Saturday, December 19, 2009

An 11th Hour Deal?, Plodding Along With the Recovery Act

Health Care Deal, Part 2?

Senator Charles Schumer (D-NY) has announced that a deal has been struck between Senator Ben Nelson (D-NE) and Majority Leader Harry Reid (D-NV) to secure Nelson's vote to invoke cloture on the health care bill. Now, it's understandable if we are all a little skeptical, given that this comes a week after the first "deal" between liberals and moderates was announced, and then promptly criticized by Sen. Joe Liebermand (I-CT) and Nelson as unacceptable.

I get the sense that this time things are different. First of all, Senator Nelson himself was the person with whom the negotiations took place. Secondly the deal appears to deal with the abortion issue, whereas the first "deal" dealt only with a compromise on the public option. I think this deal is the real deal.

Which is not to say that passage is assured. The Democrats could still lose another Senator from the center (Jim Webb being an unofficially undecided vote who apparently was not involved in these negotiations) or from the left (Roland Burris, for instance, has indicated that he might vote down a bill that doesn't have a strong enough public option, although he has moderated his tone in recent weeks.) And the Democrats still have a calendar problem -- it is razor thin to try to even get to a cloture vote by December 24th, and you have to believe that Republicans will continue to use every tactic available to them to slow things down. Today, the Senate is working through the Defense Appropriations Bill (the last regular appropriations bill of the year, at long last), hamstrung by the fact that the previous continuing resolution expired at midnight and non-essentially Defense operations are technically unfunded at the moment (which is okay on a Saturday, but pretty bad come Monday if a bill isn't signed.)

Finally, even assuming Senate passage of the bill, there is still the whole conference much will liberals in the House be willing to give ground to keep Nelson on board?

But, despite the remaining obstacles, Democrats are far closer to passage than I expected them to get this year, assuming this deal is real.

What exactly the deal contains is not yet clear. The Reid "manager's amendment" that makes all these changes is posted online at the link below:

It is almost 400 pages long, so I haven't had time to digest it yet, but I'l provide full analysis as soon as I can.

How Much Does H.R. 1 Matter?

It is the crowning political achievement for the still-young (although looking older) President Barack Obama -- the American Recovery and Reinvestment Act. The $787 billion stimulus bill, the heart of a brutal political fight last winter and spring and the largest economic stimulus ever passed in absolute dollar terms (although certainly FDR had a larger stimulus program relative to the size of the economy), this bill is certainly the most significant legislation signed into law of the 115 bills the President Obama has signed in the past 334 days.

But, does it matter? It was (unwisely) advertised as keeping unemployment below 8% (unemployment stands at 10.0% today, down slightly from last month's high of 10.2%). The number of jobs even its strongest advocates claim to "save" or create is dwarfed by the overall job losses in the economy. And in many ways, the actions under TARP and the massive expansion of the Fed's balance sheet, gobbling up everything from bonds to mortgage-backed securities to keep easy money flowing in the economy, contributed far more money to stabilizing the economy (TARP was $700 billion, the Fed's balance sheet has ballooned to over $2 trillion.)

Finally, the stimulus is now pretty unpopular. People don't tend to be particularly patient where unemployment is concerned (ask George Herbert-Walker Bush, who went from 91% to 38% approval in about a year, thanks to an unemployment rate nowhere near as bad as this one.)

Actions under the stimulus bill have been slow as well. The government will miss my benchmark of having 40% of the funds distributed in the 2009 calendar year. The latest government report, as of December 11th:
Tax Cuts: $92.8 billion paid out of $288 billion authorized (32.2% spent)
Spending: $152.6 billion paid out of $499 billion authorized (30.6% spent)
Total: $245.4 billion spent out of $787 billion authorized (31.2% spent)

A quarter of a trillion dollars is a lot of money to have spent this year, but is a small piece of the $3 trillion or so that all of the sources above add up to that has been pumped into the economy since the start of the financial crisis.

So was the stimulus even worth doing?

Absolutely. As amazed as you might be by this, I actually think the bill looks better in retrospect. The coordinated actions of the federal government, while imperfect, have had a huge impact in staving off a massive depression and spurring positive economic growth in the third quarter (and almost surely the fourth quarter as well.)

(1) TARP for Banks
Without TARP (credit goes to President George W. Bush on this one for alienating the base of his party to do what needed to be done), it is very likely that Citigroup and Bank of America would have gone bankrupt, causing such a severe contraction of credit that we would likely be mired in depression for years. The banks are paying back the money with interest, meaning that on top of saving the economy, the bank-funding portion of TARP is actually turning out to be a good financial investment for the government.

Yes, the final plan looked nothing like what Hank Paulson described to congress when the bill was passed, whereby the government was supposed to buy the bad assets, not invest in the banks and certainly the original approach was better in many ways, but the government quickly determined it was not feasible in the timeline with which they needed to act.

(2) TARP for AIG
This was a bad deal. A big chunk of money was poured into insurance giant AIG ($180 billion in total) and short of a miracle, I see no path to recovering all that money. I have also been highly critical of this funding in the past -- you don't need to bail out the guy insuring the loan if you bail out the guy making the loan. There was a legitimate interest in protecting the stakeholders in other divisions of AIG (seniors who depending on a fixed annuity from AIG for retirement income, for instance), but this could have been accomplished by severing those portions of AIG and providing much smaller levels of funding to keep them afloat.

(3) TARP for the Auto Industry
Okay, so President Bush got this wrong initially, pumping more money into a losing business model. President Obama initially made the same mistake, before realizing that bankruptcy was the ONLY path to survival for GM and Chrysler. These bankruptcies should have come months earlier without the thrown-away federal money, but the structure of providing bridge capital to these companies in exchange for large equity stakes was ultimately the right way to go. Without these actions, two industrial giants would have collapsed entirely, sending manufacturing into a deadly tailspin (you think 20% unemployment in Detroit is bad, try 50%!)

(4) Ben Bernake's Management
Federal Funds rates of 0.25%, the lowest in history have spurred short-term borrowing rates as low as 4% for many consumers and even lower short-term borrowing rates for businesses. Money has been made historically extremely cheap. You think the credit crunch is bad now, try to the same environment with interest rates at 1.5x or 2x this level.

The Fed sopping up other securities to the tune of $2 trillion is another mechanism to inject liquidity into the monetary system. In essence, it amounts to the government printing money and using it to suck up debt. This would be a really bad move in an economy with even moderate inflation, but inflation risk has been extremely low to date.

(5) The Stimulus
While it doesn't look like a ton of money in the grand scheme of 1-4, the stimulus has done several very important things. First, it stabilized state governments, who can't deficit spend in a recession, avoiding massive layoffs of government workers. Second, it has started to provide infrastructure employment, which has a halo effect on economic growth beyond the immediate employment impact of those projects. Third, it has provided support for two key industries, the auto industry and the home-building industry through cleverly designed, highly effective tax subsidizes. Fourth, lest we forget, for the most part, the infrastructure spend is by and large things that NEED to be done anyway. In fact, I would argue that there wasn't ENOUGH investment in roads, bridges, rail and green energy in the bill.

The stimulus is structured to be a slow-burn: stabilizing state governments and providing the tax subsidizes immediately, but putting out the infrastructure spending on a much slower calendar. This is a politically-losing structure, at least in the short-term, but may be the right move in the long-term.

Working together, all these things have staved off disaster. I freely admit that looking out over the abyss, I did not see the magnitude of this crisis. Fortunately, Bernake, Paulson, Geithner and company did and the coordinated effort of the federal government is an example of government actually doing a massive program well.

There is a ton of mess to clean up:
(1) Unwinding all the TARP investments in banks. This has started, but getting all that money back is a slow process.
(2) Unwinding the AIG investment. This could take years as AIG is still in no position to pay.
(3) Unwinding the auto industry investment. GM owns a huge stake in GM (as the controlling owner) and a smaller stake in Chrysler. Unwinding this will take a stock offering that fetches a price enabler the government to recover its money.
(4) Unwinding the Fed balance sheet. This should start immediately, but in a measured way. The risk of inflation is starting to return as the economy sputters back to life. Acting too late on this could have terrible effects on our currency and the value of savings. The indications from the Fed so far is that it may take too long to act.
(5) Returning interest rates to normal levels. When the fourth quarter GDP figures come out, if they continue in the 2-3% growth range, I would argue that slowly bumping up rates should begin immediately. The currently low rates are great for borrowers, but are killing savers and people living off interest income, mostly seniors. They also risk allowing a surge in inflation, which would further destroy individual assets Historical norms put this rate around 3%. Bumping it to 0.5% in the spring wouldn't be so bad, would it? Alas, the Fed seems unlikely to touch rates until at least early 2011, at which point, the risk of inflation may be significant.

I was overcritical of men like Bernake and Geithner. Bernake deserves a second term at the Fed, having, on balance, made mostly the right moves. Geithner, for all his flaws, has done important work to stabilize the economy and deserves to stay on the job.

Here's to a better economy in 2010.

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