For a moment, ignored the traditional argument that what should have happened wasn't politically feasible. We're not talking about what could have happened. Ignoring actual solutions in favor of reinforcing "political reality" solves nothing and only guarantees we'll fall into the same traps when economic catastrophe strikes again. What this article aims to do is provide a blueprint for what should happen during a severe recession where the Federal Reserve has little to no effect.
We know what should have happened. The reason we know what should have happened to stave off the crisis is because all of this has happened before.
A couple of times.
“But wait, why should the government do anything? Why can’t the marketplace fix the problem itself?”
Short answer: the marketplace isn’t very good at this. In fact, before the United States had a functioning Federal Reserve system, recessions commonly lasted years and depressions—usually caused by financial crises—lasted even longer. Look at this graph. See how tiny those recessions are after the Great Depression? That’s mainly because of the Federal Reserve.
“But sometimes a society deserves a recession.”
No. Economics is not a morality play, and oftentimes—especially in the case of the Great Recession—a lot of very innocent people have been made to suffer. More importantly, since this recession started, the U.S. economy has lost between $1 trillion and $3 trillion in potential GDP growth. Who loses out here? I’ll give you a hint: it’s not the people who have million-dollar vacation homes.
Our government should have solved this crisis in the same way you solve a math problem that you’ve seen before. That our government couldn’t do this only shows what kind of people have been elected, which of course shows what kind of people we have chosen to elect. Now, I understand that not all of this was politically feasible at the time, and that’s a failing we as a society all share the blame for—we elected our own representatives, after all. But on the other side it’s important to note that you can’t actually prove any of this wasn’t possible, either, since none of it was tried.
So consider this section a moment of clarity, a reference for the next economic catastrophe in the hopes that we might finally do what’s supposed to be done.
Step one: Nationalize Some Banks
Specifically, the ones that are failing. This would not have been the massive money-saving idea that many people have suggested, nor would it have been an impossible-to-manage disaster, like some “experts” appearing on CNN and CNBC suggested during the 2008 crisis. The goal in nationalizing the big failing banks like Citibank and Bank of America would have been to clear the massive amount of toxic debt from their books. Since lending was down 90 percent following the bailout, the government could have increased the lending sooner had banks not had to worry about all the toxic debt on their books. Also, most of the bailed-out mega banks received additional bailouts shortly following the initial 2008 shock.
Yes, doing this would have meant taking a leadership role in complex financial institutions, institutions that are already so complex that even they don’t know what they’re doing half the time. The point, according to a number of economists, is this: if the government is flooding taxpayer money into these failing banks like Citigroup, shouldn’t taxpayers get to call the shots instead of the same banking executives who caused the financial meltdown? Yes. Yes. Yes. More importantly, it’s important to understand that the U.S. government wouldn’t need to permanently own these failed mega-banks. It would have been a temporary solution, and the government could have sold off its assets once the economy improved.
This isn’t anything new. The FDIC does it all the time. When your local bank becomes insolvent, the FDIC comes in and takes it over, clearing its bad debt and selling the bank off without damaging any of the customers’ money. In fact, the FDIC is designed to ensure you can put your money safely in a bank and never have to worry about ever losing your money during a bank run. It’s a government insurance program, and it’s incredibly effective. The FDIC is good at doing this, and if the FDIC had had more control during the Great Recession, taxpayers would have had more control over the bailout.
Bottom line: the government provided millions and billions of taxpayer dollars into failing mega-banks, including Citibank and Bank of America, without demanding any say in how these banks handled the crisis. Taxpayer money should equal taxpayer control, even if it’s not total control. Temporarily nationalizing the banks would have freed more money into the marketplace more quickly, providing an essential tool to the economic recovery.
Step Two: Establish a Mortgage Rescue Plan
This isn’t a popular thing to do. What it basically amounts to is an attempt to provide some financial rescue for homeowners who are struggling following the initial financial shock. The argument will be that homeowners knew what they were getting into and it’s their fault; homeowners who can’t pay their bills should be kicked out just like everyone else in more normal economic times.
Fair arguments, but they’re incredibly vague and generalized, especially given how many people fell behind in their mortgages as the job losses continually piled up (remember: job losses began months before the stock market collapse in late 2008). There are solutions that can work and minimize the number of people “getting off easy.” A home rental plan that takes ownership away from delinquent homeowners—but doesn’t kick them out on the street—is a plausible solution. A reduced monthly payment—even if only temporary—is another.
What President Obama did instead was enact an incredibly inefficient and unsuccessful program. It was unsuccessful for a number of reasons, but the fact that it was allowed to continue solely to avoid accepting blame for failure was unacceptable. It was a classic example of “politics as a game” where someone wins and someone loses, and no one wants to lose. The goal of such a program, like any rescue plan enacted during a financial crisis, is to fix what’s broken. One of the reasons President Franklin Roosevelt was so popular during his time wasn’t because everything he tried during the Depression worked—some things didn’t, but the difference is when they didn’t work he tried something else. Even FDR could have admitted failure a little more often …
But at least he didn’t abandon his plans altogether. Obama’s homeowner assistance program simply chugged along for over a year, as if it was running on cruise control. One of the biggest problems was that the Obama administration was attempting to create a program that relied heavily on for-profit banks to do much of the legwork. Would this have been a problem if the government had nationalized the banks? Tough to say … but it would have been less of a problem.
We suffered a massive housing boom followed by a massive housing bust, which is the standard formula for a recession. But the scale along required some kind of solution that actually worked instead of leaving an unsuccessful program in place.
Bottom line: with so many toxic mortgages killing the bottom line of our nation’s lenders, it was necessary to enact some sort of assistance program. In the future, multiple mortgage assistance programs should be offered and whichever one is most successful should be enacted on a nationwide scale. It won’t be popular, even if considerations are taken to assure citizens that troubled homeowners aren’t getting a “bailout.” But sometimes a politician needs to make an unpopular decision for the good of society—it’s one of the fundamental strengths of living in a democratic republic.
Step Three: Pressure the Federal Reserve Expand the Monetary Base
The Federal Reserve’s efforts to expand the money supply—i.e. put more money into the economy—had a limited effect, mainly because their interest rate was so low when the Great Recession started. Still, it was clear from the start that the Federal Reserve had a few creative options available to it. Things are different now that the U.S. is off the Gold Standard (and that’s a very, very good thing). Specifically, the Federal Reserve has more power to loosen and tighten the monetary supply, which it couldn’t do in the lead-up to the Great Depression because back then the dollar and gold were tied together in a ridiculous, long-dead marriage.
During the Great Recession, Quantitative easing allowed the Federal Reserve to purchase government bonds and then duplicate those new reserves “in the fractional reserve banking system.” It’s not an easy concept to understand fully without some extra background in banking policy, but here’s a simplistic version: the Federal Reserve’s QE program was designed to put more money into the economy by increasing its money supply.
There is a fear that doing this would cause increased inflation that would cripple the currency. But of course the same people who are so afraid of this are the ones who were wrong about everything else during the Great Recession and so it’s pretty easy to find the errors in this argument. Credible economists who understand how a liquidity trap works know that QE is only partially effective—if at all—and in order to trigger inflation it would require the economy to improve at a rapid pace.
Why? Because the Federal Reserve can just as quickly pull some of that money out of the economy, reducing the risk of inflation. More importantly, the increase in money supply hasn’t caused a rise in U.S. Treasury yields, which is the rate at which the government borrows money. This was another criticism that was floated by Serious People on television and in print publications. The fact that neither of these things has happened—higher government interest rates and inflation—should be proof in future recessions that basic QE can be performed without causing damage to the economy.
In fact, let’s up the ante.
What the Federal Reserve should have done at this time was set a higher inflation target to pursue a more aggressive QE program and keep it going until the jobs market improved. That the unemployment rate as late as 2011 was still at 9% means the Federal Reserve shouldn’t have slowed down its QE program at all during this time. Early calls for the Federal Reserve to stop were premature: job growth wasn’t regularly outpacing population growth and GDP growth was weak at best.
Here, it should be mentioned that the Federal Reserve could have used more scrutiny as well during this time. People were profiting from the Fed’s QE programs when they shouldn’t have, and in the future there should be safeguards in place and necessary oversight as well.
Bottom line: Fears about inflation were widespread but misinformed, and the Federal Reserve should have pursued a more aggressive policy until the unemployment rate was considerably lower. The Federal Reserve also should answer for the weak oversight of where its money went.
Step Four: Establish a Stimulus Program
There are a variety of ways the stimulus that was enacted in 2009 could have been improved. President Obama’s stimulus amounted to less than $1 trillion and had a fair amount of tax cuts and tax breaks, which don’t stimulate the economy nearly as well as infrastructure programs. The goal of the stimulus program should be to make up for as much of the loss of economic activity caused by the recession as possible, which in the case of the Great Recession was much, much more than $1 trillion dollars. The best way to make up for that economic activity is to put people to work by any means possible so they have money in their pockets that they can spend.
Since economic calamities like this only happen once every twenty or so years (or longer, if the Federal Reserve is being run moderately well), any federal stimulus program should be focused on our country’s infrastructure. The United States is a big place. Really big. And if there’s one thing local and state governments hate doing, it’s housework. You know: replacing old pipes, repaving old highways, old roads, public water systems, parks, etc. etc. Those are usually the types of things that are delayed again and again when the coffers dry up. Why? Because it’s easy to put off upkeep. Upkeep can always be done somewhere down the line, just like housework.
Creating a stimulus program that focuses entirely on infrastructure puts people to work. Period. There isn’t any hidden math here. There isn’t any way this “doesn’t work.” In fact, the main argument against Obama’s stimulus by conservative critics is that it eventually stopped. They interpreted this as meaning it “stopped working,” and point to the unemployment rate’s miniscule decline as proof. The problem is that Obama’s stimulus was always too small, and the Obama administration’s estimates that unemployment wouldn’t grow higher than 8% was also wrong. That’s President Obama’s fault for hiring economic advisers who helped cause the Great Recession in the first place.
Make no mistake: there’s no shortage of infrastructure that needs to be fixed. In fact, the United States has one of the shoddiest infrastructures in the developed world, and it’s only going to get worse as concerns about the debt continue. So what, exactly, does a massive recession offer that can’t be done during a normal period of strong economic growth?
Treasury yields. In a severe recession where there’s little hope of recovery coming from the Fed (because of already-low interest rates), investors pull out of the stock market and put their money into the safer treasury market, which drives down its interest rates. So what happens then? The government has more money to borrow at low, low interest rates. Where the government was paying comparably outrageous interest rates to borrow money to fund the Iraq War and Bush tax cuts during 2006, it was paying next to nothing in 2010 and 2011.
So the government can borrow during this recessionary period at next-to-nothing interest. That’s good. It’s like having a credit card with a 0% interest rate, which makes it a lot easier to pay off your $600 dental bill compared to a credit card that charges a 10% annual fee. I like to use the “dental bill” analogy because waiting to put in a crown can turn out to be a lot more expensive if you put it off (ever had a root canal?). In the same way, putting off infrastructure investment can have disastrous, costly affects, too.
Is there any other reason infrastructure spending would have worked well during this moment? As a matter of fact, there is: low demand. With the entire economy suffering from low demand, prices on goods and labor dropped significantly. What this means is the cost of building a highway during the Great Recession would have been much, much cheaper than building a highway during normal economic times. So every dollar spent on infrastructure during this time would have saved U.S. taxpayers oodles and oodles of money.
None of this is to say it would have been easy, especially given how intellectually weak the Republican Party was at the time. But it should have been tried and citizens should have demanded it. More time should have been spent on jobs, putting people to work even if it meant getting the government involved, because you can’t have a recovery if millions of people are afraid of losing their jobs. 30 million people didn’t just suddenly decide to stop working during the Great Recession. They wanted to earn money just like everyone else.
This isn’t new. The U.S. government spent billions during the early 1940s in preparation for World War II. The only difference was that a lot of money was spent building bombs, bullets, and other things that either ended up exploding or only being used once. Such is the way of war. Now imagine what had happened if the United States spent a similar amount of money on roads, updated water systems, electric grids, renewable energy programs, etc. etc.
If push came to shove and it was necessary to “fund” these improvements to the infrastructure, then revenue should have come from additional tax increases on millionaires and, more importantly, billionaires. A simple, small, graduated tax increase that doesn’t even affect people making less than $1,000,000,000 a year could raise as much as $80 billion a year to fund an initiative like this.
Bottom Line: Infrastructure spending is necessary. During a severe recession, it’s also incredibly cheap and creates jobs. More importantly, any stimulus program should be designed to be most effective, and there’s nothing more effective than investing in the country’s infrastructure.
Step Five: Don’t Cut Spending
Every dollar the government spends goes into someone’s pocket. I know, I know, there are inefficient government programs out there, and I understand that those government programs can be made “more efficient.” It’s a good cause. It’s a cause that can cross the ideological boundaries.
But that’s not an excuse to hack and slash at the budget in order to try and preserve a misguided notion of fiscal discipline. Because in order to cut government spending under any condition, you have to cut jobs. And we’re not just talking government jobs, either. The government farms out a lot of its functions to private companies, especially when it comes to defense spending (which makes up a significant part of our budget). Defense spending, in fact, has plenty of places where things can be cut. That doesn’t change the fact that you’re cutting jobs.
Consider this: during the Great Recession, a company in Oshkosh, Wisconsin, won a contract to build military vehicles for the U.S. government. The money was borrowed, of course—stimulus!—and paid to the company, which then added more jobs in order to build the equipment.
This is a microcosm of government money being spent. And while we’d like to believe there’s always “tons” of money just being dumped into a hole somewhere, reality is quite different. President Obama provided a great example when in 2011 he began slashing at the budgets of already overworked regulatory agencies. The FDA, while attempting to expand its oversight of food safety, was already underfunded before the call to “balance the budget.”
What you ultimately end up with is a déjà vu moment. Remember when I mentioned that we’d seen this before? We have. It happened in 1937, when President Roosevelt attempted to balance the budget by raising taxes and slashing government spending, and the Federal Reserve tightened the money supply.
The only thing worse than simply “cutting the budget” is tearing away the social safety net. When Republicans in Congress held the debt ceiling hostage and demanded massive budget cuts, they wanted budget cuts that would directly affect Americans’ standards of living: Medicare cuts, Social Security cuts, cuts to basic programs that help the poor afford groceries and baby items, etc. etc. Social Security is a no-brainer: it’s retirement insurance and nearly all of it is spent in the marketplace immediately. Cutting Medicare only means insuring fewer people who can’t afford private health insurance or health care. Taking away money that pays for baby items? Yeah...
Bottom line: Spending cuts have no place being on the table during a severe recession. The economic health of the society should be placed ahead of any partisan battles over the size and scope of government because reducing government spending only slows economic recovery by taking more money out of the economy.
Conclusion
Follow these steps and you have a recovery. Period. It’s not brain surgery—no, getting at this point requires a look back into history without ideological glasses off. It means looking at the Great Depression and Japan’s weak recovery during the 1990’s. It means casting aside ridiculous arguments about inflation and bond vigilantes in order to focus on what really needs to get done.
Again, it wouldn’t have been easy to enact all of these policies. That’s not the point. The point is that moments like the Great Recession caused unnecessary pain (financial and otherwise) to people who had nothing to do with the financial crisis. It affected students recently graduated from college. It affected hard-working, middle-class people in their forties who enjoyed their job before it evaporated overnight. It affected retirees who saw their 401(k) fall apart. And the longer the recession lasted, the more people suffered. The more our economy suffered.
We can prevent these moments from happening and, when our society misjudges the intelligence of its leaders and the marketplace, we can also ensure that future recessions are as painless as possible.