Obama Must Defeat Spite on Bailouts to Beat Recession

By Rich Miller

Feb. 27 (Bloomberg) -- Greed helped get the U.S. into its worst recession in more than a quarter century. Now President Barack Obama has to make sure spite doesn’t hinder a recovery.

By proposing $750 billion more in aid for financial institutions and $275 billion to stabilize the housing market, the president is taking on the public’s aversion to handing out more money to bonus-hungry bankers and spendthrift homeowners. Failure to overcome that antipathy might thwart his efforts to revive an economy stuck in a vicious downward spiral.

“The administration has to communicate that we have to do this,” said Nariman Behravesh, chief economist at IHS Global Insight in Lexington, Massachusetts. “If they don’t, the risk is that the programs will not be big enough and effective enough, and that the crisis will drag on.”

That’s what happened to Japan in the 1990s. Faced with public opposition to government bailouts of banks, the Japanese government dithered before moving forcefully to fix its financial system. The result: a lost decade in which economic growth averaged less than 1 percent a year and the unemployment rate more than doubled.

To be sure, the U.S. is moving much more quickly than Japan did in tackling its problems, said David Weinstein, professor of the Japanese economy at Columbia Business School in New York. Since taking office on Jan. 22, Obama has won congressional passage of a $787 billion stimulus package, rolled out his anti- foreclosure plan and proposed a budget yesterday that more than doubles rescue funds for the banks.

Faster Deterioration

Yet the economy may be deteriorating even faster than the administration is acting. Gross domestic product contracted in the fourth quarter at a 6.2 percent annual rate, the worst drop since 1982, and U.S. durable-goods orders fell for the sixth straight month in January. Joseph Lavorgna, chief U.S. economist with Deutsche Bank AG in New York, said it’s conceivable that the economy might shrink at an annualized rate of 10 percent in the first quarter.

“It’s getting uglier by the day,” said Harm Bandholz, an economist with UniCredit Markets and Investment Banking in New York.

Administration officials defend their efforts to date and vow not to repeat Japan’s mistake of doing too little, too late.

“What we are not prepared to do is to stretch this out, to be tentative, to do too little because it feels easier,” Treasury Secretary Timothy Geithner said on Feb. 25 on public television’s “The NewsHour with Jim Lehrer.”

‘Bailout Fatigue’

The public may not be fully on board with such an aggressive strategy, notwithstanding the president’s high approval ratings - - 63 percent in the latest New York Times/CBS News poll. “There is a growing public sentiment that you might call ‘bailout fatigue,’” said University of Central Florida economist Sean Snaith.

Given the choice between giving more money to homeowners, banks and auto companies or stopping handouts altogether, 54 percent of Americans chose the latter, according to a telephone survey carried out Feb. 21-22 by Rasmussen Reports.

A mini-bailout backlash flared after the administration on Feb. 18 put forward its plan to help up to 9 million homeowners avoid foreclosure by reducing their monthly mortgage payments.

Critics, including Representative Jeb Hensarling, attacked the program as unfairly benefiting lax lenders and homeowners who lived beyond their means. “President Obama is proving the old adage that ‘nice guys finish last’ by rewarding those who have not behaved responsibly,” the Texas Republican said.

Voters’ Sentiment

That argument had some resonance with the voters. Fifty-five percent of Americans believe the government would be rewarding bad behavior by providing mortgage subsidies to financially troubled homeowners, according to the Rasmussen survey.

The Obama administration counterattacked, with White House Press Secretary Robert Gibbs going so far as to single out a media opponent of the plan, CNBC television reporter and former Wall Street trader Rick Santelli, for criticism. Gibbs, responding to Santelli’s on-air comment about subsidizing “losers’ mortgages,” said the administration’s plan is aimed at “people who have been playing by the rules.”

The administration may eventually have to court even more criticism by expanding its help to include reducing the balances that households owe on their mortgages, rather than just the monthly payments, to stem foreclosures.

“Substantial principal reductions are going to be necessary,” said Alan Blinder, a former Federal Reserve vice chairman who is now a professor at Princeton University.

Foreclosure filings in the U.S. surged 81 percent last year to 2.3 million, the most on record, according to RealtyTrac Inc. of Irvine, California, a provider of real-estate data.

Stress Tests

Obama is also risking the public’s ire with his proposal to expand the government’s financial-rescue program to give banks more money after subjecting the biggest institutions, including Citigroup Inc., Bank of America Corp. and Wells Fargo & Co., to rigorous stress tests.

The plan would be initially funded by the bulk of the roughly $315 billion left in the $700 billion Troubled Asset Relief Program approved by Congress in October. The administration penciled in another $750 billion of support in its budget outline submitted yesterday.

That much may be needed for the plan to work. “You can’t successfully do a stress test unless you have $1 trillion of financing ready to go into the banks,” said Simon Johnson, a former chief economist at the International Monetary Fund who is now a professor at the Massachusetts Institute of Technology.

Yet given the public’s revulsion to rescuing bankers who helped create the crisis, the administration may have its work cut out for it in persuading Congress to go along.

‘Zero’ Tolerance

“The tolerance in Congress right now for any additional funds for TARP, I think, is zero,” Senate Banking Committee Chairman Christopher Dodd of Connecticut said Feb. 20 on Bloomberg Television’s “Political Capital with Al Hunt.”

Administration officials acknowledge that the public is skeptical about bailouts, especially for bankers. Yet they argue that they have little choice but to press ahead for the good of the overall economy.

“It is surely tempting to say the hell with them all,” Lawrence Summers, director of Obama’s National Economic Council, said at a forum in Arlington, Virginia, yesterday. “But as the president said on Tuesday night, you can’t responsibly govern out of anger.”

To contact the reporter on this story: Rich Miller in Washington rmiller28@bloomberg.net