Welcome to Hooverville

Whatever the fate the of financial reform bill in Congress, it does little to fix the short term problems with the US economy. Last Friday the news of weak job production followed up stories of declining consumer confidence and weakening new homes sales. Couple these together with signs of increased mortgage foreclosure and all the signs of a double-dipped recession are becoming more clear and real.

So what are Obama and Congress doing about all this? Not much. Obama proposes an anemic jobs bill that Congress cannot pass, new action to extend unemployment insurance is stalled, and there is pressure among deficit hawks to cut government spending now, well in advance of the economy sustaining itself. It seems as if the lessons of John Maynard Keynes have been lost as many rush to join Hoovernomics. Soon I bet we will pass a new version of Smoot-Hartley and we will be completely back to Depression era economics.

It is bad enough that the individual states are hurting recession recovery by cutting spending in order to maintain balanced budgets. These moves, while they sound fiscally smart, actually counteracted the federal stimulus law adopted last year. Instead of creating new spending they merely forestalled state budget cuts which are now coming in force this year.

These cuts will undo or undercut whatever good the federal stimulus did. Now with pressure mounting on the federal government to tackle deficits first, any effort to stimulate the economy at the time it most needs a second bounce will also be damaged. The assumption seems to be worries about inflation and belief that cutting spending and taxes now will free up capital for the private sector to grow. This is still the same old pie in the sky supply-side economics hope and belief that has not worked in the past.

There have been too many roads not taken since 2008 to help the economy. First there was the $150 or so billions stimulus in the spring, 2008. That measure failed as it was too small and too diffuse. I argued then the $150 was a waste and measures should have been taken to directly help the residential mortgage market.

TARP helped banks but did little to address the underlying problems with the mortgage market that caused all the problems. We have yet to address mortgage speculation, subprimes, defaults, and falling or negative equity. Both the short term and long term health of the economy needs to stabilize this market. Several times I have argued that this is a core issue and there still seems to be no clue or effort to address this problem.

The weak housing market is paralleled by a weak jobs market. There is no question that a real job bill (not just milk toast tax breaks for businesses) are needed. My laundry list of legislation for both the mortgage and labor market includes:

• Immediate moratorium on residential foreclosures for one year
• Require banks to renegotiate loans
• Federal support to reduce principal on many residential mortgages
• Federal jobs bill that consists of direct hiring for public works projects (A WPA for 2010 that is not just roads and highways).

My overriding goal? Keep people in their homes and get them to work. These are both good individual goals and socially smart in that they benefit us all. They address personal problems and market failures. Both require serious government investments in the short run before we worry about the longer term problem of deficits and inflation which are still distant issues.

Alas, if we do not do this, as I suspect we will not, we will remain trapped in Hooverville and in the economics that exacerbated the first Depression and which is in danger of doing the same here.

The Timidity of Reform

But will it work? This is what someone asked me last Friday after Congress sealed the deal on the financial reform package for the banks. My simple answer is that there are some nice reforms here, but much like the health care law, the economic stimulus bill, and the other reforms of the Obama Administration, this too was short of real reform, demonstrating once again the timidity of this president and Congress in addressing real reform that matters.

Economically, there are multiple problems with the US and world economy. One way to slice it is to look at short and long term needs. Short term the problems in the economy are the high unemployment figures, the still depressed real estate market, and slow economic growth. Longer term the problems are many, including financial institution instability, energy consumption, and a looming debt crisis.

The bank and financial regulation bill agreed upon last week addresses some of the longer term problems, but not all of them, and does little for the short term. Long term the best potential features of the bill are the Volker Rule to limit bank speculation and the creation of the consumer credit protection agency. At present the agency looks weak but perhaps over time it can use its administrative rule making to actually do real work to help consumers.

Having said the good things, the bill falls short on real reforms. Real reform should have reinstated Glass-Steagall, imposed more requirements on banks holding capital to cover losses, extended more regulations to cover non-bank financial institutions, and made it illegal for institutions to do hedge funds that bet against their investors.

It might have also made sense to consider policies that make it illegal for FDIC entities to speculate on Wall Street, something similar to a Glass-Steagall requirement. Finally, limits on compensation packages for officers to depress financial incentives to speculate make sense. All of these ideas would help, as would be preventing banks from selling office mortgages that finance (so that they have to bear the risk of their loans). However, even with all these reforms, it is still not clear banks will serve the public interest. Remember, they are private for-profit entities that are not there to serve the public good. This is the purpose of government regulation.

Government regulation is meant to address market failures and correct externalities and moral hazards that the free market cannot address. Beginning in 1978 the USA has been on a deregulatory path, placing firm belief in the market over the government. The Reagan-Thatcher era is famous for this. Obama took office with the promise of change, and he has made some, but they have not signaled the full repudiation of the Reagan Era. Ronald Reagan is dead, but we do not see a real return to regulatory behavior anywhere near the like of the New Deal or close to the scope of what is needed for the economy.

The 2009 economic stimulus was too small and we are now paying the price with a sluggish economy on the verge of a second recession. We never addressed the core problem with the economy–the collapsed residential home market–and now it is slipping again and defaults continue. The health care bill ensures more but does little to address cost containment or quality. Consistently, Obama and Congress have gone less the distance to fixing the problems.