Summers overplays stimulus, silent on zombie bank drag
By Benn Steil
The opinions expressed are his own.
Reuters invited leading economists and writers to reply to Larry Summers’ op-ed on his reaction to the debt ceiling deal. We will be publishing the responses here. Below is Steil’s reply. Here are responses from Laura Tyson, Russ Roberts, Donald Boudreaux, Robert Frank and James Pethokoukis as well.
Larry Summers expresses relief, cynicism, and anxiety in the wake of the debt deal. I second these emotions. Whereas those elected to the House on a hardline anti-tax, anti-spending platform had every right to press for their policies, threatening to push the country into a catastrophic default if the democratically elected Senate and president didn’t give them their way was reprehensible. Mind you, these congressmen were some of the same folks who backed the 2005 Bankruptcy Reform Act on the grounds that default was a form of moral turpitude.
I suspect that Larry still overestimates the stimulus (or “fiscal multiplier”) effects of temporary government spending and tax cuts, though his suggestions — in particular, extending the payroll tax cuts — are hardly outlandish. What concerns me is that the Administration believes, and Larry’s silence suggests he believes, that we’ve done all that needs to be done to fix the structural problems in the financial sector that are still weighing the economy down.
There are real dangers lurking in the breakdown of a major part of the credit transmission mechanism. Large corporations, like IBM, that can bypass the busted banking sector and issue securitized debt are clearly benefiting from record low borrowing costs. But small- and medium-sized companies have always been dependent on small- and medium-sized banks, whose balance sheets are still cluttered with the detritus of soured loans. These banks will not lend, except on vastly greater collateral and at much higher real interest rates than before the bust. Little recognized is that the firms, for their part, have for years relied overwhelmingly on real estate for their collateral, the value of which has been badly impaired or obliterated. So a zero Fed funds rate is doing little for them.
I still believe it was a mistake that TARP did not ultimately include an element to extract impaired assets from bank balance sheets — particularly those of smaller institutions that are the backbone of nonsecuritized business lending. Government equity injections are not enough; banks consider them politically toxic, and therefore have focused on disgorging them at the earliest opportunity.
Previous U.S. administrations recognized the importance to economic recovery, at home and abroad, of moving aggressively to repair or resolve zombie banks. Macroeconomic interventions such as payroll tax cuts, extended unemployment insurance, or even another round of Fed quantitative easing are not enough given the nature of the financial crisis we’ve just been through.