Stimulus Is For Suckers

President Barack Obama (how sweet those words) has already transformed American politics. The GOP is in crack-up. Obama's coattails
in Congress give him leverage, and his vast public support gives him
power. There is an economic crisis and a demand for action to deal with
it. More than at any time since Ronald Reagan in 1981, what the
president wants, he will get.

So, what should he ask for? How big and far reaching should
changes to the economy be? Nearly everyone in Obama's circle agrees
that more public spending and tax cuts are needed: a "stimulus package." The cautious say $150 billion (about 1 percent of gdp), while the bold and the worried say $500 billion (or just more than 3 percent of gdp). Both focus attention on what is needed in 2009-as if the economic problem can be solved in a year.

That is almost certainly wrong.

When the free fall began, Treasury Secretary Henry Paulson and Fed
Chair Ben Bernanke argued that the problem with the economy was frozen
credit. Banks were unable to lend, they said, because they could not
get the funds. This was not true, as we discovered when Treasury gave
the banks the funds, only to realize that banks had no wish to lend
them out. Instead they used the money to build capital and on dividends
and executive pay. (Goldman Sachs,
which received $10 billion as part of the bailout, got good press when
it announced its top seven execs would forgo their year-end bonuses.
But a government ban on bonuses was likely coming, and by limiting the
sacrifice to top managers, the company retains leeway to spend the
estimated $6.9 billion set aside for bonuses on slightly lesser
employees.)

In any case, banks did not wish to lend, and ordinary Americans,
desperately cutting costs, did not wish to borrow, and with their homes
underwater many had little collateral to borrow against.

What began as a housing collapse will not go away soon. Empty houses
wreck home values for their neighbors. The ratings agencies are
discredited, the investment banks are gone, and high finance is in debt
deflation. Foreign investors won't soon trust the market for US private
debt, even for blue chip corporations, so long as they remain saddled
with toxic health care costs. Regulation will have to be rebuilt. In
short, the money wells have been poisoned, and it will take time and
patient effort to clean them up.

The historical role of a stimulus is to kick things off, to grease
the wheels of credit, to get things "moving again." But the effect ends
when the stimulus does, when the sugar shock wears off. Compulsive
budget balancers who prescribe a "targeted and temporary" policy
followed by long-term cuts to entitlements don't understand the
patient. This is a chronic illness. Swift action is definitely needed.
But we also need recovery policies that will continue for years.

First, we must fix housing. We need, as in the 1930s, a Home Owners'
Loan Corporation to restructure failed mortgages on sustainable terms.
The basic objective should be to keep people in their homes by all
necessary means, except where borrowers committed willful fraud, so as
to stop the spread of blight and decay. Government can use its power
over banks to make this happen, as it has with IndyMac, the California
bank that is now, as a federally owned company, revising unsustainable
mortgages. But this is no small endeavor: The fdr-era holc operated for almost two decades and at its peak employed 20,000 people.

Second, we must backstop state and local governments with federal
funds. Otherwise falling property (and other) tax revenues will implode
their budgets, forcing destructive cuts in public services and layoffs
for teachers, firefighters, and police. And when these public servants
are laid off, guess what? They have trouble paying their mortgages.
General revenue sharing-unrestricted federal grants to states and
towns, a program invented by Richard Nixon and killed by Ronald
Reagan-is required. Luckily it can be reintroduced quickly on a large
scale.

Third, we should support the incomes of the elderly, whose nest eggs
have been hit hard by the stock market collapse. We can't erase those
losses case by case (nor should we), but we can sustain the purchasing
power of the group. The best way is to increase Social Security
benefits. Useful steps would include boosting the formula for widowed
spouses, ensuring a minimum benefit for retirees who worked their whole
lives in low-wage jobs, and allowing college students to receive
survivors' benefits up until the age of 22. But let's go further and
raise benefits across the board, which has not been done for a
generation. I'd say raise them 30 percent, and let the federal
government make the contributions for five years. This would be good
for the elderly, who could retire; good for working-age people, who
would replace the retiring; and good for the economy, since people who
need money spend it when they get it.

Fourth, we should cut taxes on working Americans. Obama proposes to
effectively offset the first $500 of Social Security taxes with a
refundable credit. It's a good idea, but can be expanded. If the
economy continues to spiral downward and a really large fiscal boost is
needed, let's declare a payroll tax holiday, funding Social Security
and Medicare
directly from the treasury, until the economy gets back on track.
Workers would get an immediate 8.3 percent raise to help meet their
mortgages; employers would have the same amount to spend on wages, job
creation, or investment. (Not all efforts to jump-start the economy
deliver so much bang for the buck. See chart below.)

Is this the standard "liberal line"-borrow and spend? No. It is the
situation, not the philosophy, that demands this action both grand and
sustained. Economic recovery in an existential crisis like this means
actually building a new economy. For that, we need
investment-to restore our roads, rails, transit, broadband, and water
systems, to build parks and museums and libraries, to protect the
environment. Right now, states and localities can't borrow for these
things. Creating a National Infrastructure Fund, using Uncle Sam's
borrowing power to put money where it's needed, is one way forward.
Federal capital spending should be bond financed and exempt from budget
rules, especially pay-as-you-go. It makes no sense to finance projects
whose benefits will last for 50 years solely from tax revenues of today.

Finally, we must change how we produce energy, how we consume it,
and above all how much greenhouse gas we emit. That's a long-term
proposition that will require research and reconstruction on a grand
scale: support for universities, for national labs, for federal and
state planning agencies, a new Department of Energy and Climate. It's
the project around which the economy of the next generation must be
designed. It's the key to future employment and future growth-and to
our physical survival.

Energy transformation is key for another reason. Even during this
crisis, the world has supported the dollar. Why? Because no alternative
safe haven exists. Despite our faults, we have a well-designed economic
system, the enduring fruit of the New Deal and Great Society. Thus
Uncle Sam can borrow, at very low cost, whatever he needs-a terrific
advantage over the competition. But in the long run, the world will
support us only if we give something back. Ushering in new technologies
that the rest of the world can adopt in order to save the planet is the
right sort of gift. By helping to save the physical world, we may be
able to save our currency, our credit, and our economy as well.

BANG FOR THE BUCK

What a dollar of stimulus puts back into the economy when spent on...