Obama’s Change You Can Believe in Meets Reality: Caroline Baum

Commentary by Caroline Baum

Nov. 6 (Bloomberg) — Karl Rove‘s permanent Republican majority, already eroded by the 2006 midterm election, was sent into exile on Nov. 4 along with an unpopular president.

Barack Obama and the Democrats swept the 2008 elections, winning a decisive Electoral College victory and picking up at least five and 18 seats, respectively, in the Senate and House of Representatives.

Change you can believe in has come to Washington. What will it look like to the rest of us?

The newly elected president inherits an economic and financial mess. The U.S. economy is in recession. The residential real estate market is being buffeted by rising delinquencies and foreclosures, falling home prices and tightening credit conditions.

Overseas economies are slowing. Many developed nations are contracting.

The consumer is retrenching after years of living beyond his means. Real consumer spending fell 3.1 percent in the third quarter, the biggest decline in 28 years.

The federal budget deficit hit a record $455 billion in fiscal 2008, which ended on Sept. 30, and analysts glibly talk about trillion-dollar deficits this year and next.

The government is throwing money at banks and non-banks seemingly on an ad hoc basis — in some cases without instituting the necessary management controls to minimize the loss to taxpayers. For example, American International Group Inc., which received an $85 billion credit line from the Federal Reserve on Sept. 16 to keep it afloat and an additional $38 billion three weeks later, is burning through cash at an alarming pace.

No Road Map

In other words, the era of big government was here even before the Dems took Washington.

A fiscal stimulus package is a near certainty, either before or after President Obama takes office on Jan. 20, or both.

“Bush won’t make enacting Obama’s stimulus package his last legislative action, but there will be pressure on Congress to do something for the economy before leaving,” write Tom Gallagher and Andy Laperriere of the ISI Group in Washington in their daily report.

The package is apt to put “more emphasis on spending, less on tax rebates,” says Jan Hatzius, chief economist at Goldman Sachs Group Inc.

The spending will be focused on infrastructure, things like roads and bridges. Unless this time is different, the money won’t necessarily be allocated efficiently.

“We have no grand economically inspired road map for allocating funds to transportation infrastructure,” says Jim Glassman, senior U.S. economist at JPMorgan Chase & Co. “There is no plan to assess the cost of sitting in traffic jams, for example. So we get irrational things: The money goes to building bridges.”

Help for Homeowners

What will Obama and the Democrats do about the implosion in housing, which begat the mortgage defaults that precipitated the credit crunch?

Expect “more forbearance and mortgage modification,” which means increased cost to the government, according to Alec Phillips, an economist focusing on policy research in Goldman’s Washington office.

President Obama and a Democratic-controlled Congress would be more favorably disposed to a plan floated by the Federal Deposit Insurance Corp. that would reduce interest rates for borrowers and write down the principal amount on some mortgages, Phillips says. A foreclosure moratorium could be possible next year.

Real Change

If it’s real change Obama is looking for, the new administration “could make housing into a middle-class entitlement,” says Neal Soss, chief economist at Credit Suisse in New York. “Once Fannie Mae and Freddie Mac are in government hands, it’s tempting to use them for policy purposes.”

Soss says the analogy would be to Medicare and Medicaid, the government health insurance programs for the elderly and the poor. As with those programs, the government “could set the rules, determine what it would reimburse and pay for, and lend against it,” he says.

While Obama hasn’t weighed in on the ultimate destiny of Fannie and Freddie, his administration — any administration, for that matter — should revisit the pros and cons of a national policy directed at homeownership for all. Many of today’s owners are owners in name only: They owe the bank more money than their home is worth.

More subsidization without consultation would be a mistake.

Some of Obama’s priorities — health-care reform, energy and environmental legislation and a more progressive tax code — will be either scaled back or postponed, Phillips says. Tax changes can be enacted under the budget reconciliation process, requiring a simple majority (51 votes) in the Senate.

Passive Action

The temptation will be to “stand still and do nothing,” Soss says. With the Bush tax cuts expiring in 2010, “there’s no urgent need to do anything,” especially when tax increases are the wrong prescription for the faltering economy.

The Democratic Congress may go forward with Obama’s proposed tax cut on 95 percent of Americans, some of whom don’t pay taxes. Just add that to the spending column, which is bloated and getting bigger by the day.

Obama may have promised to go through the federal budget “line by line, page by page,” cutting programs that don’t work and making necessary ones work better, but fiscal responsibility has been tabled for now. Neither the climate nor the composition of Congress argues for much in the way of line-item editing.

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