The Magazine

Geithner Lays an Egg

And that's only one of the problems with the Obama economic strategy.

Feb 23, 2009, Vol. 14, No. 22 • By LAWRENCE B. LINDSEY
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Elections have consequences. That is what democracy is about after all. Barack Obama is correct when he states that his victory last November gives him the right, or more specifically the power, to have things his way when it comes to handling the nation's economic challenges.

The country, moreover, could use some decisive economic action. The financial system is a mess, unemployment is rising and will keep increasing. The government will likely run a deficit of 10 percent or more of GDP both this year and next--roughly twice the share of the Reagan deficits and roughly three times the size of President Bush's deficits. To fight the credit contraction, our central bank is expanding its balance sheet at a pace that might lead a visitor from another planet to confuse the United States with Argentina.

This makes it all the more frustrating that less than a month into his presidency, Obama has made a complete hash of economic policy, utterly squandering his mandate in a series of missteps that suggest he has not made the transition from campaigning to governing. This, even as Obama never stops reminding us in his constant televised appearances that the economy is slipping fast and time is of the essence.

The problems began with the inexplicable decision by the administration not to submit its own economic stimulus package, but instead delegate the job to Nancy Pelosi and the barons on the House Appropriations Committee. Appropriations is the reptilian brain of the political process. It is where all the back scratching, logrolling, and pork barreling gets done. Macroeconomic coherence is just not part of the skill set of House Appropriations members. So even rebuilding the nation's infrastructure got short shrift. Instead, the package was loaded with largesse for fellow politicians and civil service employees back home. The standard was not the proclaimed "shovel-ready" but "social-worker ready."

This package was marginally improved by the House Ways and Means Committee. Ways and Means gave money directly to workers as opposed to local politicians. It also ramped up the various medical spending conduits, which will push more money to health care providers--though not necessarily provide more health care. But there was no improvement in the tax system, which might, say, encourage job creation and retention by lowering the tax burden on employment or investing.

So the package the House produced was not "stimulus" in any normal understanding of the word. Of the $820 billion package that emerged from the House, only 20 percent would be spent in fiscal 2009 and only another 40 percent in 2010. That left 40 percent of the package to be spent in 2011 or later, when even the more pessimistic forecasters (of whom I am one) expect the economy to be in full recovery. This plan delivers the stimulus at precisely the wrong time.

The package was so bad that it made criticism of the new president socially acceptable, a rare development for the first initiative of a president elected with a large mandate. Alice Rivlin, doyenne of Democratic party policy economists, criticized the lack of macroeconomic benefit in the plan. Her sentiments were echoed by just about every leading economist in both parties who was not employed by the administration.

The new administration fell into this hole by belatedly discovering the fiscal realities of the country. Government spending takes time to get going, and, once flowing, is difficult to stop. During the transition, Team Obama surveyed the agencies for "shelf ready" spending needs and found them woefully inadequate as a credible stimulus package. The incoming Obama policy-makers had been focused on spending, not tax cuts, because they wanted to draw a line between themselves and their predecessors. But, faced with the facts, they made a virtue out of necessity by having the president call for taxes to be 40 percent of the package. This annoyed the more left-leaning Democrats of Congress, who were then appeased by being given the power to craft the spending.

The legislation was written by Democratic committee chairmen with no Republican input. The president covered this up by going to the Hill and meeting with the Republican caucus. But, since Obama had no direct role in writing the package, the signal to congressional Republicans was twofold: Bipartisanship was just a façade the president needed to maintain his approval ratings, and Nancy Pelosi and Harry Reid were the ones with the power, not Barack Obama.

The shreds of comity on which Washington depends were saved by Senator Susan Collins of Maine, who drafted a compromise that eliminated some of the most wasteful spending and sped up other parts. The bill that emerged from conference is close to the Collins compromise and is better than the House one at moving spending into the present. The Congressional Budget Office estimates that a quarter of the spending in the conference agreement would leave Washington this year and a total of 75 percent by the end of 2010, a substantial improvement. But it is still not "stimulus," and that fact is going to become apparent later this year. Money leaving Washington for state capitals is different from money actually entering the economy and creating jobs.

The administration released a report by its top economists saying that passage of the stimulus bill would mean that national unemployment would peak in the third quarter of 2009 at about 8 percent and start going down thereafter. Let's just say that we should all hope they are right. The economy will get a pop from the start of stimulus just as the economy got a pop in 2008 from the one-time checks that were sent out. Growth in the second quarter of 2009 is likely to be positive as the first round of stimulus hits the economy. As the rate of new stimulus slows in subsequent quarters, growth will turn negative again. The odds are high that unemployment will still be rising on the first anniversary of the Obama presidency next January with the prospect (but not a certainty) of double-digit unemployment at the time of the midterm elections.

As the stimulus bogged down, a new word crept into the administration's economic policy vocabulary--"comprehensive." The problems would not be easy to solve, and stimulus alone was insufficient. Bank recapitalization and housing mortgage issues would also have to be dealt with. The task for announcing these was delegated to Treasury Secretary Timothy Geithner. But the scripting of the message and indeed the whole "rollout" of the issue was tightly controlled in the West Wing.

Like so much of what happens in Washington, the reasons for this odd locus of decisionmaking authority are less nefarious than meets the eye and more a matter of simple necessity. The first problem is a lack of personnel at Treasury. Geithner is the only confirmed appointee in the department. No deputy secretary, no undersecretaries of either domestic or international finance, no assistant secretaries, no deputy assistant secretaries. The West Wing is the only place where the personnel reside who can make decisions.

The second problem is political. There are no easy answers when facing a trillion-dollar hole in the banking system. Either the banks will fail, or money is going to have to be given to the banks to fill the hole, or the proverbial can will be kicked down the road with enough money being slowly injected into the system to keep it going. The first option is a nonstarter. This brings the essential choice down to writing a big check now to the banks or writing a lot of little checks over time, and bankers are not the most politically sympathetic recipients of federal largesse at the moment.

So there is a political incentive to create a focus on issues that are tangential to the trillion-dollar problem. Make sure that bankers sell their corporate jets! No more bonuses!

The sale of 50 corporate jets in today's market might fetch you $1 billion if you're lucky. End all the bonuses on Wall Street and you get real money--another $18 billion. Put the two together and a $1 trillion problem shrinks to a mere $981 billion one. The administration's hope was that such measures plus the group flogging of the CEOs of the big banks on the Hill last Wednesday would focus the media, Congress, and the public away from the fundamental enormity of the task at hand.

But Geithner still had to say something, and none of the various options available was attractive. Buy the assets from the banks? Set the price high enough to bail out the banks and you have a trillion-dollar overpayment. Set the price at current market prices and you have to come up with the same trillion as a bank capital injection. Do what Bill Seidman and the George H.W. Bush administration did during the S&L crisis by nationalizing the banks and then reselling the pieces into the market? Might work, but while Seidman disposed of the thrift industry by selling them to the basically healthy commercial banks, there aren't any basically healthy banks left on the planet to buy an institution like Citibank or Bank of America. Combined, those two institutions have 14 percent of the deposits in the American banking system, and there are plenty of other banks that need help as well.

The Geithner announcement was repeatedly put off while each of the options was publicly discussed. In the end the political decisionmakers decided there was no politically acceptable decision. But expectations had been building, stoked higher with each postponement of the speech. When Geithner finally spoke and by omission essentially admitted that the Obama administration hadn't come up with a solution, the stock market plummeted.

But it wasn't only the stock prices of America's publicly traded companies that collapsed. So did the stock of the Obama administration. A discredited stimulus package followed by an overly hyped but largely vacuous bank-rescue speech proved to be too much. The mainstream media, which had given Obama a free ride since the election, turned on their choice. In the space of just over three weeks, Obama and company squandered the greatest stock of political capital any president since Lyndon Johnson had inherited from an election.

It is certainly not too late for Obama to create a sensible government policy and assist in an American economic recovery. But he has to stop campaigning and start governing. This means fewer speeches (his strong point, and something he evidently enjoys) and more noodling through wonky decision trees and detailed analyses in concert with expert advisers on both the inside and the outside. All presidents in my experience--and I have served four different administrations--have to learn the difference between campaigning and governing. Obama, whose vita contains lots of campaigning for high offices but remarkably little tenure in such offices, has a bigger challenge than most in making this transition. But he is a smart and well-intentioned fellow. Most important, he has a strong survival instinct. Perhaps he'll sense that unless he makes a rapid transition, he will be a one-term president as the economic catastrophe he warns against so often comes to pass.

Lawrence B. Lindsey, a former governor of the Federal Reserve, was special assistant to President Bush for economic policy and director of the National Economic Council at the White House. His most recent book is What a President Should Know .  .  . but Most Learn Too Late (Rowman and Littlefield).