Not since 1933 had an American president taken the oath of office in an economic climate as grim as it was when Barack Obama put his left hand on the Bible in January 2009. The banking system was near collapse, two big car manufacturers were sliding towards bankruptcy; and employment, the housing market and output were spiraling down.
Hemmed in by political constraints, presidents typically have only the slightest influence over the American economy. Obama, like Franklin Roosevelt in 1933 and Ronald Reagan in 1981, would be an exception. Not only would his decisions be crucial to the recovery, but he also had a chance to shape the economy that emerged. As one adviser said, the crisis should not be allowed to go to waste.
Did Obama blow it? Nearly four years later, voters seem to think so: approval of his economic management is near rock-bottom, the single-biggest obstacle to his re-election. This, however, is not a fair judgment on Obama’s record, which must consider not just the results but the decisions he took, the alternatives on offer and the obstacles in his way. Seen in that light, the report card is better. His handling of the crisis and recession were impressive. Unfortunately, his efforts to reshape the economy have often misfired. And America’s public finances are in a dire state.
Seven weeks before Obama defeated John McCain in November 2008, Lehman Brothers collapsed. AIG was bailed out shortly afterwards. The rescues of Bank of America and Citigroup lay ahead. In the final quarter of 2008, GDP shrank at an annualised rate of 9%, the worst in nearly 50 years.
Even before Obama took office, therefore, there was a risk that investor confidence would vanish in the face of a messy transition to an untested president. The political vacuum between FDR’s victory in 1932 and his inauguration the next year made those months among the worst of the Depression.
Obama did what he could to ease those fears. As candidate and senator, he had backed the unpopular Troubled Asset Relief Program (TARP) cobbled together by Henry Paulson, George Bush’s treasury secretary. After the election he selected Tim Geithner, who had been instrumental to the Bush administration’s response to the crisis, as his own treasury secretary. The rest of his economic team—Larry Summers, who had been Bill Clinton’s treasury secretary; Peter Orszag, a fiscally conservative director of the Congressional Budget Office (CBO); and Christina Romer, a highly regarded macroeconomist—were similarly reassuring.
Resolving a systemic financial crisis requires recapitalizing weak financial institutions and moving their bad loans from the private to the public sector. Under Bush, the government injected cash into the banks. But doubts about lenders’ ability to survive a worsening recession persisted. Obama faced calls to nationalize the weakened banks and force them to lend, or to let them fail. Summers and Geithner reckoned either step would shatter confidence in the financial system, and instead hit upon a series of “stress tests” to determine which banks had enough capital. Those that failed could either raise more capital privately or get it from TARP.
The first reaction was one of dismay—stocks tanked. Pundits predicted Geithner would soon be gone. But the tests proved tough and transparent enough to persuade investors that the banking system had nothing nasty left to hide. Banks were forced to raise hundreds of billions of dollars of equity. Bank-capital ratios now exceed pre-crisis levels and most of their TARP money has been repaid at a profit to the government. Europe’s stress tests were laxer, and some banks that passed have subsequently had to be bailed out.
General Motors and Chrysler presented a different challenge. Ordinarily a failing manufacturer would shed debts and slim down under court-supervised bankruptcy. But in 2009 no lender would provide the huge “debtor-in-possession” financing that a reorganization of the two would require. Bankruptcy meant liquidation. That would have wiped out local economies and suppliers just as the banks were being rescued. On the other hand, simply bailing-out badly run companies would have been too generous.
Obama’s solution was to force both car makers into bankruptcy protection, then provide the financing necessary to reorganize, on condition that both eliminated unneeded capacity and workers. Both companies emerged from bankruptcy within a few months. Chrysler, now part of Italy’s Fiat, is again profitable, as is GM, which returned to the stock market in 2010. Nonetheless, the government will probably lose money on these two rescues.
The audacity of hope
Obama’s attempts to fix the housing market were less successful. By early 2009 9% of residential mortgages, worth nearly $900 billion, were delinquent. The traditional playbook called for the government to buy and then write down the bad loans, cleansing the banking system and enabling it to lend again. But when the Treasury studied such proposals, it found there was no ready mechanism to extract dud loans from securitised pools. An alternative was to pay banks to write down the loans to levels homeowners could handle. But the risk then was “you either overpaid the banks…doing a backdoor bail-out without enough protection for taxpayers, or paid too little and banks would not be willing to do it,” recalls Michael Barr, who worked on those efforts and now teaches at the University of Michigan.
Instead, lenders were prodded to reduce payments on mortgages with subsidies and loan guarantees. Even Fannie Mae and Freddie Mac, though now explicitly owned by the government, resisted taking part. As of April, only 2.3m mortgages had been modified or refinanced under the administration’s programs, compared with a target of 7m-9m. Had Obama ploughed more money into writing down principal at the start, the results might have been worth the political risk. “They were prudent,” says Phillip Swagel, an economist who tackled similar questions under Paulson. “In retrospect, I bet they wish they had been imprudent, spent a lot of money, and actually solved the problem.”
Textbook economics dictates that when conventional monetary policy is impotent, only fiscal policy can pull the economy out of a slump. For the first time since the 1930s, America was facing just those circumstances in December 2008. The Federal Reserve cut short-term interest rates to zero that month and experimented with the unconventional, buying bonds with newly printed money. The case for fiscal stimulus was therefore good.
Sluggish growth since 2009 has fed opposing assessments of the $800 billion American Recovery and Reinvestment Act. Conservatives say stimulus does not work, or that Obama’s was badly designed. Most impartial work suggests they are wrong. Daniel Wilson of the Federal Reserve Bank of San Francisco inferred the stimulus’s effect through an analysis of state-level employment data. He concluded that stimulus spending created or saved 3.4m jobs, close to the CBO’s estimate.
Charges that the plan was made up of ineffective pork are also unfair. Roughly a third of the money went on tax cuts or credits. Most of the spending took the form of direct transfers to individuals, such as for food stamps and unemployment insurance, or to states and local governments, for things like Medicaid.
Liberals make the opposite case: the stimulus was too small. Romer originally proposed a package of $1.8 trillion, according to an account by Noam Scheiber in his book, “The Escape Artists”. Told that was impractical, she revised it down to $1.2 trillion. Obama eventually asked for, and got, around $800 billion. Some critics note that this was too small relative to a projected $2 trillion shortfall in economic activity in 2009 and 2010. But it was far more than Congress had ever approved before. Despite the Republican takeover of the House of Representatives in 2010, Obama eventually got nearly $600 billion of further stimulus, including a two-year payroll-tax cut.
If stimulus worked, why has the recovery remained so sluggish? GDP has grown by just 2.2%, on average, since the recession ended in mid-2009, one of the slowest recoveries on record. For one thing, the economy hit air-pockets in the form of higher oil prices, caused partly by the Arab spring, and the European debt crisis. Moreover, from the fourth quarter of 2009, state and local belt-tightening more than neutralized the federal stimulus, according to Goldman Sachs.
Perhaps the simplest explanation is that recoveries from financial crises are normally weak. Obama was guilty of hubris in thinking this one would be different. He also created expectations that, once his team gave up radical intervention in the mortgage market, he could not meet.
An economy in his own image
From his earliest days on the campaign trail, Obama made it clear he wanted to do more than just restore growth: he dreamed of remaking the American economy. Its best and brightest would devote themselves to clean energy, not financial speculation. Reinvigorated public investment in education and infrastructure would revitalize manufacturing, boost middle-class incomes and meet the competitive challenge from China.
Once in office, Obama devoted himself to that agenda, in the process displaying a fondness for industrial policy. “When we first started talking about the Recovery Act in December of 2008, the earliest discussions were about clean energy: smart grid, wind, solar, advanced batteries,” says Jared Bernstein, then an economic adviser to Joe Biden, the vice-president-elect. Some advisers, like Summers, were uneasy with industrial policy. Others, like Bernstein, argued that orthodox economics allowed for government intervention in early-stage technology.