By Rich Miller and Matthew Benjamin
April 27 (Bloomberg) -- Ronald Reagan used to joke that the nine most terrifying words in the English language were “I’m from the government and I’m here to help.” Barack Obama is making those words welcome.
As he approaches his 100th day in office, Obama is rolling back the Reagan Revolution and restoring government to a central role in the economy. He has passed the biggest budget stimulus ever, prepared the way for an overhaul of the U.S. automobile and banking industries and proposed a $634 billion government- funded expansion of health-care benefits.
“It’s profound,” says presidential historian Richard Norton Smith of George Mason University in Fairfax, Virginia. “There are very clearly taking place some long-term, even transforming shifts in priorities and resources.”
The ultimate consequences of rebalancing the roles of government and capital are far from clear. In the short run, though, Obama has managed to dissipate some of the doom-and- gloom talk that the U.S. was headed for a depression.
The Standard & Poor’s 500 Index has surged more than 25 percent since March 9, with shares of banks that have taken government money soaring three times as much. Rates on 30-year mortgages have fallen below 5 percent, the lowest in records going back to 1971, as strains in credit markets have eased. Consumer confidence is up and a plunge in retail sales is abating.
“The system is beginning to stabilize as the grip of fear is starting to ease,” former Federal Reserve Chairman Alan Greenspan said in an April 21 interview. At the same time, the 83-year-old Greenspan, a Reagan appointee, said he’s concerned that the Obama administration has “taken on too much” with its long-term budget proposals.
Necessity and Ideology
Obama’s shift toward a bigger role for government in the economy has been born of both necessity and ideology. To combat the credit crisis, the 47-year-old president has put forward a variety of programs, including help for homeowners and battered banks.
“In a financial crisis, the biggest mistake that a government can make is to do too little, not too much,” Treasury Secretary Timothy Geithner said in an interview April 21.
In the longer run Obama has proposed a 10-year budget plan, including $3.55 trillion for 2010 alone, to pay for his proposals to expand government’s role in such areas as health care and education.
The White House programs would leave federal spending in 2012 and after at around 22 percent of the U.S. economy or higher, up from a 40-year average of 20.6 percent.
Stronger Economy
“These investments will boost productivity and growth, and build a stronger, more resilient and competitive economy,” Geithner said.
The move toward increased government intervention in the economy started under President George W. Bush, who was forced to take over mortgage giants Fannie Mae and Freddie Mac and to go to Congress for $700 billion to prevent a collapse of the banking system.
“We suddenly faced a crisis that clearly was not being dealt with by the market,” says Douglass North, an economic historian at Washington University in St. Louis and winner of the 1993 Nobel Prize in economics.
Obama is going much farther than his predecessor did.
He’s set aside $50 billion of the money Bush won from Congress to help credit-squeezed homeowners avoid foreclosure. With General Motors Corp. and Chrysler LLC both close to bankruptcy, Obama demanded that they radically revamp the way they do business if they want to get government money to survive. As part of the White House-driven retooling of the industry, GM Chief Executive Officer Rick Wagoner was forced to resign after 32 years at the company.
Banks in Crosshairs
Big banks are also in the crosshairs. The Obama administration is forcing the 19 biggest to undergo stress tests to prove their financial durability. Those found wanting may have to accept a bigger role for the Treasury in their business. Obama also wants to extend regulation in the financial-services arena to include big hedge funds.
The centerpiece of Obama’s crisis-fighting effort is the $787 billion stimulus package he signed into law Feb. 17. The plan includes a $230 billion, three-year individual tax cut and boosts spending on projects from weatherizing homes to increasing access to broadband technology.
Unprecedented Legislation
“We have plenty of big, complicated pieces of legislation that come down the pike, but this is unprecedented,” says Stuart Rothenberg, a political analyst in Washington.
In spite of the breadth of Obama’s measures, some economists argue he hasn’t done enough to combat the worst financial crisis and the deepest recession in at least a generation.
While credit markets have improved in Obama’s first 100 days, and some indicators show signs of a stabilizing economy, the U.S. is still a long way from recovery.
Investors are still demanding big premiums to justify putting their money into consumer and business loans rather than Treasury debt. Unemployment, at a 25-year record 8.5 percent, is forecast by some economists to exceed 10 percent next year. Home foreclosures continue to rise.
Much of the criticism of Obama’s response to the crisis focuses on efforts to aid banks through a program to buy up their illiquid assets and impaired loans using financing from the Fed and the Federal Deposit Insurance Corp.
More Radical Solution
R. Glenn Hubbard, who was chief White House economist under Bush and is now dean of the Columbia University Graduate Business School, voiced doubts that the asset-purchase plan will work and says more dramatic action -- and taxpayer money -- will be needed to fix the financial system.
“Some more radical solution is going to be in order,” such as dividing a troubled institution into a so-called good bank and bad bank, he says.
Nobel Prize-winning economist Joseph Stiglitz charges the plan will just end up bailing out bank shareholders and bondholders and accuses the Obama economic team of being too close to Wall Street.
The team is led by two former colleagues from President Bill Clinton’s administration: Lawrence Summers, who heads Obama’s National Economic Council, and Geithner. Both men earned their government stripes serving at Treasury under Robert Rubin, the former executive at Goldman Sachs Group Inc. and Citigroup Inc.
Greenspan Endorsement
Greenspan called the Obama team “as good a group of economic leaders as you can get.”
Geithner says the administration’s plan to fix the banking system, including public-private partnerships to buy up devalued assets, would limit the cost to the taxpayer. He adds that more radical solutions -- such as nationalization -- would expose the government to bigger losses and risk destabilizing the financial system by undercutting investor confidence in the banks.
It isn’t only the crisis that has driven Obama to reassert a bigger role for government in the economy. It’s also his belief that the Reagan revolution went too far in unshackling the markets from government oversight and rewarding the wealthy.
“Obama’s 10-year budget is the biggest attempt at rebalancing the roles of business and government in the economy in a generation,” says Robert Reich, labor secretary under Clinton and now a professor at the University of California in Berkeley.
Shift in Priorities
Obama’s long-term plan extends the shift in priorities that started with the stimulus program’s focus on middle-class tax cuts and government-assisted job creation in selected industries such as renewable energy. The 10-year plan lays the groundwork for universal health care and redistributes income from the rich to those less well-off. It also boosts spending on education and infrastructure and proposes a so-called cap-and-trade system to help limit carbon dioxide emissions by U.S. businesses.
“We laid out a broad redirection of priorities for the country by making critical investments in basic public goods,” Geithner said.
Summers says the administration wants to avoid what he calls the “bubble-driven” growth of the past 15 years, when first a stock-market surge and then a house-price explosion drove the economy higher, only to have it relapse later. The goal is to build the next expansion on a sounder foundation.
Price of Vision
That vision may come at the price of a ballooning budget deficit that America can’t pay for on its own and foreigners might balk at financing, fiscal conservatives maintain.
Obama has defended the deficit, saying massive government spending is necessary to combat the financial crisis. He has pledged to cut the shortfall in half by 2012. That would still leave the government $581 billion in the hole for that year.
And budget experts are skeptical even that can be achieved. “We’re not going to be able to turn off the spigot completely when this downturn ends,” says Isabel Sawhill, who’s at the Brookings Institution in Washington.
The cost of hedging against losses on U.S. Treasuries using credit-default swaps rose to a record on Feb. 23, the week after Obama signed the stimulus bill. While the cost has since come down, it remains about seven times the level of a year ago.
“You cannot finance this without an increase in real interest rates,” Greenspan said. “They’ve got to stretch out their timetable.”
Some economists also argue that Obama’s plans to intervene more forcefully in the economy will lead to slower, not faster, productivity growth.
Mohamed El-Erian, chief executive officer of Newport Beach, California-based Pacific Investment Management Co., says a combination of increased government regulation, more abstemious U.S. households and less leverage in the financial sector will lead to slower growth.
Lower Speed Limit
“We are lowering the speed limit for safe economic growth in the U.S.,” says El-Erian, whose company manages the world’s biggest bond fund. “We’re going from somewhere near 3 percent to probably just below 2 percent.”
Whether for good or ill, what’s clear from Obama’s first three months is that he wants to bring the full power of his office to bear on the economy.
If he gets everything he wants, says Alan Blinder, a former Federal Reserve vice chairman who’s now at Princeton University, “he would have completely changed the rulebook for the financial system, put the country on the road to universal health insurance and changed the face of the economy in many ways.”
To contact the reporters on this story: Matthew Benjamin in Washington at mbenjamin2@bloomberg.net Rich Miller in Washington rmiller28@bloomberg.net
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