Obama's Bailout

It may also reflect the character of Obama's economic team, which is smart but perhaps too conventionally minded. I had no problem when Obama chose familiar faces like Larry Summers and Tim Geithner to be in charge: The urgency of the crisis means that there's no time for a learning curve, so you have to appoint people who know where the bodies are buried (but preferably people who weren't personally responsible for any of the burials). But perhaps the very familiarity of the economic team with Wall Street is making it reluctant to lower the boom on bankers, even when they deserve it.

This could all change quickly. One part of Geithner's plan that seems comprehensible is his call for a "stress test" on major banks: Government auditors would study their books to determine whether they are viable. This could be turned into a Claude Rains moment, in which the Obama administration declares itself shocked — shocked! — to find that several giant banks are insolvent, leaving no choice except temporary government receivership.

But so far, at least, Obama is trying to finesse the crisis; he's looking for solutions that are less radical than temporary nationalization. On February 23rd, the administration floated a complex plan to convert some of the $45 billion in preferred shares it currently holds in Citigroup into common shares, while avoiding taking a controlling interest. Nobody outside the administration seems to think this would make much difference — it sounds as if Geithner is rearranging the deck chairs on the Titanic, while hoping the iceberg melts.

The truth is that there aren't any non–radical solutions to the banking crisis. The only way to resolve the crisis without nationalization would be a huge giveaway of taxpayer money, and that's impossible both fiscally and politically.

So the result of the Obama administration's caution is that the banking crisis remains unresolved. As long as government aid is perceived as a handout to bankers (because it is), that aid will be deeply unpopular. The result will be a banking system that, while being kept by government aid from outright collapse, has too little capital to provide the economy with the credit it needs. That's what people mean when they talk about "zombie banks" — they're still walking around, but they're too crippled to fulfill their proper role. And we know from Japan's experience in the "lost decade" of the 1990s that zombie banks can stifle economic recovery, even if the government spends heavily on fiscal stimulus.

LOOKING AHEAD

So far, at least, the administration's recovery plans seem to be based on the belief that the economy will somehow heal itself within five years. The official projections for the stimulus bill assume that even without it, the unemployment rate, after peaking at nine percent next year, would begin a steady decline back to five percent by 2014. Because the effects of the stimulus plan will fade out over time, this long–term return to normal levels of unemployment depends on unspecified natural forces of recovery.

In reality, however, it's hard to see where that recovery is supposed to come from.

The closest parallel in modern times to our current crisis is Japan's "lost decade." As the name suggests, this slump went on for much longer than the slump assumed in the administration's projections. And when Japan finally did recover, the revival was led by booming exports to China. With the whole world now caught up in economic crisis, the United States can't count on that kind of economic rescue.

Our own Great Depression, of course, also lasted more than a decade and was brought to an end only by a gigantic war — not something we want to emulate. Now, it would be wrong to suggest that there are no forces that will lead to recovery, given enough time. The revival of private saving will, gradually, boost consumer wealth. Home construction is now running at its slowest rate in half a century, which will create a pent– up demand for new homes. Auto sales are so low that at current rates it would take 27 years to replace the existing fleet; as cars wear out, sales will surge. In the long run, the U.S. economy will indeed recover even without government support.

But as John Maynard Keynes famously declared, in the long run we are all dead.

Here's what I think will happen: At some point, probably later this year, the Obama administration will realize that what it has done is not enough. (The economic team is very smart and intellectually flexible; if they were on the outside, they would probably offer an analysis quite similar to the one you're reading now.) At that point, the administration will devise a more ambitious plan, one designed not just to provide a cushion against the slump, but to lead the way to full recovery. That will almost surely involve nationalizing several major banks on a temporary basis and pumping in a lot of cash to get them running effectively.

Can such a plan be passed, when the administration was barely able to scrape up enough Senate votes to get the original stimulus through? I think so, for three reasons. First, as the economy deteriorates, more Republicans may see the need to do something sensible. Second, Al Franken will eventually be seated, meaning Obama will only need to win over one Republican to avoid a filibuster. And third, the next phase of the stimulus won't necessarily need 60 votes: The administration can use the budget process to increase spending or reduce revenues by a simple majority — something Obama can easily obtain.

Whatever the legislative maneuvering required, much more must be done. Right now, there's a strong chance that the unemployment rate will go into double digits — which means 15 million or more Americans seeking jobs but unable to find them. Millions more could lose their homes, even with the new housing plan. And worst of all, this could last for a long time: At this point, America is following right in the tracks of Japan's "lost decade."

When it comes to fixing the economy, President Obama has only begun his work.

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