Whew. Now that 2008 is in the history books, $8.5 trillion in federal bailout money is in the pipeline, and bold leadership is set to take command, Americans can all breathe a little easier, right?
Uh, no. The unhappy fact is that 2009 is almost certain to feature more economic hardship than the year that preceded it. President-elect Barack Obama may think he has steeled himself and his administration for this outcome, but three major factors argue against Obama truly being prepared for what's to come.
Insane expectations. It was no mistake that Vice President-elect Joe Biden was dispatched to try to dampen surging overseas expectations that the Obama presidency will quickly reverse American actions around the globe. But a similar threat lurks domestically, where the federal government under Obama will be expected to correct every dislocation from the confused Bush years—all while providing free health care and full employment.
Most telling is the continued misunderstanding of the role that Obama's Treasury chief pick, Tim Geithner, has played in the Bush bailouts from his current perch at the New York Federal Reserve. Geithner has in every way possible functioned as a loyal member of Hank Paulson's Goldman Sachs army, seeking to reverse market judgements on bad investments with billions in federal cash. Why anyone would expect substantially different policy from an Obama administration with Geithner in place escapes me.
The one exception to this is at the Federal Reserve, where Ben Bernanke might end up as the poster-child for economic malaise, giving Obama license to show Bernanke the door. If nothing else, this could buy Obama time and reset the clock on his honeymoon. But otherwise, without some sort of dramatic gesture to placate the public, by late spring the euphoria over Obama's inauguration could give way to a crushing let down.
State and local implosions. The coming spring will also prove crucial as many states and localities write their budgets. These are the same entities that came hunting for roughly $200 billion in federal “stimulus” handouts via thousands of make-work projects.
The real trouble, however, lies in the hundreds of general funds, enterprise funds, pensions, and health care plans which are skirting the edge of bankruptcy right now. The nearly $3 trillion market for state and local debt remains in flux with the certitude that borrowing costs will creep up by about 50 basis points for all but the most well-insulated jurisdictions.
For many others, 2009 will bring a cruel ratcheting effect when reduced revenues from the slowing economy, coupled with increased investor and analyst wariness, combine to reduce debt ratings. This will further push up the cost of borrowing, which will then further strain revenues. Tax hikes might help, but only at the cost of further depressing business activity.
For that reason, the federal government will once again be called on to bail out insolvent operations—but this time it will be cities, counties, and maybe even a state or two.
Incidentally, this process may have a profound impact on winnowing the field of Republican statehouse superstars who might be in a position to challenge Obama in 2012. If Sarah Palin, Bobby Jindal, or Mark Sanford watches their state circle the drain in '09, you can pretty much write them off as a serious candidate in a time of economic strife. Conversely, should a governor truly rise to the occasion by shrinking the cost of their operations while maintaining services, they would jump to the front of the line.
Addled economics. When otherwise smart people start talking about the positive effects of inflation, we've entered desperate times. Let's walk through the root cause of America's housing bubble, which is widely held to be at the epicenter of America's 2008 economic meltdown, to see why inflation can only compound our economic woes.
Why did housing prices embark on a rocket-ride straight up in recent years? Because banks created an unlimited supply of ready buyers at every price point. How did they do that? By lending money to people without the income historically required to pay back a mortgage of a given size or, in many cases, of any size. So the ongoing housing correction, or “collapse” in some quarters, represents a return to a more sane relationship between a borrower's income and their ability to borrow.
Given this reality, income will be at a premium in 2009. Rising unemployment has already started to batter income levels. But real income can also be impacted by rising inflation, which leaves fewer dollars available to pay for things like mortgages.
In effect, those pundits pushing the inflation solution do not advocate jumping off the fake-wealth-via-permissive-lending treadmill, they just want Americans to run faster to get nowhere.
Already we see that when policymakers debase the currency with zero short-term interest rates they provoke a market response. Long-term interest rates, led by the benchmark 30-year fixed mortgage, inched up last week. This is exactly what you would expect as lenders realize that the dollars they will be getting back will have less—perhaps much less—purchasing power than the ones they are lending out.
In basic terms, this is a process that has gone on for thousands of years, since the dawn of human civilization. When kings, pharaohs, or emperors try to tamper with a society's store of value, that value shifts.
Indeed, all the talk of deregulating or reregulating markets misses the simple yet essential point that the serial bailouts of 2008 were designed to avoid market consequences for bad investments. The New Year will demostrate that this was a waste of both time and resources. In 2009, market forces will punish the human hubris that peaked in 2008, setting the stage for a brighter tomorrow.
Jeff Taylor writes from North Carolina. This column first appeared at Reason.com.