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Obama Needs A Big Play

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By DAVID M. SMICK

Special to The Washington Post

Published: January 18, 2009

Back in the early 1990s, when Fed Chairman Alan Greenspan was still considered "the Maestro," I asked him what he thought of the Reagan administration's economic program. I anticipated a discussion of 1980s tax and interest rate policy. That's not what I got.

Greenspan theorized that the paradigm shift that moved the 1980s toward greater optimism came largely from something unanticipated. In 1981, President Reagan fired striking air traffic controllers. This act could have instantly produced a nationwide transportation walkout with devastating economic consequences. Everyone held their breath. But the strike didn't happen. At the time, American businesses had been written off as competitive dinosaurs. But now they had the political green light to restructure and become lean and mean. Economic optimism became infectious.
Barack Obama desperately needs his own paradigm-shifting spark. Like Reagan, he embodies a sense of optimism. But for the first time since the 1930s, we have entered a period of demand destruction. Increased fiscal stimulus is essential, yet new roads and bridges, more generous unemployment insurance, and tax credits hardly constitute "audacious" policymaking - the spark necessary to shift public attitudes.

American consumers are undergoing long-term retrenchment. They are forgoing spending in an effort to replenish the $10 trillion in collective household wealth they have lost. Consumption patterns may be returning to the lower levels of previous decades. That could mean that even a $1 trillion package may be far too small to do more than keep the contraction from worsening.

But there's a larger point. Economies are driven by more than numbers - the size of either stimulus spending or interest rate cuts. They are driven by psychology. Right now, psychologically speaking, Americans see the U.S. financial system and the larger global system as a bus racing down an icy mountain road toward a village - with no one behind the wheel.

Obama needs a big play. The place to begin is by confronting our banking system - possibly even breaking up the financial behemoths considered "too big to fail." Our banks are sitting on mountains of capital. Taken together, their excess cash reserves normally amount to $3 billion to $7 billion. Astonishingly, those reserves today are estimated to exceed $800 billion, a portion of which is our bailout money.

We have moved from reckless financial risk-taking to a situation even more dangerous: no financial risk-taking. Many suspect that this cash buildup indicates that the banks' off-balance-sheet debt exposure is far larger than acknowledged.

The first step is to reverse the Paulson policy of idolizing the banks. These are hardly noble institutions. Today's bankers have shown themselves to be devoid of leadership skills and, in some cases, common sense.

Let's not forget, too, that the subprime crisis mushroomed not simply because loans were made to people who couldn't afford them. The banks played games.

It's time to bring out the bully pulpit. Obama needs to do with the bankers what JFK did with the steel executives. The bankers say they won't lend, or are imposing extraordinarily tough terms on borrowers, because 2009 will be a tough year. Urge them, at a minimum, to help reduce mortgage rates and increase refinancing. How? By using their Troubled Asset Relief Program bailout funds to buy Fannie Mae and Freddie Mac debt. There is no excuse for not doing so. The debt is now explicitly federally guaranteed.

It's time for a regulatory decision that encourages lending. Worry about bank capital standards after recovery begins.

Obama needs to lay out for the banks the potential political risk of the status quo. Imagine this scenario eight to 10 months from now: Unemployment at 10 percent with mountains of bankruptcies and the banks still not lending. Congressional calls to break up the banks - and remove current management - would ring out.

The financial crisis has entered a new phase. Nobody trusts anybody, or any institution. That is why Obama needs the big play, a policy with a psychological "wow" factor. He needs to shock the flat-lining patient.

David M. Smick is a global financial strategist and the author, most recently, of "The World Is Curved: Hidden Dangers to the Global Economy."

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