The Stimulus Plan We Need Now

Further legislation to deal with the economic crisis should not wait until the new president takes office. Fortunately, the president-elect will be a senator and can propose legislation without waiting to be sworn in as president. Immediately after Nov. 4, the winner could, and should, take the lead in the legislative process.

The economy faces two separate problems: the downward spiral of home prices, which hangs over the financial markets, and the decline in aggregate spending, which could cause a deep and prolonged recession.

Home prices have already fallen about 25 percent from their peak in 2006, and experts say they must fall an additional 10 to 15 percent to get back to pre-bubble levels. But they could fall much further than that as a result of mortgage defaults and foreclosures. Further declines from the current level would increase the number of homeowners whose mortgages exceed the value of their homes, creating a strong incentive to default. Defaults and the resulting foreclosures would put more homes on the market, driving down prices even more.

And this fear of a deep drop in home prices depresses the value of mortgage-backed securities, contributing to the difficulty that banks are having raising funds and to their reluctance to make loans.

Although home prices must get back to pre-bubble levels, Congress should enact policies to reduce defaults that could drive prices down much further. Direct help to the 12 million homeowners who already have negative equity in their homes could help to stop foreclosures. But it is important for Congress to go further and stop declining prices from pushing a large portion of the other 37 million homeowners with mortgages into negative equity, which could tempt them to default. The mortgage replacement loan plan that I suggested in June, essentially a congressionally enacted mortgage “firewall” to prevent prices from dropping too far, is one possible way to do that.

Falling home prices have already reduced homeowner wealth by about $3 trillion; the stock market decline has cut wealth by an additional $8 trillion. This reduced household wealth is causing consumers to cut spending, leading to lower employment, lower incomes and, therefore, further cuts in consumer spending.

Other components of aggregate demand are also falling. The decline in consumer spending will lead to less business investment in plants and equipment. And the recession in Europe and Japan will further reduce our net exports.

With the Fed‘s benchmark interest rate down to 1 percent, there is no scope for an easier monetary policy to stop the downward spiral in aggregate demand.

Another round of one-time tax rebates won’t do the job. The rebates that Congress enacted this spring failed to stimulate consumer spending: More than 80 percent of tax rebate dollars were saved or used to pay down existing debt.

The only way to prevent a deepening recession will be a temporary program of increased government spending. Previous attempts to use government spending to stimulate an economic recovery, particularly spending on infrastructure, have not been successful because of long legislative lags that delayed the spending until a recovery was well underway. But while past recessions lasted an average of only about 12 months, this downturn is likely to last much longer, providing the scope for successful countercyclical spending.

A fiscal package of $100 billion is not likely to be large enough to revive the economy. The fall in household wealth resulting from the collapse of the stock market and the decline of home prices may cut aggregate spending by $300 billion a year or more.

The president-elect should focus on developing a mechanism for identifying and funding spending initiatives that can occur quickly and that would otherwise not be done. While it would be good if some of the increased spending also contributed to long-term productivity, the key is to stimulate demand. Any plan to finance this spending by raising taxes, even if postponed, as Sen. Barack Obama has suggested, would hurt the recovery by causing affected taxpayers to cut their spending now.

The increased government spending should include not only money for infrastructure such as bridges and roads but also for a wide range of equipment. Rebuilding some of the military capacity that has been depleted by the wars in Iraq and Afghanistan could be done relatively quickly and should be part of the overall package.

Although the economy is facing severe challenges, the president-elect can turn the situation around by introducing legislation to deal with the downward spiral in home prices and with the declining level of aggregate demand. It is important that such legislation be enacted as quickly as possible.


Orginally published at The Washington Post and reproduced here with the author’s permission.

11 Responses to "The Stimulus Plan We Need Now"

  1. Guest   October 31, 2008 at 7:57 pm

    If the government covers half of mortgage companies’ losses incurred in rewriting mortgages, as is being discussed, that could easily cost $40 billion to $500 billion.That’s a tremendous price to pay to reward the reckless and, indirectly, penalize the prudent. The benefit is obvious. Bailing out millions of individual property owners saves them much disruption and, ideally, serves to stabilize the housing market.But consider the lesson it imparts. City by city, neighborhood by neighborhood, people who live beneath their means and manage money carefully will see more careless neighbors supported by federal decree. Those who are current on mortgage payments, but still squeezed, may be tempted to let two or three payments slide, so they can negotiate money-saving terms on their own mortgages.We are becoming a nation of people who feel it is not only okay but justified to cheat, lie, and swindle each other and the rest of the population. Personal responsibility is discouraged by the govenment. White collar crimes are rarely prosecuted because FBI is so stretched. Our nation is eating ourself from within just to keep a facade of prosperity. Hope is being replaced by anger and desperation. Welcome to the new dawn.

    • Michael Khor   November 1, 2008 at 6:59 am

      The whole episode of the bailouts from financial institutions, corporations to home speculators only breeds the culture of socialization of losses and irresponsibility among Americans. It is peculiar that economists and politicians have not encouraged frugality and induce Americans to save just for the sake of economic growth which will eventually result in higher personal and national debt. Has any politician and economist think of drafting legislation to reward the prudent Americans 3-5 years down the road after the economy recovers. In particular, prudent Americans should fight to socialize financial institution profits instead of just rewarding the corporate fat-cats who will be idolized again.

    • Anonymous   November 2, 2008 at 7:15 am

      Good points? One may ask “what is the value of producing the best and the brightest, if those same people use their superior intellect to defraud the rest of us?”

  2. Sandhu   October 31, 2008 at 10:29 pm

    Govt. should facilitate orderly devauation of housing assets transitioning market factors to take over instead of rewarding the crooked system and punishing and discouraging the very sincere minority who is responsible and takes seriously paying off their obligations.Giving easy funds to people who created this mess will again hurt our nation and its essence of decency and credibility ,previous commentator has already mentioned what will happen,if we continue to support the status quo and prevent market to work towards true affordability..thanks

    • Anonymous   November 2, 2008 at 7:18 am

      Agree! Should a society be ruled by a few dishonest men or by the majority of hardworking, law abiding citizens?

  3. Guest   October 31, 2008 at 10:35 pm

    America has not been prosperous in a long long time!Easy credit had created an illusion of prosperity.Saying slavery was abolished in America is foolish . Creditors have had a nation of slaves for ages.I’m sorry but there is no cure for your nations sickness. Manage it they may , but cure it neverI’m afraid the pleasure of consumption has become an addiction.

    • Anonymous   November 2, 2008 at 7:22 am

      Correct! The rules of the powerful including our Government have created a very strong economic slavery system which unfortunately, most Americans are unaware of! Yet, our young students are not made aware of this as they are being educated in our high schools and colleges!

  4. artichoke   November 2, 2008 at 5:02 am

    Too much easy credit makes it very painful not to go into debt. Prices zoom up to match the available credit, making people into “payment” buyers. Those who do not want to have so much debt can afford only very undesirable housing.I don’t know whose ox to gore here, certainly the bankers deserve a lot of blame but they are getting away with it, it seems. But in the future, we must remember that too-easy credit is a crime against the prudent.

    • Anonymous   November 2, 2008 at 7:29 am

      Good question! I wonder if it was you or me or the other 100 million hardworking Americans who have lobbyed Congress for minimal regulation of large corporations while assuring us that the free market will take care of itself! Now, it seems, they are on the welfare bailout line outside the Federal Reserve!

  5. Anonymous   November 2, 2008 at 7:51 am

    What’s the matter with our leaders? As foreclosures mounted and there were cries for immediate action, Reps and Dems were too busy promoting their own agendas and getting their candidate elected for President. Not until the financial titanic was already 50% underwater did they start to act in a panic. Now, the only answer seems to be “keep throwing money at the problem so we can buy out way out”. Yet, haven’t we been told ever since the Fed was established that individuals, towns, cities, states and yes the federal government can only function effectively by not spending mor than we consume; ie. budgets! Hasn’t this been the main and really only reason we have been trained to believe we cannot have better roads, schools, healthcare, education, social security, retirements, etc: because there just isn’t enough money! Yet, it seems, when it comes to WAR or saving the Super Rich and their institutions, suddenly, there is unlimited amounts of money! Where are all the cries from the economists, business as well as government leaders stating the obvious: we either have a free-market system that follows the economic principles of consumption that we have been brainwashed to bvelieve or we don’t. If we don’t, then why not kddp printing the money and give $1 million dollars to every working American with a guaranteed government interest rate of 10% per year, FDIC insured, and do away with all the large corporations and financial instutions which serve no other purpose but to constantly devise new ways to take our hard earned money?!

    • artichoke   November 2, 2008 at 10:40 am

      I assume you refer to some concept like spending more than one produces or earns. It does make a bit of sense, I like the concept myself. The flip side is no panacea either, look at China which is admittedly well positioned for this crisis but they have tough decisions to make too.The real problem is that we don’t control things. If normal nice people were in charge things would not get this far out of whack. Someone would say “hey CDOs are like insurance but where is your huge mass of capital to back up that insurance you’re writing” and that would be nipped in the bud. Well let me introduce you to the actual identity of that insurance in the real world. Look in a mirror.As “Bank” Bernanke said in a recent speech, he counts on the strength of the general US economy to pull the banks through this. Needless to say the “general economy” is given no choice in the matter.This is especially unfair because the “general economy” throws off tremendous surpluses even in the US where we have a lot of deadweight realtors and such. The average person probably has to work 1/2 hour per day to provide his sustenance (just a guess on my part), if we put at his disposal an average amount of the capital stock we have. Farming machines, factories, airplanes, washing machines, all our intellectual capital at the service of mankind. People could get by a thousand years ago, with none of it, so life should be a breeze now. But the system is designed so that we must work til we drop and barely get by. That surplus we are being denied is being accumulated somewhere, by somebody.