Paul Krugman has attacked Senator Evan Bayh‘s suggestion that the Obama administration “overreached by focusing on health care rather than job creation during a severe recession.” Krugman expresses great difficulty in seeing what this statement could mean.
Are people who say that Mr. Obama should have focused on the economy saying that he should have pursued a bigger stimulus package? Are they saying that he should have taken a tougher line with the banks? If not, what are they saying? That he should have walked around with furrowed brow muttering, “I’m focused, I’m focused”?
To answer Paul Krugman’s question, let me suggest that the severity of the current recession could have been reduced if the Obama administration had made financial regulatory reform its top legislative priority in 2009.
When President Obama was inaugurated in January 2009, the American economy was sliding into recession because of a catastrophic loss of confidence in our financial system. In the previous decade, global investors’ confidence in American financial institutions had brought vast capital inflows into the American economy. This confidence had been based on a perception that America’s legal and political system provided safeguards for investors that were second to none in the world. This confidence was shattered in 2008 with the collapse of Lehman Brothers.
A meaningful and effective financial regulatory reform in 2009 could have restored investors’ confidence, reviving investment flows and stemming the loss of jobs. Imagine how different the economic environment might have been on election day in 2010 if President Obama could have announced by September 2009 that, after an intensive review of the financial regulatory system by both Congress and the White House, he was signing into law some carefully designed and well-focused reforms that could restore investors’ and taxpayers’ confidence in American financial institutions.
The focus on health care reform made it impossible to achieve meaningful financial regulatory reform for more than a year after President Obama took office. Health care reform and financial regulatory reform are both extremely complex issues and both have been fiercely resisted by powerful vested interests. Neither reform could be accomplished without strong political leadership at the highest level. The Obama administration could only address one at a time, and only one could be the central focus in the crucial first year when the new President’s political capital was greatest. The Obama administration chose in 2009 to focus on health care reform.
It may be surprising that, when a catastrophic macroeconomic decline is clearly being caused by a loss of confidence in the basic regulatory controls of our financial system, that many leading economists would not see financial regulatory reform as an urgently needed remedy. The reasons may also be found in the history of economic theory, on which I may comment later.
[Thanks to Jeff and Sandeep for letting me guest-blog here.]
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November 8, 2010 at 7:19 am
foosion
Was the problem lose of confidence or was the problem that the banks were so leveraged and had made such bad investments that they were insolvent?
I believe it was the later (they were insolvent), unless by “confidence … that legal and political system provided safeguards for investors” you mean that the government would bail out the investors no matter what.
What regulatory reform were you proposing at the time and how would it have helped?
November 8, 2010 at 8:29 am
Bill
You do not know Congress. I worked there as a counsel on a rather bipartisan and technical committee 25 years ago, serving both Republicans and Democrats.
There is NO WAY that financial reform would have been done any earlier. No way on this planet earth.
The premise of your post is incorrect.
November 30, 2012 at 1:56 pm
Maria
Rich, we’re looking for a PATTERN here. Ok, so I asked for one expmale I think the Cantor incident is highly suspect. He’s a Jewish congressman amdidst the HCR fallout in Virginia. It’s not so far fetched to think it was a bigot, or that it may have been a warning on how to vote. (Note: He says it happened Monday night, i.e., before the vote.) Dan, I’m not claiming brilliance or anything of the sort. I just think it’s weird for someone to post an exact copy of somone else’s comment, without adding anything himself.
November 8, 2010 at 9:13 am
Nathan
I really don’t think it would have been any different. Health care reform, like financial regulatory reform, polled extremely well. Health care reform was also one of the major promises of Obama when he was a candidate in 2008. In the end, the point is this: if Obama has decided on pursuing financial regulatory reform INSTEAD of health care reform, the battle would have been just as grueling, just as tough, and probably would have passed by the skin of its teeth, just as health care reform did. Furthermore, it would have been just as watered down from its initial conception as was health care reform. Republicans would have battered the Democrats in the same way, said it would kill, rather than improve, the economy, etc., etc., etc. And in the end, the economy still would not be in a very positive state, just as it is. As with health care reform, financial regulatory reform would/will take quite a while to fully implement. …My point is: it wouldn’t really have changed much by NOW. Maybe the long term would have a very different effect, but for the NOW? The present? Not much, if anything, would be different.
November 8, 2010 at 1:04 pm
Fernando Fuster-Fabra Fdz.
First of all, let me congratulate you for using an original building facade for your blog picture. However, in all fairness, you should indicate that it is the work of a genial Spanish architect, Antoni Gaudí.
Secondly, I must say that the crisis is more than a mere issue of lack of confidence in the U.S. economy but rather to the leadership held by an erratic president bent on fulfilling a divine mission in Iraq. The loss of confidence came with him at the White House and the extreme unregulated abuse with his favouritism of those who were with him in the invasion plot. Now, the USA must pay the consequences of its actions then, and unfortunately the rest of the world is feeling the backlash.
December 2, 2012 at 12:55 am
Jesse
It is a HORRENDOUS bill, and does NOT go after what all is wrong with the present sytesm. Cost it will cost FAR MORE than what the WH tells you. Just look at the track record of any entitlements from the Fed Gov\’t, the costs have ALL spiraled out of control. Furthermore, they HID many costs in OTHER LEGISLATION that should have been included in this HC bill.
November 8, 2010 at 1:42 pm
Tom Grey
Welcome! While I fully agree with your conclusion about focusing on financial reform rather than health care, I don’t believe your premise:
In the previous decade, global investors’ confidence in American financial institutions had brought vast capital inflows into the American economy.
I think it was Mortgages (& their Backed Securities), which all rocket scientist models showed as increasing for 20+ years (all data tracked plus more!). And all investors who believed this had been making higher ROI than other classes of investment.
Of course, the models became wrong. Like foosion said, bank holders of MBS & CDS junk were insolvent.
The financial reform should have been more big financial bankruptcies, with the equity risk owners losing all and the bond holders getting new equity for debt — and the top CEOs getting booted. You know, the way a good market controls for irresponsible risky behavior.
With the Fed/ Treasury/ FDIC to make sure small depositors didn’t lose, and possibly have direct loans to companies who prior primary bank went under.
On fiscal stimulus, NONE should have gone to any states, which should be also pressured into bankruptcy/ forced spending reductions.
$1 tril in tax cuts only would have been far more stimulative, with less negative long term gov’t growth, than the same deficit with the gov’t spending it.
November 8, 2010 at 7:53 pm
Jonathan Weinstein
Nicely put, Roger. I was also (as many) disappointed that financial reform was not the top priority, but (oddly in retrospect) it hadn’t hit me as a response to Krugman’s column.
The current conservative party line is that a rash of new regulations, and uncertainty about the tax code, has a created an environment which is too uncertain for businesses to invest in growth. Naturally this is a justification for weakening regulation (environmental as well as financial), and of course continuing at the Bush tax levels. You have a nice response here, that of course *lack* of regulation created tremendous instability. Perhaps this is true for environmental and other regulations as well? Oil companies that followed well-defined, well-written regulation would presumably not face the volatility of the occasional multi-billion liability. For both Wall Street and big energy companies, it appears the cries of instability caused by new regulations are putting lipstick on their actual cries of “Please don’t reduce our juicy oligopoly rents.”
November 8, 2010 at 11:07 pm
Tom P
What do you think is the best evidence that a lack of new financial regulations prevented recovery? I’m open to the possibility but I worry that most arguments are post hoc rationalizations.
Deflationary expectations also seem to be correlated with sharp drops in asset prices both recently and in historically. Why not think of them as a major causal factor? An advantage of that theory is that it has been “out of sample” since the time of David Hume.
Looking forward to your future posts!
November 9, 2010 at 1:48 am
Extinct Species
I can imagine a lot of things, both good and bad.
Just what are the details of this effective financial regulatory reform and how likely is it that it could have successfully made it through the political process? And even if it did how likely is it that it would in fact have had the positive result you claim? It is highly unlikely that we got good effective health care reform. And it is highly unlikely we would have gotten good effective financial regulatory reform had that been the focus.
This is just like all the calls out there for certain political actions with no details, no case for how those details generate positive results, no assessment of the probabilities of those results, no assessment of the downside risks and no assessment on how realistic such actions are given the political environment. Hey, let’s have legislation that lowers unemployment to 5%, balances the budget, gives everyone health insurance, lowers health care cost and eliminates our trade imbalances! While we’re at it, let’s imagine world peace!
But I do agree that under the circumstances health care reform probably should not have been given such a high priority. Then again, after a loss at midterm it is easy to imagine that Obama doesn’t get any of the legislation he wants going forward.
June 28, 2011 at 12:53 am
Anonymous
Dr. Meyerson
To think that the GOP, which brought about the deregulation of financial markets and the speculative housing market bubble, would get behind regulation of the financial is just plain delusional.
September 5, 2011 at 9:58 pm
Food for thoght – WHAT I BELIEVE
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