With Republicans poised to sweep into office and obstruct Obama's agenda, is there anything he can do to revive the economy over the next two years? Last week I wrote about the possibility that we’re in a Japan-style recession—a rare form of economic disease that’s largely unresponsive to conventional remedies, like lower interest rates. This type of malady—the fashionable term is “balance-sheet recession”—tends to follow a collapse in the price of housing or stocks, at which point people become so preoccupied with paying down debt that they refuse to borrow even on super-attractive terms. Consumer spending plummets, dragging the economy down with it, until the debt-repayment cycle runs its course. Devastatingly, that process took more than a decade in Japan, and the fear is that a similar fate might befall the United States.
The easiest way to confront this situation is, well, to pray that we’re not in a balance-sheet recession. Or, failing that, to hope that the disease is mild and most of the debt-repayment (economists call it deleveraging) is already behind us. As I explained last week, there’s some reason to think that’s the case. The model of consumer behavior favored by economists at the White House suggests the saving rate—the fraction of your paycheck you save—has risen about as high as it needs to in order to manage the debt from the recent bubble. From here on out, the thinking goes, consumer spending may not juice the economy the way it did in the 2000s. But it won’t weigh on it heavily either.
On the other hand, if we actually are in a Japan-style recession, the news is even grimmer than the economics would suggest. According to the economist Richard Koo, Japan only managed to keep its economy from shrinking into oblivion through massive government spending. But with Republicans almost certain to control the House of Representatives, a repeat of last year’s stimulus is highly unlikely. What then, is the Obama administration to do?
As it turns out, there are still a few viable options:
Shoot the hostage (i.e., kneecap your allies to finagle more government spending). It’s no secret that Democrats are keen to pass a major infrastructure package, which would have the dual benefit of supporting the economy in the short-term while making us more productive over the long-term. Pretty much everyone who studies these things agrees that our infrastructure is either badly outdated, in a state of disrepair, or both. (The American Society of Civil Engineers estimates that the country could use about $2.2 trillion worth of upgrades and repairs over the next five years.) But, of course, Democrats had zero luck passing a major infrastructure package after the initial stimulus in early 2009. It’s hard to believe they’re going to fare much better with a House Republican majority that’s constantly looking over its shoulder at pitchfork-wielding Tea Party activists. Particularly since several of these activists are on the verge of coming to Congress themselves.
Still, a deal on infrastructure spending may not be entirely out of reach, at least if the White House is ruthless enough. One idea along these lines comes care of David Shulman, a senior economist at UCLA’s Anderson Forecast center. Shulman proposes a several-hundred-billion dollar infrastructure package in which the administration agrees to suspend Davis-Bacon, the law requiring contractors for government-funded construction projects to pay locally prevailing wages, as deemed by the Labor Department. Conservatives complain that the law artificially inflates costs and is a sop to labor. (I have somewhat mixed feelings toward the law but am more sympathetic.)
Shulman would also have the administration fast-track environmental approval of construction projects—under current law, it can take months to assemble the various environmental-impact statements and reports, and there can be costly litigation along the way. Shulman recommends that the White House oversee an accelerated environmental review process and set up some provision for expediting judicial review. (The American Prospect’s Harold Meyerson hinted at some similar ideas back in May.)
Unions and environmentalists would howl, of course—in many cases for good reason. But that’s partly the point. (In fact, the louder the better.) If a spending package has the right opponents, then the conservative media-industrial complex may come around, bringing the GOP leadership along with it.
Strike a grand-bargain with Republicans on tax cuts. The administration tried to limit the portion of last year’s $800 billion stimulus that got allocated to tax cuts, the thinking being that tax cuts are less efficient as stimulus than government spending. This is true in normal times: People tend to save a large fraction of their tax cuts, while government spending works its way into the economy’s bloodstream more directly, at least if well-executed. But this tax cut/spending debate is largely beside the point during a balance-sheet recession. In that case, people refuse to spend until they’ve paid down debt. If you give them a tax cut that they end up mostly saving, you’ve still accelerated the debt payback and moved up the date when they’re willing to spend again.
The real problem with tax cuts is that the ones Republicans favor skew heavily toward the wealthy, whereas its lower- and middle-income people who are groaning underneath piles of debt. In order to get a tax-cut deal, the administration may have to lavish more goodies on the wealthy than would be ideal. But, given the alternative—again, think lost decade—that may be a reasonable price to pay.
One obvious basis for discussion here would be a proposal by Larry Lindsey, George W. Bush’s first White House economic adviser. Lindsey has spent the last 20 months urging a two-year halving of the payroll tax for both workers and businesses. This would save each of them about $1,200 on average, and cost about as much overall as the Obama stimulus. The benefit to workers is that it provides a nice chunk of cash for repaying debt. The benefit to employers is that it makes it cheaper to hire new workers—something that can’t hurt at a time of near double-digit unemployment.
In fact, the White House itself considered a business payroll-tax cut late this summer, but administration officials have told me they discarded it because they didn’t think it would be the most efficient use of government money. (The administration believes businesses have plenty of money to hire new workers if only they were motivated to do so.) But as part of a deal to get money to existing employees, cutting payrolls taxes for companies seems like a reasonable (and not morally offensive) price to pay.
Launch a massive, unilateral homeowner bailout. Keep in mind the reason spending plummets and saving rises during a balance-sheet recession: The weight of that huge helping of debt taken on during the boom years. To deal with this, the government can embark on a spending spree of its own (option 1) or hand consumers more money to spend and save (option 2). But maybe the most efficient solution gets right to the source of the problem—the debt itself. If there were a way to hack away big chunks of personal debt, Americans wouldn’t be obsessed with paying it off and could start spending again straight away.
By far the biggest source of household debt is, of course, houses. Mortgages represent about three-quarters of the total, according to the most recent numbers from the New York Fed—or about $9 trillion out of $12 trillion. If the government were able to slice $1 trillion off of this sum, it could dramatically accelerate the timeline for consumers to resume their spending. Keep in mind, after all, that household debt has only fallen $800 billion since the height of the crisis two years ago.
Better yet, there are actually two effects here—not just lowering the borrower’s overall debt, but also lowering his or her monthly payments. Suppose you owe $100,000 on a 30-year mortgage with a 5 percent interest rate. If the government winnowed your balance to $75,000, your monthly payments would fall from $537 to $403 per month, leaving you more than $1,500 extra to spend or save as you please each year. So the debt-reduction also works as conventional stimulus.
Now it’s true that congressional Republicans would never go for this. (You can imagine the White House pitch to GOP leaders: We hear what you’re saying about another $100 billion in spending. How bout $1 trillion for mortgage-debt relief?) The good news is that the administration could do it without congressional approval. Fannie Mae and Freddie Mac basically have an unlimited credit line with the U.S. Treasury, and the government has controlled Fannie and Freddie since it seized them in 2008. The mechanics would be hairy: How do you decide which mortgages to write-down? Do you only write-down mortgages Fannie and Freddie already own, or do you have Fannie and Freddie go out and buy new ones? If it’s the latter, do Fannie and Freddie eat the whole cost themselves, or do they split the losses with banks? Etc., etc. But the bottom line is that it can be done.
The far bigger obstacle is the politics. Suffice it to say, if you thought the bank bailout and the stimulus went down badly, then watch how the Tea Partiers react if the government spends a $1 trillion without so much as asking Congress. This is obviously why the administration quickly shot down rumors of a homeowner bailout when they cropped up this summer. And it’s probably why it will never happen. But before you sneer, ask yourself the following: Will Barack Obama be in better shape two years from now with the economy humming along and an apoplectic Tea Party movement, or with 9 percent unemployment and a slightly less apoplectic Tea Party movement?
I’m not saying I’d do this tomorrow—I’d wait another six months to see if we really are in a Japan-style recession. But, once you do the basic math, it doesn’t seem so crazy after all.
Noam Scheiber is a senior editor for The New Republic and a Schwartz Fellow at The New America Foundation.