Administration Allies Float Trillion Dollar Bailout to Offset Rising Savings Rate

by Hans Bader on November 1, 2010

in Bailout Watch, Economy, Stimulus to Nowhere

Alarmed by the rising savings rate, which liberal Keynesian economic theory views as potentially bad in a weak economy, intellectuals with close ties to the Obama administration, such as Matthew Yglesias, and liberal commentators such as Noam Scheiber, are floating the idea of a trillion-dollar bailout at taxpayer expense, using government-controlled mortgage giants Fannie Mae and Freddie Mac. The bailout would involve Fannie and Freddie writing off part of the mortgage balances of many people who are perfectly capable of making their mortgage payments, not in order to prevent defaults, but just in order to increase borrowers’ purchasing power so that they can spend more money. (The bailout would not cover all Americans, only many of the loans held by Fannie and Freddie.)

The cost of this bailout — perhaps a trillion dollars — would be borne by taxpayers, since Fannie and Freddie are already insolvent, and are expected to need as much as $363 billion more in taxpayer bailouts, even if this massive bailout proposal is not adopted.  (Democrats in Congress blocked GOP proposals to reform Fannie and Freddie or wind them down in May.)

This entire proposal, like many of the administration’s stimulus proposals, is based on the faulty assumption that weak consumer demand is the primary reason for the slow recovery. In fact, personal consumption has resumed rising, while private investment has fallen and remains low. Private investment is way down compared to past recoveries, driven partly by lack of confidence in the administration (a well-deserved lack of confidence given the administration’s anti-business policies).  The savings rate has only increased slightly and remains lower in the U.S. than in most of the world.

Matt Yglesias of the Center for American Progress (CAP) is one of the people floating this proposal. CAP is widely credited with “shaping the agenda of the new Obama administration.”

Yglesias concedes that this proposal may not even be legal, and that “there are real doubts as to whether the Housing and Economic Recovery Act of 2008 actually authorizes this.”  But legalities are unlikely to stand in the way for this administration, which showed little reluctance to take actions in the past that were deemed illegal by many commentators, like the multi-billion dollar auto bailouts, which were criticized for flouting federal bankruptcy laws, the TARP statute, and the Constitution.

Behind such radical proposals are the false assumption that we are in a recession due to “a collapse” in private consumption.  But as Mark Calabria notes, “private personal consumption” is “actually up and higher than at any point during the boom, after reaching bottom in the Spring of 2009.”  Meanwhile, “unlike consumption, which has largely rebounded, investment today is about 20% below its peak.” It’s investment that needs to increase dramatically, not consumption.

There is no reason to think this proposal would help the economy even in the short run.  As Yglesias concedes, this proposal would not be costless even under liberal assumptions: “if the US government deliberately takes on a trillion dollars in additional debt, that may lead the interest rate the US government needs to pay on its debt to rise. Rising interest rates on treasuries will increase interest rates throughout the economy and hurt growth.””

Other bailout proposals have ended up harming rather than helping the economy.  A $75 billion Obama mortgage bailout program is actually harming the economy, the housing market, and the construction industry, economists and real estate experts say.  Many other Obama administration jobs programs have backfired, like a biofuels program that wiped out jobs, and a green-jobs program in the stimulus package that ended up funneling money mostly to foreign firms.  The stimulus package wiped out jobs in America’s export sector, and even the Congressional Budget Office, which claims it will help the economy in the short run, admits it will reduce the size of the economy in the long run.

There are additional problems with the trillion-dollar bailout proposal that its floaters don’t recognize.  The increased national debt it produces would lead to higher taxes and interest payments in the future — crowding out private investment in the future, and thus shrinking the economy in the long run.  And most of the bailout might be saved rather than spent by its recipients, preventing it from increasing consumption in the short run.

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