopping 8%.

2. In terms of inherited wealth only 1.6% inherit moe than $100,000. 91.9% receive nothing. Yet the "death tax" is the highest priority on the ultra-conservative agenda.

Now for some sobering reminders:

Under Clinton we enjoyed a $287 Billion SURPLUS that's now an ever-growing DEFICIT that at last peek was nearing $1.4 Trillion and national debt that has grown from $5.7 Trillion to $10.2 Trillion in just seven years.

It wasn't because Clinton was an economic genious. He simply returned out-of-control revenue reduction (tax cuts) back to the Reagan rates and chose folks who shared his philosophy of government and its role. I'll put my money in the hands of the guys that believe that it's the government's job to invest in the 80% of us that need practical ways to grow our own wealth (smart energy policy, infrastructure development, education).




On Jan 29 01:59 PM Old Rick wrote:

> WP: I hope your other 235 comments here were a bit more pithy and
> accurate than this one. Under the Bush tax cuts (as under the Reagan
> ear cuts) the percentage of total income tax revenue paid by upper
> income brackets increased. In 2007, the top 10% of earners paid nearly
> 75% of income taxes. On the other end, the bottom 40% of earners
> paid a fat ZERO. In the Clinton era the top 10% paid around 60% of
> the total. As much as you and your MoveOn buddies disagree with tax
> RATE cuts, it has been proven over and over that tax RATE cuts increase
> tax collections and skew the % paid by the upper income group higher.
> You might do some real research next time.

Jan 29 04:31 PM

[mediapro:]

OK. SO that's $2.35 Billion of a $825 Billion package. Good job! Myopia will never give clear vision a chance. BTW, contraceptives are out of the House package. Alarmist research is in the eye of the beholder who chooses not to listen to the majority of climate sceintists. And funding the NPS actually supplys summer jobs to youth and construction jobs to unemployed working folks.

We've argued CAFE standards for more than three decades. SO now it takes an automobile industry crisis for conservatives to cry foul when they are not in power.

As for inefficient energy solutions, you don't have any more of an idea than I whether a move away from subsidizing the oil industry in favor or new solutions will have merit. Using your reasoning the same cyclical argument used in the author's argument will no doubt continue.

Either get with the program or keep your obviously discredited supply side solutions at bay until you are back in power.


On Jan 29 04:02 PM Whippet wrote:

> "The Obama team in contrast is decisive and strategic in its approach
> toward a problem with gigantic proportions. It is using unconventional
> methods and is boldly going ahead despite criticisms and queries,
> because it knows the approach is right."
>
> Mr. Author, I'm assuming you mean these elements of the pork-(ahem)-stimulus
> plan are the "right approach", "strategic", and "decisive":
> $50 million for the NEA
> $1 billion for global warming alarmist research at NOAA
> $300 million for contraceptives
> $1 billion for the National Park Service
> Billions in wealth transfers from taxpaying Americans to welfare-(ahem)
> refundable-tax-credit-... Americans
> Billions poured down economically non-viable alternative energy ratholes
>
> New CAFE standards that will put the death blow on the American car
> industry
>
> I would agree with you that they are "unconventional"...
> The only stimulus plans that have EVER worked in this country are
> wars and tax cuts. Not tax refunds to people who don't pay taxes.
> TAX CUTS on producers, employers, capital investors, and spenders.
>

Jan 29 04:42 PM