Saturday, October 8, 2011

How Obama Misjudged the Great Recession

Ezra Klein has a post in his blog at The Washington Post detailing how Obama's administration got the size of the 2008 recession/depression wrong:
By that point, the shape of the crisis was clear: The housing bubble had burst, and it was taking the banks that held the loans, and the households that did the borrowing, down with it. Romer estimated that the damage would be about $2 trillion over the next two years and recommended a $1.2 trillion stimulus plan. The political team balked at that price tag, but with the support of Larry Summers, the former Treasury secretary who would soon lead the National Economic Council, she persuaded the administration to support an $800 billion plan.

The next challenge was to persuade Congress. There had never been a stimulus that big, and there hadn’t been many financial crises this severe. So how to estimate precisely what a dollar of infrastructure spending or small-business relief would do when let loose into the economy under these unusual conditions? Romer was asked to calculate how many jobs a stimulus might create. Jared Bernstein, a labor economist who would be working out of Vice President Biden’s office, was assigned to join the effort.

Romer and Bernstein gathered data from the Federal Reserve, from Mark Zandi at Moody’s, from anywhere they could think of. The incoming administration loved their report and wanted to release it publicly. Romer took it home over Christmas to double-check, rewrite and pick over. At 6 a.m. Jan. 10, just days before Obama would be sworn in as president, his transition team lifted the embargo on “The Job Impact of the American Recovery and Reinvestment Act.” It was a smash hit.

“It will be a joy to argue policy with an administration that provides comprehensible, honest reports,” enthused columnist Paul Krugman in the New York Times.

There was only one problem: It was wrong.

The issue is the graph on Page 1. It shows two blue lines sloping gently upward and then drifting back down. The darker line — “With recovery plan” — forecasts unemployment peaking at 8 percent in 2009 and falling back below 7 percent in late 2010.

Three years later, with the economy still in tatters, that line has formed the core of the case against the Obama administration’s economic policies. That line lets Republicans talk about “the failed stimulus.” That line that has discredited the White House’s economic policy.

But the other line — “Without recovery plan” — is more instructive. It shows unemployment peaking at 9 percent in 2010 and falling below 7 percent by the end of this year. That’s the line the administration used to scare Congress into passing the single largest economic recovery package in American history. That line is the nightmare scenario.

And yet this is the cold, hard fact of the past three years: The reality has been worse than the administration’s nightmare scenario. Even with the stimulus, unemployment shot past 10 percent in 2009. (See the updated graph here.)

Click to Enlarge

To understand how the administration got it so wrong, we need to look at the data it was looking at.

The Bureau of Economic Analysis, the agency charged with measuring the size and growth of the U.S. economy, initially projected that the economy shrank at an annual rate of 3.8 percent in the last quarter of 2008. Months later, the bureau almost doubled that estimate, saying the number was 6.2 percent. Then it was revised to 6.3 percent. But it wasn’t until this year that the actual number was revealed: 8.9 percent. That makes it one of the worst quarters in American history. Bernstein and Romer knew in 2008 that the economy had sustained a tough blow; they didn’t know that it had been run over by a truck.
Go read the whole post.

Ezra Klein goes on to paint a determined effort by the Obama administration to get on top of this "bigger than expected" recession. But I just don't buy Klein's story. I've read Ron Suskind's Confidence Men. That paints a picture of confusion and temerity on the part of Obama, a slowness to react. This agrees with what I saw. From March 2009 until early 2011 Obama kept putting on the front that his stimulus had been "just right". But as the above shows, even when the stimulus was passed in March 2009 it was obvious that it was going to be far too small! Rather than react and go bigger, Obama remained passive and pretended he had done "just enough". This created the political poison of today where the Republican poke at him saying his "stimulus didn't work".

Here's what Obama never faced up to:
The stimulus was a bet that we could get out of this recession through the one path everyone can agree on: growth. The bet was pretty much all-in, and it failed. Reinhart and Rogoff are not particularly surprised. It’s hard to get through a debt-driven crisis without doing anything about, well, debt.

In our crisis, the “debt” in question is housing debt. Home prices have fallen almost 33 percent since the beginning of the crisis. All together, the nation’s housing stock is worth $8 trillion less than it was in 2006. And we’re not done. Morgan Stanley estimates there are more than 2.2 million homes sitting vacant, and 7.5 million more facing foreclosure. It is housing debt that has weakened the banks, and mortgage debt that is keeping consumers from spending.


The Obama administration, perhaps cognizant of the politics, was not nearly so bold. It focused on stimulus rather than housing debt. The idea was that if people could keep their jobs and pay their bills, they could pay their mortgages. But today, few on the Obama team will mount much of a defense of its housing policy.

Its efforts to heal the troubled market at the core of the financial crisis are widely considered weak and ineffective. The Home Affordable Modification Program, which proposed to pay mortgage servicers to renegotiate with financially stressed homeowners, couldn’t persuade the servicers to play ball and so has left most of its $75 billion unspent. The Home Affordable Refinance Program was projected to help 5 million underwater homeowners. It has reached fewer than 1 million.

Even so, the administration rejects the more radical solutions that are occasionally floated. The problem, it says, is that the choices are mostly between timid and unworkable.
What Klein doesn't face up to is the fact that Obama came in "green" and simply doesn't have good "management skills" and failed to understand the economics of the situation. He mismanaged the problem. He failed as a leader. FDR would admit his mistakes and try and try until he got something right. Obama dithered, acted late, and then failed to accept that his attempt had fizzled and instead stonewalled any attempt to recognize the failure and try something else. That is pathetic in a leader.

I criticize Obama for getting stuck in the ditch instead of rescuing the economy. The Republicans would have (and if elected will) drive the economy over a cliff and destroy it. So America has no future worth getting excited about. The 2012 election will be between an ineffective leader and an absolutely incompetent leader. Hopefully Americans choose ineffective and not the "nuclear option" of an incompetent Republican leader.

Update 2011oct09: I've posted some reaction by Paul Krugman and Dean Baker here.

The following is a bit from a blog post by Steve Randy Waldman in his Interfluidity blog:
Ezra Klein is a wonderful writer, but I don’t love his retrospective on the financial crisis. (Kevin Drum and Brad DeLong do.) The account is far too sympathetic. The Obama administration’s response to the crisis was visibly poor in real time. Klein shrugs off the error as though it were inevitable, predestined. It was not. The administration screwed up, and they screwed up in a deeply toxic way. They defined “politically possible” to mean acceptable to powerful incumbents, and then restricted their policy advocacy to the realm of that possible. The administration could have chosen to fight for policies that would have been effective and fair rather than placate groups whose interests were opposed to good policy. They might not have succeeded, but even so, as Mike Koncazal puts it, they would have lost well. We would be better off with good policy options untried but still on the table than where we are now, with policy itself — monetary, fiscal, whatever — discredited as both ineffective and faintly corrupt.

There is a lot in Klein’s piece that I could react to, but I want to highlight one point that is particularly misguided:
But when talking about what might have worked on a massive, economy-wide scale — that is to say, what might have made this time different — you’re talking about something more drastic. You’re talking about getting rid of the debt. To do that, somebody has to pay it, or somebody has to take the loss on it.

The most politically appealing plans are the ones that force the banks to eat the debt, or at least appear to do so. “Cramdown,” in which judges simply reduce the principal owed by underwater homeowners, works this way. But any plan that leads to massive debt forgiveness would blow a massive hole in the banks. The worry would move from “What do we do about all this housing debt?” to “What do we do about all these failing banks?” And we know what we do about failing banks amid a recession: We bail them out to keep the credit markets from freezing up. There was no appetite for a second Lehman Brothers in late 2009.

Which means that the ultimate question was how much housing debt the American taxpayer was willing to shoulder. Whether that debt came in the form of nationalizing the banks and taking the bad assets off their books — a policy the administration estimated could cost taxpayers a trillion dollars — or simply paying off the debt directly was more of a political question than an economic one. And it wasn’t a political question anyone really knew how to answer.

On first blush, there are few groups more sympathetic than underwater homeowners or foreclosed families. They remain so until about two seconds after their neighbors are asked to pay their mortgages. Recall that Rick Santelli’s famous CNBC rant wasn’t about big government or high taxes or creeping socialism. It was about a modest program the White House was proposing to help certain homeowners restructure their mortgages. It had Santelli screaming bloody murder… If you believe Santelli’s rant kicked off the tea party, then that’s what the tea party was originally about: forgiving housing debt.
This all sounds very hard-nosed. There were debts. There were economic losses, such that the debts could not be serviced at initially agreed terms. The consequences of leaving those unserviceable debts in place — frozen household spending, bankruptcy courts and litigation, blown up banks — were intolerable. Therefore, the losses were going to have to be socialized, borne by taxpayers, one way or another. Ultimately, in this view, it is all a matter of dollars and cents. The taxpayer is going to eat the loss, so what’s the best sugar to make the medicine go down?

But human affairs are not about dollars and cents. Santelli’s rant and the tea party it kind-of inspired were not borne of a financial calculation — “Oh my God! My tax bill is going to be $600 higher if we refinance underwater mortgages!” Santelli’s rant, quite legitimately, reflected a fairness concern. The core political issue has never been the quantity of debt the government would incur to mitigate the crisis. It was and remains the fairness of the transfers all that debt would finance. A fact of human affairs that proved unfortunately consequential during the crisis is that people perceive injustice more powerfully on a personal scale than at an institutional level. Bailing out the dude next door who cashed out home equity to build a Jacuzzi is a crime. Bailing out the “financial system” is just a statistic. So the anger Santelli channeled led to economically stupid bail-outs of intermediaries rather than end-debtors.

Once you understand that the problem is a fairness issue rather than a dollars-and-cents issue, the policy space grows wider. Holding constant the level of expenditure, one can make bail-outs more or less fair by the degree to which you demand sacrifice from the people you are bailing out. TARP was deeply stupid not because it meant socializing risks and costs created by bankers. TARP was terrible public policy because it socialized risks and costs while demanding almost no sacrifice at all from the people most responsible for those risks. The alternative to TARP was never “let the banks fail, and see how the bankruptcy system deals with it.” The alternative would have been to inject public capital (socialize risks and costs!) while also haircutting creditors, writing-off equityholders, firing management, and aggressively investigating past behavior. It was not the money that made TARP unpopular. It was the unfairness. And the unfairness was not at all necessary to resolve the financial problem.

If the Obama administration, or any administration, decided to encourage principal writedowns by having the government simply cover half the loss, that would be unfair. The Rick Santellis of the world might object more than I would, but that would be to my discredit more than theirs. Fairness should never be a policy afterthought. Widely adhered norms of fair play are among the most valuable public goods a society can hold. A large part of why the financial crisis has been so corrosive is that people understand that major financial institutions violated these norms and got away with it, which leaves all of us uncertain about what our own standards of behavior should be and what we can reasonably expect from others. When policy wonks, however well meaning, treat fairness as a public relations matter, they are corroding social infrastructure that is more important than the particular problems they mean to fix.

The good news is that there are lots of ways to craft good economic policy without doing violence to widely shared norms of fairness. See, for example, Ashwin Parameswaran’s “simple policy program“. On a less grand-scale, you’ll find that very few fairness concerns arise if underwater borrowers enjoy principal writedowns in the context of bankruptcy. Such “cramdowns” are consistent with a widely shared social norm, that society will grant (and creditors must fund) some relief from past poor choices to individuals who go through a costly and somewhat shameful legal process. Including mortgages and student loans in that uncontroversial bargain will piss-off bankers who wish to avoid responsibility for bad credit decisions. But it won’t provoke a revolution in Peoria.

The Obama administration campaigned on “cramdowns”, but ultimately decided not to push them. I wonder why? Perhaps Ezra Klein will explain how research by Reinhart and Rogoff shows that this too was inevitable.
Go read the original Waldman post to get the embedded links.

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