James Pethokoukis

Edward Harrison of Credit Writedowns has a great piece on Obama and crony capitalism:

There is a rather large body of evidence demonstrating that the Bush and Obama Administrations have favored large banks in an unseemly way. The same is true for the Congress and other big business insiders like Big Pharma, the Defense Industry and Health Insurance companies.

Witness these posts from the last month alone:

• The less optimistic view of Treasury’s handling of the crisis – Nov 2009
• Healthcare insurance industry insider: “We win” – Dec 2009
• Why is Barney Frank allowing lobbyists to gut financial reform? – Dec 2009
• Bank lobbying e-mail: Quid Pro Quo to kill mortgage modification bill – Dec 2009
• Obama and the Fat Cat bankers – Dec 2009
• U.S. forfeiting billions in future taxes to let Citi repay TARP – Dec 2009
• Gasparino: No woodshed for the fat cats, just a lovefest – Dec 2009
• The phony Senate health care reform bill – Dec 2009
• On releasing Citi from TARP and banking by accounting subterfuge – Dec 2009
• Blodget: Obama suffers because “taxpayer always finishes last” –Dec 2009

I could provide you with a far longer list of posts from the January to April period when the Citi and BofA bailouts were conducted and the alphabet soup of liquidity programs began which Bank of America and Citi were prepared to game.

I said in March it’s the writedowns, stupid. When accounting rules were formally changed to reflect the de-facto accounting policies favoring banks, I knew the big banks were on easy street and The Fake Recovery had begun. So, by April, I said Wells profit forecast is a clear bullish sign. Don’t even get me started on the stress tests. They were a sham from the start and were merely a means of recapitalizing the banks via inflated equity valuations. They were neither tests nor stressful, as Bill Black has demonstrated.

More recently, posts by Yves Smith and Bruce Krasting confirmed my long-held suspicions that Fannie Mae and Freddie Mac would be used as a nationalization of America’s mortgage problems via a back door bailout of banks.

The evidence, therefore, tends to demonstrate that we have witnessed an orchestrated campaign by the Bush and Obama Administrations to recapitalize too big to fail institutions by hook or by crook, bypassing Congressional approval if necessary. And when it comes to healthcare, both Congress and the White House have bent over backwards to keep the lobbyists onside. As I see it, our government has favored special interests in the past year of Obama’s tenure to our detriment. … Personally, I don’t buy the line that Obama is a liberal. I consider him more a corporatist (i.e someone who coddles big business).

Interesting analysis from Deutsche Bank, especially the last part which I put in bold (via Econbrowser):

Based in part on CBO estimates, we expect the combined positive effects on the level of real GDP of the tax cuts, transfers, and spending increases in the ARRA package to peak around the middle of next year and then to begin to diminish. Translating these level effects into impacts on the annual rate of growth of GDP yields a boost of 1 to 2 percentage points to GDP growth through mid-2010. That growth effect then drops to zero and eventually turns negative during the second half of the year, subtracting about a percentage point from growth during 2011. This is a key reason why we see growth receding somewhat in 2011 relative to 2010. We have not assumed that a major portion of the Bush tax cuts will be allowed to expire at the end of 2010, but that does pose a downside risk to the forecast.

Me: And here is all that in chart form:

Paul Krugman makes his case for the New Normal:

1) Earlier recessions were preceded by sharp rises in interest rates, as the Fed tried to choke off inflation. This produced a housing slump, with a lot of pent-up demand; when the Fed decided that we had suffered enough, it relented, and both housing and the economy sprang back.

2) But later recessions took place in a low-inflation environment, in which booms died natural deaths from overextended credit and overbuilding. Getting the economy growing fast enough to bring unemployment down after these recessions was therefore much harder, since the usual channel of monetary policy — housing — lacked any pent-up demand.

3) So what about our current situation? It’s just like the two previous “postmodern” recessions, only more so, since the bubble before the slump was in housing itself. This suggests a long period of jobless growth; so does the international evidence on the aftermath of financial crises.

That said, there’s been a lot of optimism out there lately, reflected in the steepening yield curve. I’d like to think that’s right. But Ed McKelvey at Goldman (no link) has a new report titled “Recovery more Ho-Hum than Ho-ho-ho”, in which he acknowledges that growth will be good this quarter, but presents evidence that it’s all a temporary inventory bounce.

The great Andrew Biggs makes a great point about the Medicare advisory commission in the Senate healthcare bill, a cost-control measure that Peter Orszag calls one of the most potent in the bill:

The new board is empowered to impose cost reductions if Medicare cost growth exceeds the growth of Gross Domestic Product plus 1 percent. Congress must accept these reductions or come up with equivalent cuts of their own.

But here’s the problem: Medicare’s baseline level of growth is right around GDP plus 1 percent. In the past, the Medicare trustees made their “GDP plus 1” cost growth assumption explicit; currently, they use a more sophisticated model of healthcare cost growth that nevertheless mimics the effects of GDP plus 1.  (See pages 178–180 of the 2009 Trustees Report.) CBO’s projected rate of “excess cost growth” is slightly higher than the trustees’, but this plays out mostly in the longer term, by which time we’re long since broke.

In other words, the Medicare advisory commission—despite all the controversy over “rationing care”—isn’t tasked with much more than limiting Medicare cost growth to a rate baseline which some experts have calculated will generate over $62 trillion in deficits over 75 years. Even if Medicare cost growth were held to GDP plus 1 percent, total costs through the 2030s would cut by only around 5 percent.

The WSJ nicely sums up 2008:

To prevent crumbling housing and credit markets from sinking the broad economy, the Bush and Obama administrations and the Federal Reserve spent, lent and invested more than $2 trillion on one initiative after another. If you owned a credit card or a money-market fund, had a savings account, bought a Dodge pickup or even a hunting rifle, or borrowed to buy a home or finance a small business, odds are good that the U.S. stood behind you or the firm that served you.

Washington pumped $245 billion into nearly 700 banks and insurance companies and guaranteed almost $350 billion of bank debt. It made short-term loans of more than $300 billion to blue-chip companies. It propped up life insurers and money-market funds.

It bailed out two of the three U.S. auto makers. It lent billions trying to jump-start commercial-real-estate, small-business and credit-card lending. In two February stimulus bills enacted a year apart, the government committed $955 billion to rouse the economy. Today the U.S. government, directly or indirectly, underwrites nine of every 10 new residential mortgages, nearly twice the percentage before the crisis. Just last week, the Treasury said it would cover an unlimited amount of losses at mortgage giants Fannie Mae and Freddie Mac through 2012.

But voters don’t seem to be buying the idea that the government saved the economy. This from pollster Rasmussen (note the last sentence):

The number who believe that the stimulus plan has hurt the economy rose from 28% in September, to 31% in October, and 34% in November before jumping to 38% this month. The week after the president signed the bill, 34% said it would help the economy, while 32% said it would hurt.

The Political Class has a much different view than the rest of the county. Ninety percent (90%) of the Political Class believes the stimulus plan helped the economy and not a single Political Class respondent says it has hurt. (See more on the Political Class). The underlying reason for skepticism about the stimulus plan is that 50% of voters believe increasing government spending is bad for the economy. Just 28% believe that increased government spending helps the economy.

Me: Americans rightly think the economy is in terrible shape. The argument that the economy would be worse if not for government is a hard one to make for Team Obama … especially since government played a critical role in creating the housing and financial crises. Making all this worse is a 2010 economy that may be a muddle at best — so-so growth, unemployment still above 9 percent, rising interest rates and moribund housing.

So the Treasury Department announces unlimited support for Fannie Mae Freddie Mac for the next thee years. I think Wall Street Pit raises a very provocative point on this might all relate to the 2010 election:

In an attempt to limit the damage the economy does to their majority in the 2010 elections, the administration is likely to go all in on mortgage modifications that require principal reduction. They can only take so much skin off of the banks in this effort and the last thing they want is to put the financial system back in another crunch. That leave Fannie and Freddie as the vehicles to bail out homeowners that so far have resisted efforts to “save” them. It makes perfect sense that the Treasury’s announcement of unlimited support would be followed by a big, new homeowner bailout program.

Business Insider also touches on this:

Revisions to the flagging Homeowner Affordable Housing Program (HAMP). Any changes will likely increase near term bailout costs to Fannie and Freddie if HAMP’s current reliance on interest reduction is replaced in part by principal reduction. The losses associated with a modification of a loan using an interest rate reduction are spread out over time while a modification using principal reduction results in taking a more immediate loss.

As does Calculated Risk:

There is a possibility that the Treasury is planning on introducing a principal reduction component to HAMP in January, and this could lead to significantly larger losses for Fannie and Freddie (just speculation on my part). There has been no announcement yet, and even if this is proposed it might only apply to Fannie and Freddie related loans, and not private MBS (the number of Fannie/Freddie loans compared to private MBS varies significantly by servicer).

[See update at bottom] A group of Republican senators, led by Jeff Sessions and Judd Gregg, are accusing the Democrats of double-counting Medicare tax hikes and spending cuts as both extending the solvency of the program and paying for expanded healthcare coverage. So they asked the CBO for its opinion. Here is the CBO’s response:

The key point is that the savings to the HI trust fund under the PPACA would be received by the government only once, so they cannot be set aside to pay for future Medicare spending and, at the same time, pay for current spending on other parts of the legislation or on other programs. Trust fund accounting shows the magnitude of the savings within the trust fund, and those savings indeed improve the solvency of that fund; however, that accounting ignores the burden that would be faced by the rest of the government later in redeeming the bonds held by the trust fund. Unified budget accounting shows that the majority of the HI trust fund savings would be used to pay for other spending under the PPACA and would not enhance the ability of the government to redeem the bonds credited to the trust fund to pay for future Medicare benefits. To describe the full amount of HI trust fund savings as both improving the government’s ability to pay future Medicare benefits and financing new spending outside of Medicare would essentially double-count a large share of those savings and thus overstate the improvement in the government’s fiscal position. [Bold is mine-JP]

Me: Basically, the government is taking money out of Medicare’s Hospital Insurance trust fund, replacing it with IOUs and then spending it. But the CBO doesn’t score such intra-governmental transfers as the same sort of debt as when a Treasury bond is issued. But it is an obligation just the same. If not for this accounting quirk, the Senate health bill seemingly would be scored as increasing the budget deficit by $170 billion or so over the next decade (itself a funny number since taxes come first, then benefits) instead of cutting the deficit by $130 billion.  This is a similar shell game played by the government when it uses Social Security surpluses to mask the true depth of the budget deficit. I don’t see how supposed Dem budget hawks like Mark Warner and Kent Conrad and Evan Bayh can go along with this. This is just as bad as the shunting $250 billion in doctor payments into a different bill to hold down the official cost of ObamaCare.

The Centers Medicaid & Medicaid Services made a similar statement a couple of weeks back on Medicare funding:

The combination of lower Part A costs and higher tax revenues results in a lower Federal deficit based on budget accounting rules. However, trust fund accounting considers the same lower expenditures and additional revenues as extending the exhaustion date of the Part A trust fund. In practice, the improved Part A financing cannot be simultaneously used to finance other Federal outlays (such as the coverage expansions under the PPACA) and to extend the trust fund, despite the appearance of this result from the respective accounting conventions.

UPDATE: Douglas Holtz-Eakin, a former CBO director, adds his two cents:

I read the CBO and they made the point exactly right: money can only be spent once.  The D’s are (again) trying to use dollars twice.  The first time (Bennet) amendment said they would not reduce Medicare benefits, but used medicare savings to fund subsidies.  Now they are saying they will put the money in the trust fund (and spend it on medicare) but use it to fund subsidies.  It is fundamentally dishonest.

The super-steep yield curve is hinting at a powerful recovery in 2010, so says Larry Kudlow:

When the curve is wide and upward sloping, as it is today, it tells us that the economic future is good. When the curve is upside down, or inverted, with short rates above long rates, it tells us that something is amiss — such as a credit crunch and a recession.

The inverted curve is abnormal, the positive curve is normal. We have returned to normalcy, and then some. Right now, the difference between long and short Treasury rates is as wide as any time in history. With the Fed pumping in all that money and anchoring the short rate at zero, investors are now charging the Treasury a higher interest rate for buying its bonds. That’s as it should be. The time preference of money simply means that the investor will hold Treasury bonds for a longer period of time, but he or she is going to charge a higher rate. That is a normal risk profile.

The yield curve may be the best single forecasting predictor there is. When it was inverted or flat for most of 2006, 2007, and the early part of 2008, it correctly predicted big trouble ahead. Right now it is forecasting a much stronger economy in 2010 than most people think possible. So there could be a mini boom next year, with real GDP growing at 4 to 5 percent, perhaps with a 6 percent quarter in there someplace. And the unemployment rate is likely to come down, perhaps moving into the 8 percent zone from today’s 10 percent.

Unless it isn’t, as David Goldman predicts:

The yield curve is at record steepness. I think that’s an overreaction. In fact, the steep yield curve in the present environment is NOT a harbinger of recovery — it’s a brake on recovery because it encourages banks to own Treasuries rather than risky assets.

Goldman then goes on to list 9 other reasons why he doesn’t think the recovery will be particularly strong.

A surtax to pay for healthcare? Not good. Former Bush White House economist Alan Viard explains:

First, it would significantly increase marginal tax rates for the affected households, giving them greater incentives to reduce their taxable income through various avoidance strategies. Even with moderate responsiveness to incentives, the revenue generated by the surtax would be significantly smaller than the burden that it would impose on affected taxpayers.

Second, the surtax would significantly increase the marginal tax rate on saving and investment by the affected households, whether done through corporate or noncorporate firms. The impact would be magnified because these households, despite their small numbers, account for a large portion of national saving. The resulting drag on capital accumulation would lower real wages for workers throughout the economy.

Third, the proposed surtax reflects an unsustainable approach to tax and fiscal policy. As commentators across the political spectrum have recognized, the existing fiscal imbalance cannot be addressed without imposing sacrifices on a broad segment of the population. Any new spending programs, such as those in H.R. 3962, will impose additional burdens. By linking these programs to a tax imposed on only 0.3 percent of the population, the bill obscures that fiscal reality. If the programs in H.R. 3962 are worthwhile, they are worth paying for in an open and broad-based manner.

Blue Dog Parker Griffith of Alabama is making the switch:

POLITICO has learned that Rep. Parker Griffith, a freshman Democrat from Alabama, will announce today that he’s switching parties to become a Republican. According to two senior GOP aides familiar with the decision, the announcement will take place this afternoon in Griffith’s district in northern Alabama. Griffith’s party switch comes on the eve of a pivotal congressional health care vote and will send a jolt through a Democratic House Caucus that has already been unnerved by the recent retirements of a handful of members who, like Griffith, hail from districts that offer prime pickup opportunities for the GOP in 2010.

The switch represents a coup for the House Republican leadership, which had been courting Griffith since he publicly criticized the Democratic leadership in the wake of raucous town halls during the summer. Griffith, who captured the seat in a close 2008 open seat contest, will become the first Republican to hold the historically Democratic, Huntsville-based district. A radiation oncologist who founded a cancer treatment center, Griffith plans to blast the Democratic health care bill as a prime reason for his decision to switch parties—and is expected to cite his medical background as his authority on the subject.

Me: This is a district that McCain won with 61 percent of the vote. Griffith voted against the stimulus and has stated that he would not vote again for Nancy Pelosi as speaker. The Dems will now have a 40 seat majority in the House.