Spending to a depression?
In the panic following the insolvencies of Fannie Mae, Freddie Mac and Lehman Brothers in September 2008, the American taxpayer was stampeded into bailing out Wall Street by acquiescing to Washington’s $700 billion Troubled Asset Relief Program (TARP) in order to prevent the collapse of our financial system. American International Group Inc. was at the center of the storm with its $1.5 trillion book of credit default swaps (CDS).
Inexplicably, after passage, TARP was directed at banks rather than troubled assets — almost like a bait-and-switch plan. Now, a little more than a year later, TARP inspector Neil M. Barofsky reports that AIG’s portfolio did not, after all, pose systemic risk. So if the bailout was misrepresented, it seems appropriate to question extending TARP and to reconsider all successive debt-financed stimulus spending since unemployment, foreclosures and bank failures have risen.
An accommodative monetary policy may be necessary to revive economic activity, but — even with the federal funds rate at zero — it is neither sufficient nor without risk of distortions such as inflation. Clearly, help is needed from effective trade, fiscal and regulatory policy.
Trade policy caused a decline in commerce during the Depression because of dramatically higher tariffs imposed by the Smoot-Hawley Tariff Act. Today, Washington is at odds with free trade, inserting a “Buy American” provision in the stimulus bill and pandering to protectionist labor unions.
The administration has ignored the importance of trade in other ways, such as failing to act on free-trade pacts already negotiated with South Korea, Colombia and Panama; imposing new tariffs on Chinese tires and steel products; and letting our competitors race ahead in securing new free-trade agreements.
Historians recognize that the Hoover administration’s sharp tax increases on personal, corporate, inheritance, gift and excise taxes — all increased by Franklin D. Roosevelt — were a defining feature of the Depression years. In this regard, the Obama presidency will be the first administration since the Eisenhower administration to raise taxes during a recession.
In fact, President Obama has one of the most ambitious taxincrease agendas of any president. He proposes new taxes on health plans; surcharges on the wealthy, drug companies and device makers, foreign-source earnings, capital gains, personal income, estate, financial transactions, carried interest and energy — through a capand-trade regime.
Roosevelt created an alphabet soup of new regulatory bodies and unprecedented regulations to redress business and investment excess following the stock-market crash of 1929. The New Deal sought to remedy dis- parity of wealth by empowering labor unions and farmers and introducing new regulations to reform the banking, securities and utility industries.
Washington is similarly intent on massive enlargement of government bureaucracies, expansion of labor unions and regulation of health care, banking and finance as well as the utility and energy sectors.
New health care legislation that increases the role of government would undermine the role and choice provided by private insurance and diminish innovation from medical device makers and drug and biotech companies. A new Consumer Financial Protection Agency would impose new regulation, costs and more litigation risk on a wide swath of retail businesses. Cap-and-trade legislation or regulation by proxy through the Environmental Protection Agency would dramatically increase energy prices and have broad-based ripple effects that would raise producer and consumer prices throughout the economy.
Although the shrinking of available credit to private business - the mother’s milk of recovery — has pushed the administration to ratchet up pressure on the banks to extend new loans, the anti-business legislative agenda of the White House is at the heart of this contraction of credit.
In the past 15 months, the federal budget deficit soared to $1.42 trillion, all of which is financed with U.S. Treasury debt. Successive years of additional red ink will likewise require issuing more government debt at a time when our largest creditors — notably China and the members of the Organization of the Petroleum Exporting Countries — have balked at increasing their U.S. dollar holdings. The most likely investors to fill the gap in buying this debt will be domestic banks, which will crowd out lending to businesses that need capital for expansion and job creation.
If tempting fate by repeating mistaken policies that led to the Depression is too hard to grasp, what may prove to be the tipping point is pushback on raising the federal debt ceiling to $14 trillion, a 40 percent increase since government debt broke through $10 trillion when TARP was rolled out 15 short months ago. A fitting New Year’s resolution for 2010 would be to end the madness and vote against anyone who favors continuing down failed paths and cannot commit to debt reduction.
Scott S. Powell is managing director of AlphaQuest LLC and a visiting fellow at Stanford University’s Hoover Institution. Ron Laurent is the managing partner and chief investment strategist of Veritas Partners LLC.