Watching Barack Obama deliver the State of the Union speech brought to mind the verse by George Leybourne celebrating "this daring young man on the flying trapeze" who "flies through the air with the greatest of ease." How graceful and fluent the president was, how marvelous his delivery, how witty his references to his opponents. And all despite the fact that he had to be thinking about the 15 million-plus people who are unemployed (40 percent for over 27 weeks) and the millions more who are working part time when they would rather work full time. Further, as we learned, he was carrying a huge lead weight: the impending prediction in the budget he was about to release that the federal deficit will reach a record $1.56 trillion or 10.6 percent of the gross domestic product. He could have skipped the soaring oratory and boiled his message down to three words: "We're in trouble."
The president spoke to a country that is in a mood of pessimism and deflation. Gone is much of the hope and enthusiasm that greeted Obama in the early days of his presidency. The nation had come together to derail a threatening Great Depression with strong support for the stimulus package and other measures. But Obama then squandered this political momentum by pursuing agendas inconsistent with the country's focus. The result today is talk of decline and recession and of how countries like China will surpass the United States over time. Everyone who knows somebody out of work can't help speculating if he or she is going to be next; virtually all American families who own a home have lost a huge portion of their equity, on top of their financial losses. Personal net worth, as a multiple of income, fell by almost a third from peak to trough since 2006. Now many are concerned about the ability to afford their retirement years or to fund their children's education. This is the new dismal.
Republicans continue to sit on their hands. As a party, they are singularly lacking in national, as distinct from congressional, leadership. The country needs a coherent and convincing Republican opposition presenting serious alternatives. The GOP should use its Massachusetts Senate seat victory—bequeathed by independents—not to sit back and gloat but to take itself seriously. The GOP has not been very imaginative in just saying "No" to whatever it is the Democrats want to do. Yes, Republicans are entitled to be critical of Obama's first year on the trapeze, and yes, the Democratic congressional leaders must have missed those campaign speeches in which their leader pledged a genuine bipartisan effort. It was the Democratic congressional leaders who shut out the Republicans as they pushed through the first major piece of legislation in the new era, the $787 billion fiscal stimulus bill. Republicans can certainly be incensed that the resulting package—surprise, surprise—has mostly gotten people back to work in the public sector supporting Democratic projects. And by far the worst display of congressional manipulation was the purchase of support from Democratic senators and labor unions, a form of political corruption that the Democrats resorted to in order to ram through a flawed healthcare program.
Everyone is rightly scared of the ravenous big-bad-wolf deficit, but there is little sign the economy will recover without a further boost, and that means deficit spending. History shows that a strong rise in GDP is the most potent deficit-reducer because it produces an accompanying rise in tax revenues. Obama's budget director, Peter Orszag, predicted this by estimating that the growth of the economy and the revenues that generates would reduce the scale of the budget deficit to a more manageable 4.25 percent of GDP by 2013. At the same time, we should not be misled by the 5.7 percent rise in GDP in the fourth quarter. It's worth much less than a full cheer since 60 percent of it came from cyclical factors such as reduced inventory liquidation, rather than an upsurge in consumer spending, investment, and exports—the real engines of growth and jobs. Consumers are clearly not coming back the way they once did. The new normal will be higher savings, fewer credit cards, lower consumption, and, unfortunately, slimmer paychecks.
To be fair, the president's first year wasn't exactly wasted in terms of the economy. We did barely avoid a collapse of the entire financial system, in large part thanks to Federal Reserve Chairman Ben Bernanke; the auto industry got a second chance; and education got not only a ton more money but clear-sighted leadership from Arne Duncan, the new secretary of education. The trouble in 2009 was that the economy took a poor second place to the president's obsession with an overly complex health bill, in which the key issue of cost control was fudged and political corruption in the form of buying votes fomented public revulsion.
The president was right to talk about nuclear power, high-speed rail, offshore drilling, and tax credits for small business, as well as the modest jobs bill. But he would have added to the longer-term business confidence if he had put forth a national infrastructure bank, independent from Congress, focused on large-scale interstate programs or programs paid for over time by tolls. He could have let Congress keep the smaller projects so it would still have some earmarks and pork to pass around, in return for giving up the big-ticket items.
He did focus on the financial system. The grave financial crisis is now behind us, but it was a close call. Today, the president is whaling away at the financial world in an attempt to channel public anger against Wall Street. The populist rhetoric may be politically helpful, but it is economically counterproductive. Attacking the financial world and business just adds to the climate of uncertainty and puts yet another hurdle in the path of creating jobs. Every business owner or would-be business owner already faces the uncertainty of new costs from healthcare programs, new taxes, cap-and-trade, and additional regulation. No wonder the administration's condemnation of the financial world caused a plunge in the Dow of 500-plus points, wiping out billions of dollars of equity. Instead of taking a meat ax to a business sector suffering from fragile confidence, the president should at least wait until there is a reasonable sustainable path back to mass prosperity.
Yes, the banks are not lending as they used to. But many banks' loan books remain impaired even to this day, forcing them to hoard their cash to deal with the losses they may face in the future. Banks still hold toxic assets, including subprime mortgage paper and even prime mortgage-backed securities, which are still being unwound. They are facing unprecedented defaults on credit card lines, automobile loans, student loans, and other loans to small businesses.
So credit is still constrained, especially for small businesses, 82 percent of which use credit card lines as a vital portion of their overall funding. Those credit lines have been cut by at least 25 percent, while lending standards have been tightened dramatically. Similarly, there has been a constriction in home equity loans, another widely used source of funding for small businesses. But given banks' shrinking loan books and the dubious credit of their existing loans, the only way for banks to make money is to ride the yield curve. This means taking billions of dollars in deposits or other funds, mostly from the Federal Reserve and costing them less than 1 percent, and then investing them into medium-term treasuries or high-quality paper at 3 percent or more. The administration's approach of taking proprietary trading away from the banks means that they lose the one area where they could make money over the next few years. This raises the danger that we will have a zombie banking system similar to Japan's in the 1990s, when banks were functioning but incapable of extending credit. If the administration wants to restrain certain activities of banks, it could raise the appropriate capital requirements, especially for proprietary trading, so that shareholders have more at stake and will be the ones to absorb the losses before anyone has to turn to the government.
One step to consider now would be to provide financial institutions with liquidity by having the Fed buy nonliquid, asset-backed paper for realistic discounted market prices so that the speculators and the banks would pay for their bad behavior by realizing their losses. The banks don't want to show these losses, but at least that would help restore additional liquidity to the banks.
The banks alone did not create the meltdown mess. The American public played its role when it turned from saving to borrowing, going on a consumption binge based on credit rather than earnings and then borrowing against its rapidly appreciating housing assets. Many people cheated on their mortgage applications, especially loans that required no verification of the borrowers' income or net worth, which infamously became known as "liar loans." And let's not forget the regulators from the Securities and Exchange Commission on down who failed to police these activities, or the lawmakers who failed to adopt new rules to prevent the side effects of increasingly complex financial innovations. They failed to understand that, cumulatively, this posed a "systemic risk." Congress itself, now busy pointing the finger, was grossly negligent in failing to rein in Fannie Mae and Freddie Mac, which congressional Democrats saw as honey pots for their party colleagues and as sources of campaign contributions.
This administration loses rather than gains when it gives the impression that it is putting politics ahead of policy, staying in a campaigning and not a governing mode, and attacking the business world as a political tactic. In the end, the American people are going to demand: Where are the jobs? Unemployment is the leading indicator when it comes to politics. Jobs, jobs, jobs must be the No. 1 challenge, and antibusiness rhetoric is not going to help.
This is the time for wise policy, not smart, showy politics. It would not serve the country if Obama swung for his second trapeze and it wasn't there.