What Obama Left out of His Economic Recovery Plan: Higher Wages and Debt Relief
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In a recent Financial Times op-ed, Lawrence Summers showed that he’s resolved to tackle the central issues head on. This comes as something of a surprise since Summers was one of the main proponents of deregulation. Here’s what he said:
We need to reform tax incentives that encourage financial risk taking, regulate leverage and prevent government policies that give rise to a toxic combination of privatized gains and socialized losses. This offers the prospect of a prosperity that is more firmly grounded and more inclusive. More fundamentally, short and longer-term imperatives come together with respect to policies that seek to ensure that any future prosperity is inclusive. The policies that are most effective in helping to support demand are those that help households struggling either because of low incomes or because they have recently lost part of their income. Recent events also remind us that individuals can become impoverished or lose health insurance through no fault of their own. This reinforces the need for people to have basic health and retirement security protection regardless of what happens to their employers. (Lawrence Summers, " The pendulum swings towards regulation")
Summers’ article is an indictment of the finance-driven system that he helped create. He sounds more like Robert Reich than Milton Friedman, but has he really changed that dramatically or will he continue to serve the interests of Wall Street once he’s in office?
The test for Summers will be how he goes about fixing the banking system. That will prove whether he’s sincere or not. As expensive as it may be, recapitalizing the banks and purchasing their bad assets is the easy part. The hard part is to establish a facility, like the Resolution Trust corporation (RTC), and use it as a morgue for winding down insolvent banks. It requires someone who can ignore political and institutional pressure and be impartial in deciding whether a financial institution can be saved or not. The bad banks have to be put out of their misery. It’s a tough job, but it has to be done. Otherwise, zombie banks will suck up vast amounts of public money even though they’re unable to effectively distribute credit to consumers and businesses. That’s what dragged Japan’s economy into the "lost decade."
Anil Kashyap, of the University of Chicago Booth School of Business, summed it up like this:
"Policy makers should stay focused on recapitalizing the banking system ... Financial firms won’t start lending again until their balance sheets are in better shape. But BAD BANKS SHOULD BE SHUT DOWN or nationalized more aggressively. It is a complete waste of taxpayer money to bail out somebody who is insolvent."
The good news is that there is a solution. The bad news is that it will be an excruciating undertaking to turn out the lights at hundreds of banks where the liabilities greatly exceed the assets. But that’s what it will take to get the banking system back on its feet.
The Obama stimulus package is a good place to start, but it skirts the core issues of wages and debt relief. Both of these will have to be factored into any plan that, as Larry Summers says, "seeks to ensure that any future prosperity is inclusive."