What Could Have Obama Done Differently?

To be honest, I've been pretty supportive of Obama's first two years. On almost every issue, I've seen the merits of what he's done, and although I've almost always wished he would have done more, I've understood why in the political environment he was in, he didn't.

Admittedly having 60 seats in the Senate (well for like six months he had 60 seats, he didn't get to 60 until July 7, 2009 when Al Franken finally won his disputed Minnesota seat, and then he lost it again when Scott Brown won the Massachusetts seat on January 9th, 2010) and a Democratic controlled Congress gave him a pretty cushy political environment. Except that a substantial number of Democratic Senators and Representatives represented conservative states and districts and would only support moderate bills. Also, the Republican party decided pretty early on that it was in their best political interest to oppose Obama on everything, and not only oppose, but make him seem like the most liberal, socialist, anti-American person that ever lived.

The Republican party is the master of sound bites and they have a pretty effective media machine between AM talk radio and FOX news that can reiterate those sound bites virtually on command. Those soundbites are riveting and convincing - freedom, liberty, personal responsibility, so even in the minority they have a powerful voice and significant influence.

Obama did have the power to accomplish a lot, but there were real limitations to how big that "a lot" could realistically become.

Looking back on what he did accomplish, he was successful, but could he have done better? I don't think he could have passed more legislation through. He basically used every last bit of political firepower he had to do what he did. Passing immigration reform or an energy bill or something else wasn't happening. Getting a more expansive health reform bill wasn't happening, he was lucky to get what he got, and even still he was did it with the skin of his teeth.

But maybe his priorities weren't right. Maybe he should have went after a different combination of achievements that would have left our country in a better place two years later.

Enter this rather blistering analysis by the economist Brad DeLong.

DeLong is focused in this article on the state of our economy and here he agonizes over the senseless and avoidable almost 10% unemployment that we seem to be stuck in for almost two years now (and counting).

Most people don't realize how irrational this recession was to begin with:

"For one thing, the initial financial shock that set the downturn in motion was remarkably small. We got irrationally exuberant about the demand for housing and the trajectory of housing prices. We built five million houses extra - largely in the swamps of Florida and in the desert between Los Angeles and Albuquerque - that simply should not have been built. Their cost of construction was to a first approximation covered entirely by mortgage debt. And on average one of those five million houses the purchaser took out $100,000 in mortgage debt that simply will never be repaid: the buyer cannot afford it and the house is not worth it. That means that, as of the end of 2007, there were $500 billion of financial losses to be allocated: somebody's bonds and derivatives were going to pay off $500 billion less than people thought."

In one paragraph, DeLong makes a pretty convincing estimate of the real world value loss incurred by the housing bubble - $500 billion. That's a real, tangible financial loss that had to be absorbed by the world economy in some way. And that sounds like a big number, but...

"Now in a global economy with $80 trillion worth of financial wealth, a $500 billion loss due to irrational exuberance and malinvestment should not be a problem. Double it or quadruple it and it still should not be a problem. We have modern, sophisticated, highly liquid financial markets. We have originate-and-distribute-securitization to slice, dice, and spread risk broadly across the whole globe so that nobody bears any significant part of and so is ruined by any idiosyncratic risk like mortgage defaults..."

The real problem was not the housing bubble, the problem was the way our financial institutions behaved during the housing bubble, using it as a foundation to make profits on even greater leverage:

"Regulatory forebearance allowed investment banks to ramp up their leverage to unheard-of-levels--30 to 1?--on the grounds that the financiers' had their fortunes at risk and knew their business."...

"So when the $500 billion loss hit, it hit the capital of highly-leveraged financial institutions and transformed all the liabilities of America's banks from safe, secure, and liquid high-quality assets to unsafe, insecure, and illiquid low-quality assets."

"Thus an enormous worldwide flight to quality. A $500 billion fundamental loss triggers a $20 trillion decline in global financial asset values with a financial accelerator of 40 as everybody tried to dump their risky and build up the safe assets in their portfolios. And, as John Stuart Mill knew back in 1829, whenever you have a large excess demand in finance it will be mirrored by a large deficiency in demand for currently-produced goods and services and labor".

In real-world terms, people running scared turned something reasonably small into something really, really big. The reason, of course, is that people took massive bets trying to turn their housing profits into something much bigger. And our financial institutions just were not equipped to deal with it.

DeLong spends some time talking about what Paulson and Bush, regulators and financiers could have done to prevent the recession from ever occurring. If financiers would have managed the burst properly, they could have spread out the risk and contained the damage. They did not - I'm not sure why, and DeLong does not spend much time explaining.

Housing finance (Fannie and Freddie) could have been nationalized much earlier and then the government through Fannie and Freddie could have bought up bad mortgages and contained the mess before massive unemployment hit. This would have also contained the cost of the mess. As its gone longer and deeper, people lose their jobs, they also lost the ability to pay for homes they normally would have wanted to stay in. Keeping people working would have softened the blow and contained the cost.

They could have nationalized as many banks as necessary much earlier, which would have kept banking, borrowing, lending and investing moving, while preventing any major financial runs or panics (which did occur after Lehman collapsed).

DeLong points plenty of fingers at Obama. Obama did do a lot of what Delong suggests, but in each and every case, it was never big or forceful enough to make enough of a difference. The stimulus needed to be much bigger. The Fed basically stopped doing much after the initial disaster was averted (other than keeping interest rates to basically zero). They could have advertised defined inflation and price targets and aggressively pursued them. Many more targeted bank nationalizations could have been performed.

In all of these suggestions, you find that the principle outlined in "Bagehot's Rule":

"All seven of these tools are applications of Walter Bagehot's rule: the principal that the way to deal with a panic in which nobody is sure if contracts will be honored is for the government to make sure that contracts are honored by lending freely to anybody who asks. (But, Bagehot wrote, the lending should be 'at a penalty rate' -- financiers should never profit from the fact of government assistance to stem the panic. That is the second part of Bagehot's rule)."

But why was Obama so timid?

Basically to sum up both Bush's and Obama's response to the worst economic crisis since the Great Depression: They did just enough to avoid a Depression, but not nearly enough to either prevent the severe recession nor spur a vigorous recovery.

What Obama did do was he pivoted. He spent a lot of time, energy and political capital getting health care reform passed. Additionally, he spent the next year getting a significant financial reform bill passed. Health care in particular consumed his time and attention and left him little room to deal with the economy in any significant way.

Now, I support Obama's health care plan. It was no where near adequate. I'm doubtful it does enough to control cost - my primary concern, and more work is required.

But where does that leave us now. We have an economy with 10% unemployment. In 2014 (when Obamacare will finally be working in full), we'll have a health care system in place that should provide a better framework especially in a climate of high unemployment - its not so nearly dependent on employment provided health care.

But we are at serious risk of being stuck in a situation where high unemployment becomes the norm, and the next two years, we have a political climate that will probably make things worse. Cutting government spending does not make up for this massive demand shock (we have plenty of supply), and therefore if we do too much to try to balance our budget, we risk a double dip recession.

Furthermore, the massive losses in tax revenue due to this recession puts a huge strain on our ability to pay for our health care costs (which generally continue no matter how the economy behaves - sick people still need care). This reality gives more ammunition to those who would kill or severely roll back what Obama accomplished with his health care bill.

After reading through DeLong's critique and for these reasons I've outlined, I'm inclined to agree, maybe Obama should have done things differently.

Maybe he should have spent his entire first two years on nothing but foreign policy and the economy. He could have spent every last ounce of his political capital on getting the unemployment rate down. He could have put more pressure early on to get even the Republicans in Congress on board. He could have made recess appointments to get the Federal Reserve fully staffed - bypassing Senate confirmation procedures. Then with a fully staffed Fed, they could have been empowered (and pressured) to pull more levers to boost demand much more aggressively. He could pushed to nationalize more banks and then use that leverage to to institute stronger financial regulations to prevent future crisis of this magnitude.

Perhaps Greece and Ireland and Europe as a whole would have been in better shape.

All of this would have had real political cost. He would have been described as a dictator and a socialist at every turn. But unemployment would have been much lower. Republicans would still have won seats in Congress but not nearly as many.

More importantly, many more people right now would be working. I know personally qualified people who are unemployed right now and in very real ways are suffering.

I think Obama saw a unique opportunity to get health reform passed and he took it, but he sacrificed the economy in the process. Had he focused on the economy and sacrificed health care, would that have been a better calculation? Probably. But then health care reform would have been a goal for his second term - and far from a certainty.

Time will tell if this trade-off was worthwhile.