How Should Obama Answer the Stock Market's Wake-Up Call? We-Need-Different-Cossacks Department
At least Bloomberg has taken down the "how long will the bull market last?" advertisement from the top of its S&P 500 screen…
Stock market down 17% in two and half weeks while the bond market has reduced the yield on the Ten-Year Treasury from 3% to 2.35%, and break-even five-year inflation has fallen from 2.1% to 1.7%. I think that is a very loud wake-up call for Mr. Obama--that it is long past time for him to stop talking about how surrendering to Republicans on long-run spending priorities will bring the confidence fairy who will then gift us with a strong recovery and start actually doing his job.
Back in the summer of 2009, Barack Obama had five economic policy principals on the Treasury Bench:
Tim Geithner, who thought that the administration and the Fed had done enough to stabilize the economy, that we were on track for a rapid recovery, and that the principal economic policy problems were going to be dealing with the long-run budget.
Ben Bernanke, who thought that the administration and the Fed had done enough to stabilize the economy, that we were on track for a rapid recovery, and that the principal economic policy problems were going to be avoiding an unwanted uptick in inflation and dealing with the long-run budget.
Peter Orszag, who thought that the economy probably needed some (relatively small) additional fiscal, banking, and monetary stimulus to boost demand, but that the path to getting to that stimulus was to make it part of a package with policies to deal with the long-run budget.
Larry Summers, who thought that the economy probably would need some additional fiscal, monetary, and banking-side stimulus--if only as insurance--and that dealing with the long-run budget could wait until the recovery was well-established (although in an ideal world Washington would be able to do more than one thing at a time and so it would not have to wait).
Christy Romer, who thought that the economy probably needed (much) more additional fiscal, monetary, and banking-side stimulus--especially as insurance should things break badly--and that dealing with the long-run budget crisis probably should wait until the recovery was well-established: that the key point was "no 1937s!"
Opposite the Treasury Bench was the Right Opposition, with its guiding principle: never mind everything we have said in the past, whatever Obama proposes we reject.
And over in the corner was the Left Opposition, represented by:
- Paul Krugman, who thought not quite "we are all going to die!" but rather that without five-alarm stimulus the risks were very high of a jobless recovery stemming from a combination of labor-market changes that had eliminated the temporary layoff and so the economy's ability to rapidly bounce-back on the labor side and of the fact that a financial-crisis solvency and safety squeeze was different from a monetary liquidity squeeze along the lines argued by Koo, Reinhart, Rogoff, and before them Bagehot, Minsky, and Kindleberger. And that Christy Romer was a wild-eyed optimist.
At the time I was, IIRC, somewhere between Christy and Larry--thinking that the risks of a jobless recovery were there and certainly demanded action as insurance, but that nobody wanted to see 1937 again, and that even without the cooperation of Congress the administration and the Federal Reserve had powerful tools and could and would stabilize aggregate demand.
The key, after all, is to get people to spend. Three things could keep people from spending:
A shortage of liquidity--and the Fed had and would continue to keep there from being any shortage of liquidity.
A shortage of savings vehicles--but that did not seem to be the case as the bonds of even good companies were not selling for the high prices you would have then expected to see.
A shortage of safety or an excess of risk in their portfolios--both on the debit and the credit side.
The first of these had been solved by the Fed. The second of these was not an issue. And the Fed and the Treasury had mighty tools to solve the third. The Fed via quantitative easing could take as much risk as it wanted to onto its balance sheet and replace the risky assets it bought with safe assets that the private sector wanted to hold--the Fed could push its balance sheet up from $2 trillion to $3, $4, $5, or even $6 trillion if needed. The Treasury could use its HAMP money to grease the refinancing of troubled mortgages. If HAMP wasn't enough the Treasury owned Fannie and Freddie: they could borrow at nearly the Treasury rate and refinance every house in the nation if necessary in order to get mortgage risk off of banks' books where it constrained lending and off of households' obligations where it constrained spending. The Treasury could use additional TARP money as the grease via the PPIP to take tail risk onto its books and so transform risky into safe assets. The Fed could take the TALF program and use it as a wrapper to make the long-run infrastructure projects we needed to undertake sources of the safe assets the private sector wanted to hold.
Even with a Congress gridlocked and neutralized, the Fed and the executive had enough power through their ownership of Fannie and Freddie, through the Federal Reserve act, and through the TARP to do everything necessary to guarantee a strong recovery.
But the problem I did not see in the summer of 2009 was that the stimulus skeptics were the operational managers of the government, while the stimulus advocates were staff without line responsibilities.
Hence nothing happened.
And Peter, Larry, and Christy left.
And their successors--Jack, Gene, and Austen--are very smart men and dedicated civil servants, but they lack the strong substance-matter knowledge and aggressive policy views of their predecessors.
So the only strong policy views in the administration's internal debate mix right now are those of people who were wrong in the summer of 2009.
And when I talk to their staffs, the message I hear is not "we were wrong about how the world works, and are rethinking the issues from the ground up to figure out what to do" but instead "we were unlucky: our policies were good". Never mind that Richard Koo or Carmen Reinhart or Ken Rogoff or indeed all of us who have ever taught the Great Depression in Europe foresaw the rerun of 1931s Credit-Anstalt crisis that is now playing at the European cinema. If I were as unkind as Jon Walker, I would say that I am reminded of the old Scooby-Doo TV series, in which at the end the villain always says: "My plan was perfect, perfect! I would have gotten away with it if not for those meddling PIIGS!"
Three years ago I would have said--I did say--that Ben Bernanke was among the best available candidates for Fed chair and that Tim Geithner was among the best available candidates for Assistant to the President for Economic Policy.
Today I think they both suffer from the sunk-costs problem.
In order to properly respond to the situation today they need to forget everything they thought they knew about the world in the summer of 2009 and look at the situation with fresh eyes. I don't think they have done that. i don't think they can do that. And yet theirs seem to be the only strong policy voices from people with deep substance-matter expertise that Obama hears
If you were to ask me what thing--aside from the complete and immediate collapse of the Republican Party and the resignation of all of its legislators from both houses of the Congress: if the previous fifteen years had not taught me that Republican politicians have nothing useful to contribute to national governance the last three years would certainly have done so--would most give me confidence that America would surmount this current economic crisis, it would be personnel changes to put qualified people who saw the world as it was in the summer of 2009 into the key economic jobs:
- Laura Tyson or someone like her to Treasury Secretary (recess-appointed, acting, whatever).
- Larry Summers or someone like him to Fed Chair (recess-appointed, acting, whatever).
- Alan Blinder or someone like him to CEA Chair (recess-appointed, acting, whatever)
- Christy Romer or someone like her to Assistant to the President for Economic Policy.