Thoughts on the stimulus and the bailout

Without a doubt, this has been an important week in Washington. Our elected leaders have made decisions over the past several days that will likely have an enormous impact on both the American and world economies for many years to come. On Tuesday, Treasury Secretary Tim Geithner (D-Goldman Sachs) unveiled a 1.5 trillion dollar financial rescue package, intended to restore the flow of credit to individuals and businesses. Today, the House and Senate agreed on a $789 billion economic stimulus plan, which aims to create or save 3.6 million jobs. Both the financial rescue plan and the stimulus are not completely terrible. Geithner appears to have abandoned the idea of over-paying the banks for toxic assets as a means of rescuing the financial system, likely under public pressure. Progressive activists also deserve a lot of credit for making the stimulus bill less bad than it could have been. Thanks to their activism, the bill has been stripped of some of its most awful components, including subsidies for "clean coal" and nuclear power plants, and still includes several progressive components which came under fire from the right, including the "Buy American" provision and funding for medical effectiveness research.

Nonetheless, the financial rescue and the stimulus in particular are quite disappointing. When the country is legitimately facing the most severe economic crisis since the great depression, half measures are not good enough. Progressive economists like Dean Baker and Paul Krugman have issued direct, specific recommendations for what the government ought to do to get us out of this crisis. However, their advice has gone largely unheeded. Of course, it's nothing new for the government to reject the advice of the likes of Krugman and Baker, who advocate policies like single payer health insurance and the elimination of patent protection for pharmaceuticals, which threaten the obscene profits of entrenched elites. However, given that we're facing a true crisis, I was under the bizarre delusion that our government would do the right thing. As I said, bizarre.

With regard to the collapse of the credit markets, the government really has only one solution: nationalization of the banks. We cannot allow the banks to fail completely because doing so would lead to the further collapse of the financial system and potentially depression-like conditions. We could just hand out cash to the banks through loans with no strings attached or purchases of bad assets at above market prices, aka Lemon Socialism, and there's an outside chance that might jumpstart the financial system. But Lemon Socialism, which is what we've been doing since last September with no success, leaves the banks' management in place, aka the folks who got us in this mess, and protects the banks' shareholders. In other words, it's just welfare for rich people and thus ought not to be and ought not to have been considered an option. Additionally, according to Economist James Galbraith, leaving the banks' management in place likely prevents the public from being able to access the banks' books. Without having unfettered access to their books, we won't know what their assets are worth, if in fact they're worth anything at all. Many large financial institutions, like Bank of America and Citibank, are likely already insolvent and only being propped up by the expectation of government aid. Thus, the only reasonable option we're left with is to take state ownership of the banks, fire the management and wipe out the shareholders, and then recapitalize them. State ownership ensures that the people control what the banks do with the money. Taxpayers also get an equity stake when you nationalize the banks, so if they return to profitability the returns go to you and I, not private investors. According to Matt Yglesias, the Geithner rescue might, through a roundabout way, lead to nationalization. Let's hope that actually happens. However, both Geithner and Obama have publicly opposed the idea of nationalization, so it's highly unlikely, to say the least.

As for the stimulus, according to Dean Baker, it's relatively simple to calculate how much the government needs to spend to get our economy back on track. Due to the wealth effect, the collapse of the $8 trillion housing bubble, the $7 trillion stock market bubble, and the multi-trillion dollar commercial real estate bubble will lead/ is leading to an $800 billion decline in annual consumption. Additionally, the collapse of the construction industry due to the popping of these bubbles will reduce demand by another $450 billion dollars. In total, that adds up to approximately $1,250 billion in lost annual demand. Yet, the federal government plans to spend $789 billion over the next two years, which is clearly nowhere near enough. Some of that spending, such as infrastructure investments, aid to state governments, and increased unemployment benefits, generates more dollars in increased economic output than it costs the government in additional spending, due to the multiplier effect. However, tax cuts, which represent 36% of the bill, have no such effect, and generally produce much less in added economic activity than they cost the government. Of course, it is possible that, against all odds and all predictions, the economy will recover quickly and a stimulus of such magnitude will be rendered unneccessary. But such a situation isn't really all that bad, because, as Krugman explains in his recently re-released book, The Return of Depression Economics, it would only lead to inflation. Policymakers know how to counter inflation, in fact they have many tools at their disposal to deal with it. For instance, they could raise taxes, increase the interest rate, or even better, institute wage and price controls. In contrast, when faced with the risk of deflation, which is a real possibility in this economic climate, policymakers are generally clueless; Japan was stuck in a recession for an entire decade due to deflation and it was only thanks to an export boom that they escaped it (now of course, they're back in a recession). An export-driven expansion is unlikely to happen in the United States or anywhere in the near future, because the whole world is doing badly.

Faced with such dire conditions, one would assume that a responsible congress and executive would propose similarly bold solutions. Instead, the debate on the stimulus has been absolutely maddening, with Republicans pushing for ineffective tax cuts and declaring which kinds of spending constitute stimulus (ignoring, of course, that spending is by definition, stimulus ), "centrist" Democrats and Republicans demanding billions of dollars in cuts from essential and effective programs, and Democrats being forced to defend an already inadequate House stimulus bill as the best possible option. It would be comical if the repercussions of such craven irresponsibility and indifference to suffering weren't so dangerous for our nation. In subsequent appropriations bills, there should be opportunities to add more stimulus spending. I hope congress decides to spend a lot more in the coming months, just like I hope the Geithner plan will lead to nationalization of the banks. However, given the sideshow that was the debate over this stimulus and Geithner's well known bias in favor of his former constituency, I'm somewhat less than optimistic.