Pearlstein: Obama's Economic Policies

Washington Post columnist Steven Pearlstein was online Wednesday, Jan. 21 at 11:00 a.m. ET to discuss Obama's economic policies.

Read today's column: Obama and the Expansion of Possibility.

A transcript follows.

About Pearlstein: Steven Pearlstein writes about business and the economy for The Washington Post. His journalism career includes editing roles at The Post and Inc. magazine. He was founding publisher and editor of The Boston Observer, a monthly journal of liberal opinion. He got his start in journalism reporting for two New Hampshire newspapers -- the Concord Monitor and the Foster's Daily Democrat. Pearlstein has also worked as a television news reporter and a congressional staffer.

Pearlstein was honored with the Pulitzer Prize for commentary for his columns about mounting problems in the financial markets. His award was one of six Pulitzer Prizes won by The Washington Post this year.

Read Pearlstein's latest columns.

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Washington, D.C.: Great column today. Can you talk a bit on why bank stocks plummeted again? I have a vague notion that investors are finally realizing how worthless all these CDOs and related financial instruments are, but I don't know the details. Also, what is the best way to get an honest accounting of what is on the banks' books?

Steven Pearlstein: Thanks. There are lots of reasons why banks are recording more and more losses on their books. Some of it has to do with genuinely bad loans. Some of it has to do with the fact that prices of instruments have plummeted (or are impossible to really determine) more than they should have because nobody wants to buy these instruments, which in the long run might actually be worth more than they are now prices. So investors are wary. And every quarter, we go through this exercise where the banks take bigger writeoffs than had been anticipated, and then people think, well, maybe its worse than even that, and then steps are taken to stabilize confidence, the stock goes up a bit, and then the next quarter it all happens again. Not sure there is anything to do about this other than make sure the banks continue to have adequate capital while looking for a way to make use of government funds to restart these markets, as Henry Paulson first proposed.

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Staten Island, N.Y.: Your columns and chats are great.

Thought experiment--If some of the current large banks were to fail due to toxic assets, etc., would not other new, unencumbered banks arise to pick up much of the slack?

The economy needs a healthy financial system. Does it need to include most of the same players it has now?

Steven Pearlstein: There is no problem, in theory, with a bank disappearing, which may well happen, either through a takeover by the FDIC (a failure) or through a merger. But failures have a psychological effect on markets, depositors, lenders, etc. So if we can avoid those highly visible failures, it is probably worth doing.

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Reisterstown, Md.: Here's a solution to the credit crisis that I've seen discussed by several people who, unfortunately, are not the ones in power: Yes, we need a banking system and we need credit. But instead of pouring $700 Billion dollars into the existing banks to buy up their mistakes, why don't we take that taxpayer money and fund new banks, that don't have any of those toxic assets? That way all of the taxpayer money can go right into making new loans, instead of helping the existing banks dig out from their bad debts.

Yes, we need banks, but do we really need Bank of America? They are the ones who made the mistakes and got us into this mess. Let them work their way out of it. If they go under, they go under. And we, with new banks, move on.

Steven Pearlstein: That is a very interesting idea. But to a degree it is based on an oversimplified assumption, which is that our only problem is that banks aren't lending. That is not our only problem. It is not even our biggest problem. Just as important is the fact that the shadow banking system, the markets where loan-backed securities are issued and traded, has effectively shut down. Just as important is that trillions of dollars in losses are working their way through balance sheets of pension funds, corporations and households. You have to also remember is that loan demand is down -- way down -- and that even a new bank, exercising the kind of prudence we hope bankers exercise, wouldn't lend into this economic environment.

There is something to what you say. But the mirror image of your proposal is to get some of the toxic assets off the books of existing banks, so they can make the prudent loans that are needed and requested, which they have every incentive to do since that is how they make money. Creating whole new institutions may satisfy some collective need to "punish" the idiots who got us into this mess, but it probably isn't the most practical solution.

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Sarasota, Fla.: Good morning, Steven; regular reader on vacation.

A lot of people are hoping Mr. Obama's administration represents the final un-doing of the political orientation begun under President Reagan. Remember early in his term, he said in a speech something to the effect that "under a capitalist economy, each individual can improve the total economy by maximizing their own outcomes."

While I agree the real test of Mr. Obama's rhetoric will be to increase the cooperative aspect of capitalism, isn't another important test of its effectiveness going to be whether demographically-defined groups don't insist on their special pleadings? Under a completely Democratic-controlled government, how long will it be before feminists demand a 23% pay increase in women-demoninated occupations (along with quotas to prevent men from taking those jobs after the salary goes up); or African-American organizations to claim that stabilizing their communities requires a ethnic-based mortgage loan forgiveness program?

Steven Pearlstein: I think you've been reading too many right-wing blogs and investment newsletter or listening to too much right wing radio. The idea that government is going to run the economya nd run it through some sort of racial and gender quota system is a right-wing fantasy. You've never heard Obama talk once about such a thing. He's not for it. He's not stupid enough as a politician to try it. So relax down there in Sarasota and enjoy the sunshine.

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New York, N.Y.: Hi Steve,

I work for BoA's investment bank and I'm stunned and saddened by the Fed's capitulation. Giving/guaranteeing 20/118bb is completely unfair to the tax payers of the country and the shareholder of the company. How can they continue to offer these loans but not require changes of leadership?

The amazing thing is that the same place where all these losses are supposedly emanating (we STILL haven't been told the source exactly) is the same place where the new leaders of the combined org are coming from. Thain is still prominent, several desk heads are from ML, and the combined risk organization is also a ML guy.

What am I missing? And why shouldn't I be upset (I don't care if I lose this job)?

Steven Pearlstein: It's hard to understand why the Bank of America would want to keep people who were responsible for all the bad decisions. They don't have to. And if these people are likely to make bad decisions again, it won't help anyone in management, certainly, to say nothing of Bank of America shareholders. So I'd turn the question on you and ask why you think these people are doing things that are against their own self-interest. Is it possible you and they have a simple disagreement about how inadequate you think these Merrill holdovers are?

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Bernardsville, N.J.: Mr. Pearlstein,

In your latest column, you characterized the current economic situation as "a crisis that, with luck and an extraordinary amount of public spending, can be managed and contained but cannot be quickly resolved."

Do you think that the federal government has the capacity, considering the record deficit, to inject sufficient capital into the economy to successfully contain the crisis? And even if it does, it seems to me that the manufacturing and production base that was the foundation of our economy is by no means as strong as it once was. So will this grand experiment in massive pump-priming be able to actually bring about restoration of our economy's core productivity?

Steven Pearlstein: Yes, we have the capacity. And no, its not all about manufacturing. That's an urban legend that many on the left continue to hang on to. Switzerland doesn't have much of a manufacturing base, outside of chocolate, and it is a very rich country. Obviously, given our resources and our size and our history, we should and do continue to have a vibrant manufacturing base. It could be strengthened further with ingenuity and some better public policy. But it will continue to employ fewer people even if it holds its share of GDP, thanks to welcome productivity gains and better technology. And as time goes on, there will be some things that we won't make because our labor costs (read standard of living) are simply too high. Good jobs are good jobs, in whatever sector they are created. Not all manufacturing jobs are good jobs and not all good jobs are in manufacturing.

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Berlin, Germany: Mr. Pearlstein, First, let me add my voice to the chorus thanking you for the thoughtful commentary and wise counsel you have been providing readers for so long. It was because of you that I got out of the stock market before the crash. My question: I read that last week Goldman Sachs projected banking industry losses (since the start of the financial crisis) could total more than $2 trillion. Nouriel Roubini has said the losses could reach $3.6 trillion. Do you agree with Roubini? Just wondering....At this point, when do you project that the stock market will finally start making a sustained recovery? Thanks very much.

Steven Pearlstein: I have no idea whether it is 2 or 3 billion, nor even any basis to hazard a guess. I've always intuited that it would be a big number, but in truth it depends on the path of a number of markets and the depth of the recession, because those will determine how much commercial real estate has to be written down and written off, takeover loans, home loans, etc. It's just not a knowable number, with any precision. As for the stock market, don't be in any rush to get back. There will be several more false dawns in all likelihood, and because it is unlikely the economy will start to turn around before 2011, I don't think you have to worry about a sustainable stock rally this year.

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Gerrardstown, W. Va.: What do you think of Paul Krugman's recommendation the other day for shoring up failing banks?

"A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks' debts to make them solvent; and sold the fixed-up banks to new owners."

Steven Pearlstein: We'll have to do some of that anyway, through the normal bank failure process. If we can take intermediary steps by shoring up capital and buying some toxic assets and restarting parts of the shadow banking system, however, that would be less disruptive and perhaps less costly.

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Hong Kong: Why not pay for part of the bailouts with a large retrospective tax on the senior executives of these financial institutions. This would (a) be fairer than taxing innocent citizens and (b) be a great deterrent for future banks and insurance companies from behaving like Merrill, AIG etc

Steven Pearlstein: Retrospective taxes are awfully hard to construct in a legal and constitutional manner.

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Anonymous: Steven....750 Billion right on. We don't need another Bubble.

Steven Pearlstein: Right on, that. But don't know what you refer to with 750 billion.

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Springfield, Va.: Steven: With all the talk of certain banks, financial companies, manufacturers, etc being "too big to fail", is anyone seriously doing anything to end this type of situation? Do you beleive the government will break up these huge companies in order to keep this from happening again? If they don't it would be a true slap in the face to the taxpayers. Seems like a no-brainer to me. Any new anti-trust legislation on the horizon?

Steven Pearlstein: There is no reason banks have to be as big as citigroup, but there is something to be said for having big national banks that might qualify as too big to fail. The trick is to regulate those banks well so they don't fail. Keeping the banking system highly fragmented has its downsides in terms of efficiency, cost, lack of innovation, etc.

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Alexandria, Va.: Your article is "on the money" with respect to many actions needed to enhance our society. I question the preponderance of real estate lobbies who have persuaded Congress to pass so many laws favoring home ownership that we are now strangling on the overemphasis of placing the country's precious capital into buildings. Shouldn't Congress begin to reconsider incentives to build our productivity, including strengthening our competitiveness in exports (manufacturing, entertainment, agricultural output, and whatever else we can export) in order to better balance our budget deficit?

Steven Pearlstein: On the hierarchy of problems to be addressed, getting rid of excessive (and I agree theya re excessive) inducements to home ownership is not very high at the moment. The homebuilders now predict that they will build 440,000 new homes this year, down from 1.7 milion at the 2005 peak. That is probably enough of a drop to say that whatever inducements are out there aren't distorting things very much at the moment.

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College Station, Texas: You have written that the country needs to reduce its massive debt before the current crisis is truly resolved. Given that the world has been living off of the US debt spree, there will need to massive changes in global economic system when that happens. What do you see as the system that will emerge, both in the US and globally?

Steven Pearlstein: Good question. Yes, our massive adjustment to living within our means will require a massive, mirror adjustment in the economies of our trading partners, who will have to consume more and save less and depend more on domestic demand and domestic investment than in exporting goods and credit.

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Lansdowne, Va.: I was puzzled by this line in your column this morning -- "We'll know when enough corporate tax loopholes are closed to lower the corporate tax rate to 25 percent". Did you mean "to RAISE the corporate tax rate"?

Steven Pearlstein: The corporate tax rate is 35 percent, or was when I last looked. The effective rate is lower, of course. What I was proposing was to close the gap between the posted rate and the effective rate by getting rid of all sorts of ridiculous and unproductive tax loopholes.

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Evanston, Ill.: Hey Steven, Christopher Wood wrote this in the FT yesterday, "This approach reached its ludicrous extreme in the November bail-out of Citigroup, where the US government put more money in than the entire market capitalisation of the company on the day the deal was announced. But the taxpayer ended up with only a 7.8 per cent equity stake while incumbent management was left in place!" At what point should we nationalize failing banks, a la Sweden, and resell them in a couple years? If nationalization is the probable outcome why wait for the next big crisis to do it? Prudence would seem to dictate doing it prophylactically.

Steven Pearlstein: You have anticipated a future column. There is no reason why the taxpayers can't own at least 49 percent of these companies that we effectively recapitalize and, by right, ought to own. Actually owning and controlling them brings us into a whole new territory, nationalization, that we may prefer to avoid. But at least get 49.9 percent if the company revives!

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Washington, D.C.: Should the Obama administration consider altering the "mark to market" accounting regulations?

Steven Pearlstein: There is a lot of debate about that, but I think there is some validity to it.

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Meyrin, Switzerland: What sort of regulations in the financial markets would you recommend that the new administration implement?

Steven Pearlstein: How much time have you got?

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Puzzled in Washington D.C.: Can you explain why a decline of 2.7 percent in retail sales is such a disaster? It's obviously not good, but the decline seems pretty small. Is it that retailers' margins are so small that a decline of 2.7 percent wipes out all their profit? I don't understand, and it's also obviously relevant to the new administration's economic plan.

Steven Pearlstein: I don't think it is a disaster -- its part of the necessary adjustment process. The only way we are going to get consumption back in line with production is to significantly reduce our consumption, and that means buying less stuff. That's tough on retailers, but that's the reality.

Having said that, if you have a 2.7 percent decline, at a time of inflation and still-rising incomes, however, then the significance of the decline is really much greater than 2.7 percent in terms of share of wallet, adjusted for inflation.

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The effective rate is lower, of course: The effective rate is 18 percent. The percent of taxes made by corporations in the U.S. is the lowest in the developed world.

Steven Pearlstein: My point exactly. Raise the base and lower the rate -- the basis for all good tax reform.

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Clifton, Va.: Sorry give all the American people tax cuts. Yeah even the rich. I trust them to spend their money better then the govt spending our tax dollars. Infrastructure spending will take years before it actually happens and most of it not to well in a possible Obama second term. Rushing to will just result in the poltically connected getting the Contracts and money going up in smoke.

Obama needs to restore confidence and establish an economic climate that fosters the creation of new businesses and and job expansion. Sorry Speaker Pelosi eliminated the Bush tax cuts immediately will ahve the opposite effect. We also need to cut the corporate tax to make the US competive with the rest of the world.

Steven Pearlstein: Sorry, but there is no empirical basis for your statement that eliminating the Bush tax cuts will have a bad effect on economic growth. No evidence for that in the real world, only on napkins.

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Nationalization: Okay, anyone who can read a balance sheet (or better yet in this circumstance when balance sheets are so unreliable, knows which way the wind blows) knows that this is where the bank crisis ends. How long 'til then? What Frank Luntz'ed, poll-tested euphemism do you suggest for "nationalization"?

Steven Pearlstein: Public recapitalization.

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Princeton, N.J.: I may be wrong about this, but I thought that in the S & L mess, we set up an entity that took over the bad banks & gave the shareholders nothing. They got rid of the bad loans and reconstituted the banks when they could and sold them off. I think the Swedes did something similar in their bank crisis. Our plan now seems to be to throw money at the bad banks and pray. Why aren't we doing what worked in the past?

Steven Pearlstein: We do that when banks fail. What we're trying to do is to prevent banks from failing. It is not clear, as you presume, that all of these banks are now clearly insolvent. Nor is it clear that taking them all over would be better than propping them up under a tightened set of regulatory guidelines. The big difference to the two approaches is that one preserves some value to the shares held by stockholders. Those shares have declined in value to almost nothing, so that difference isn't a big one in financial, economic or even moral terms. That leaves only this difference, which is who is to benefit once the crisis passes and those shares start to have value again. And that is where I do agree that the Treasury has been too easy on the terms of these recaps by not demanding warrants on 49.9 percent of the equity. That stops just short of nationalization and seems to get the incentives right all around: the taxpayer gets something for his risk taking, and the company still has capitalist incentives to grow rather than behaving like a government bureaucracy.

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Baltimore, Md.: Re the markets on Tuesday: I was expecting a "feel good" bounce in the markets yesterday fuelled by the inauguration. Instead, the DOW was off by some 330 points because of bad news regarding banks. My question is, is this a sign that the market is being rational--that it is not reacting to non-economic news, as it sometimes does, but instead is focused purely on fundamentals? Or is it just that everyone is so scared? Thanks.

Steven Pearlstein: Don't read too much into one day's movement, or buy into the fiction that there is some collective consensus that the Dow Jones average captures at every moment in time. The prospect of bank nationalization spooked short-term traders who determine the movement of markets on most days. That's all that happened.

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Fragmented Banking System: I'd argue that a fragmented banking system would be better for innovation than the more consolidated one we have now. More competition always drives more innovation. I like Krugman's solution better because it wipes out current shareholders of failed banks. Why should we prop up those investors?

Steven Pearlstein: You like Krugman's solution because it satisfies your very understandable emotional demand for revenge and fairness. What we don't know is if it is really necessary, or whether we can try a variety of tools that are less disruptive and ultimately less costly. On that there is still debate. If there were consensus, then we would have already done that stuff. It's always been an option on the table.

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Washington, D.C.: Why shouldn't President Obama and the congress declare a FICA tax holiday in order to stimulate the economy rather than wait for longer term "infrastructure" projects that could take 12-24 months to impact the economy?

Steven Pearlstein: Lots of reasons, but the simplest explanation is that if the governments spends a dollar to hire people and buy stuff, then a dollar is added to aggregate demand. If the government gives a dollar to a worker, he might spend half and use the other half to spend down debt. That means only 50 cents is added to aggregate demand. If stimulus is using government money to add to aggregate demand for goods and services, then one dollar is twice as effective as fifty cents.

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Evanston, Ill.: If temporary nationalization is the probable outcome, the banks are insolvent or very close to being so, why wait for the next big crisis to do it? Prudence would seem to dictate doing it prophylactically.

Steven Pearlstein: Actually, prudence dictates not creating a psychological crisis that has unnecessary spillover effects on other markets.

Folks, this isn't Sweden. This isn't even the US Savings and Loan crisis. It's bigger than that, with much more complexity in terms of how it all works back through financial instruments into the real economy. The people who are now saying the simple, inevitable solution is nationalization are many of the same people who argued that recapitalizing the banks was the simple solution, rather than buying up toxic assets. The problem is that there is no simple solution to this financial crisis, and it does not necessarily lend itself to a "rip off the bandaid" approach.

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Reston, Va.: What do you think are the chances of Obama's stimulus package raising the limit on conforming mortgage loans, in light of prices here in the capital area region? Bush had extended the limit to $749K, but my understanding is that expired on Dec. 31, 2008?

Steven Pearlstein: The jumbo market has resumed operation, but the costs are still high. We may have to extend that so Fannie and Freddie can stabilize those markets as they continue to do with the "conforming" market.

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Steven Pearlstein: That's all the time we have to today, folks. "See" you next week.

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