Flaws in Obama's Economic Stimulus and Banking System Rescue Plan

By: Money_Morning

Martin Hutchinson writes: U.S. President Barack Obama's speech to the joint session of Congress late Tuesday was a beautiful performance. His language was exquisite, his delivery was superb, his rhetoric - at times - truly uplifting. It no doubt reflects a fault in my makeup that I found it not entirely convincing - but then I'm a math major and a former banker.

The speech - which took the place of the State of the Union address since it's Obama's first year in office - concentrated almost entirely on economics , and in particular on the financial and economic crisis currently facing the United States. President Obama's comments were least convincing when they focused on the financial aspects of the crisis.

That's probably why he “ won overwhelming … approval ” on Main Street even as he failed to “wow” Wall Street , such news agencies as the Voice of America and ABC News reported.

But according to my own analysis, President Obama made three notable missteps, including an error in strategy and goal setting serious enough to nudge the U.S. economy back into a recession, should his stimulus plan and banking-rescue program create a near-term economic recovery. Let's look at all three of the miscues I've identified.

Mistake No. 1

President Obama's first mistake was one of assessment - in that he blamed the entire current situation on Wall Street . That's attractive, populist rhetoric, but where was the acknowledgement of the U.S. Federal Reserve's role in the debacle, inflating the money supply 70% faster than gross domestic product (GDP) for more than 13 years, so that asset bubble after asset bubble caused the incentive structures on Wall Street to go haywire?

Where, too, was the (admittedly subsidiary, maybe No. 3 after the feckless Fed and the greedy bankers) role that Congress played over decades, messing up the housing market by creating unregulated irresponsible government guarantee monopolies in Fannie Mae ( FNM ) and Freddie Mac ( FRE ), an extra excrescence that no other advanced economy has found necessary to finance housing?

Bashing bankers is good rollicking stuff for a campaign speech, but it is less appropriate here, when the problems must actually be fixed. This rhetoric actually obscures the reality of the current problem, and diverts attention from the still-dangerous presence of U.S. Federal Reserve Chairman Ben S. Bernanke, whose role in creating the disaster is in danger of being exceeded by his role in perpetuating it. If Bernanke's current rapid expansion of the money supply leads to violent inflation, as is likely, the crisis will indeed be prolonged for a decade, as Obama claimed was possible without government action.

Mistake No. 2

President Obama's second inaccuracy - or misstep - on the financial side in last night's speech was in diagnosis . Lending in the U.S. economy has not seized up. It did seize up for about two months after the September crisis, but even by the end of the year loan growth had resumed, as figures from the major banks show. The commercial paper market has reopened and the investment-quality bond market has run at high volumes since the beginning of January.

Only one major source of “easy money” in past lending markets has disappeared - the securitization business: Almost nobody will now invest in securitization structures, and with good reason. However, as my investigative analysis of the nation's Top 12 banks last week demonstrated , most of the major U.S. banks are in better shape than we believe, and are actually making money.

Their profitability has been greatly increased by the disappearance of competition from securitization - loan margins at the healthy US Bancorp ( USB ), for example, increased from 3.7% to 3.9% in the fourth quarter of 2008, and will have increased still further now.

Other than a few huge “zombies,” most banks are now making good money the old-fashioned way, through the interest margin between borrowing and lending rates. They will continue to do so, provided the government doesn't (as President Obama and U.S. Treasury Secretary Timothy F. Geithner are currently readying to) introduce artificial competition, by inventing new taxpayer-funded vehicles to make consumer loans and drive margins down.

Yes, loans need to remain available for houses, automobiles and other purchases, but there's no reason why they should not be somewhat more expensive - to rebalance the U.S. economy, the U.S. consumer needs to save more, not borrow more.

Mistake No. 3

Given that his first mistake was in assessment, and the second was in diagnosis, it's no surprise that his third mistake was in goal-setting: One of the central objectives he established in his speech was a promise to pursue multiple objectives - even as he slashed the deficit in a big way .

In fact, as well as appearing to be a bit shaky in his knowledge of banking, President Obama made me question both his math, and his choice of economic objectives.

Reducing the budget deficit from 10% of GDP, its level in 2009, to $500 billion, or about 3% of GDP by 2013, is a hell of a task.
And quite possibly a hell of a risk, too.

That 7% swing in the budget balance is almost double the largest four-year swing ever achieved since the end of World War II - the 3.8% swing achieved from 1996-2000. Even during the 1990s economic cycle as a whole - a period of exceptional economic good fortune and budget thriftiness - the swing in the eight years from 1992 to 2000 was only 7.1% of GDP.

The problem with trying to tighten fiscal policy so rapidly is the negative “stimulus” effect it would cause. If the U.S. economy does anything in mid-2010 but zoom like a Saturn V rocket roaring off the launch pad, sucking 7% of GDP out of government demand over so short a period is likely to abort the recovery and push the economy back into a depression. Furthermore, Obama intends to do this without raising the taxes by one penny on anybody earning less than $250,000, and while increasing the size of the armed forces, their pensions, and spending more on energy, healthcare and education.

Maybe I'm a grouchy old skeptic, but it doesn't look to me as if the math adds up.

Look, President Obama is a wonderful speaker, he really is, and he gave quite a performance in his address to Congress Tuesday night. As a gnarled old Republican, I'm prepared to admit he's as good as late President Ronald W. Reagan , I may even nurse a faint suspicion that he's better than Ronald Reagan.

And don't forget: Reagan was known as “The Great Communicator.”

But to be a great president, Barack Obama will need to pursue policies that are sufficiently middle of the road so as not to destroy the superb private sector that's the backbone of the U.S. economy, and that are also cleverly designed to work properly. It's the math, the economics and the finance, not the language, the arts and the humanities, where there are still doubts. 

[ Editor's Note : When it comes to either banking or the international financial markets, there's no one better to hear it from than Money Morning Contributing Editor Martin Hutchinson , for he brings to the table the kind of high-level expertise that our readers have come to expect. In February 2000, for instance, when he was working as an advisor to the Republic of Macedonia, Hutchinson figured out how to restore the life savings of 800,000 Macedonians who had been stripped of nearly $1 billion by the breakup of Yugoslavia and the Kosovo War.

It was Hutchinson who penned most of Money Morning 's "Election 2008" presidential election coverage. At the very start of the presidential campaign, Hutchinson personally interviewed the economic advisors for candidates John McCain, Barack Obama and John Edwards, and very early on concluded that out of the entire field of presidential hopefuls, Obama and McCain would offer the best profit opportunities for investors - and correctly predicted they would be the two finalists.

Just last week, Hutchinson published an analysis on the "Top 12 U.S. banks" report . If you missed story, which enjoyed a big response when it was published last Wednesday, please click here to access it and check it out. The report is free of charge. The follow-up story on that story was his analysis of Fifth Third Bancorp ( FITB ). The report on Fifth Third appeared last Friday . Both reports may be well worth your time to read. ]

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