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Bitter Medicine, But With A Silver Lining?

September 29th, 2008 . by economistmom

It’s mixing metaphors, but the $700 billion financial rescue plan has fiscal hawks both horrified and hopeful at the same time, leading to this Congressional Quarterly (CQ Weekly) cover story by Clea Benson, labeled Time for Bitter Medicine on the cover, but speaking of a “silver lining” of a Reckoning After the Rescue in the title of the article.  As Clea explains in the opening paragraphs:

Deficit hawks aren’t generally an optimistic bunch, and they have had little to be positive about in the past several years, with an administration and Congress in war mode and intent on fighting terrorism by doing “whatever it takes” — which has generally meant spending whatever it takes. Economic stimulus measures such as tax cuts have only added to their grief.

So last week, as Treasury Secretary Henry M. Paulson Jr. asked Congress to raise the debt ceiling — the limit on the amount of money the government can borrow — budget watchdogs had further cause for concern. To deal with the Great Financial Crisis of 2008, the government says it will need to spend $700 billion more in borrowed money. The result, if Paulson gets his way, is that the total federal debt would grow as much in the next year as it has in the past three years combined, and will be double what it was when Bush took office.

Yet the reaction from these advocates of fiscal restraint included — along with predictable dismay — an unexpected note of hope.

“Bad news is sometimes good news,” said Maya MacGuineas, president of the nonprofit Committee for a Responsible Federal Budget. “You’re always looking for a silver lining, and it does feel like a wake-up call that’s going to be very difficult for politicians to ignore. . . . You’re going to be very hard-pressed to have a politician come out and say, ‘What we need to do is spend more money and cut more taxes.’ ”

MacGuineas and others see a changed landscape with new light shining on the culture of borrowing at the federal, corporate and individual levels. The legacy of the proposed $700 billion bailout, plus the other expenses of the past six months of financial failures, may be that the rising budget deficit and the accumulated federal debt will transform every major policy discussion on government programs and force tough choices at every level for years to come.

My boss, Bob Bixby, and I are a couple of those “others” who are trying to be hopeful about what the bailout will mean for the federal budget–and indeed, for the U.S. economy as a whole:

The first evidence of a new fiscal era began to appear last week on the presidential campaign trail, when Democratic nominee Barack Obama suggested that he might not be able to implement his entire agenda at once, if he’s elected. But experts say the impact may be felt beyond the next few budget cycles and even beyond the next administration.

Robert L. Bixby, executive director of the Concord Coalition, a nonpartisan group that lobbies for government fiscal responsibility, sees a parallel between the practices that led to the meltdown on Wall Street and the federal government’s own spending and borrowing habits.

“Wall Street got in trouble by being overleveraged and having books that weren’t very transparent,” he said. “And we’ve been worried the federal government is overleveraged and making huge future promises. In effect, it’s assumed huge amounts of deficit financing these programs, and just as it became impossible for Wall Street to go on perpetually propped up by debt, so it will for the federal government, as well.”

The new reality won’t just be one in which the government tightens its belt. The financial crisis and ensuing bailouts also might curb the seemingly insatiable American appetite for consumption fueled by borrowing, which drove so many households into mortgages they could not afford and pushed the national savings rate down basically to zero.

“American voters have been very nearsighted themselves, in that it’s been very hard for many to realize they are overextended, so how can they hold their policy makers accountable?” said Diane Lim Rogers, chief economist at the Concord Coalition. “It’s very scary, but at the same time, I think this current crisis is going to help people get a grip and say, ‘OK, I guess I’m going to start to save more. I’m not going to run up my credit card debt so much.’ This crisis is going to put the brakes on a lot of borrowing over the whole economy, I hope.”

…it will become more expensive for the government to borrow in the future. Foreign governments and other investors have been lending willingly to the Treasury, but they may begin to demand bigger returns as the nation’s debt level rises.

“We are pushing the limits on how much capital we can suck in from abroad,” Rogers said. “I don’t think anyone expects interest rates to do anything but come up from this point forward. The costs of borrowing are going to get much more expensive.”…

Budget experts predict this will lead to a period of severe austerity…

Bixby described the new level of indebtedness as “having the Sword of Damocles hanging over the budget,” and he suggested that it could overshadow debates on everything from Social Security and Medicare to defense, education and taxes…

The end of lax oversight of lending may lie ahead, coupled with a new focus on regulating the kinds of financial instruments that pushed so much capital into the home mortgage market in the first place. Standards for government programs that help families buy homes, such as the Federal Housing Administration’s mortgage insurance, are already being tightened.

Rogers, for one, says the public now may have an appetite for more stringent standards and more government involvement.

“It will encourage a tolerance for a bigger government role,” she said. “These symptoms we’re seeing right now are showing us the downside of letting the private market go completely unchecked, because that’s what profit-seeking is all about. Sometimes profit-seeking leads to developments in the economy that aren’t good for the public as a whole.”

Yeah, that Bob–he’s very smart.  I had no idea what his “sword of Damocles” reference was until I googled/wikipediaed it… That’s why Bob’s the boss, and I’m just his VP–uh, I mean economist.

And here’s an excellent interview Bob did with NPR’s All Things Considered over the weekend, speaking about this bitter medicine/silver lining combo.

Be hopeful.  Things can only get better, right?  (We’re going to get out from under before that sword drops on us.)

**UPDATE, 3:30 pm:   Uh… maybe not…   Tomorrow’s post will likely be something about the children in Congress… **

One Response to “Bitter Medicine, But With A Silver Lining?”

  1. comment number 1 by: sootytern

    Sorry to disappoint you but that sword is going to drop regardless of what we do. Now the problem is what measures can we take to limit the damage. We certainly do not want to be killed but we are past the minor flesh wound stage and into the moderate to severe one.

    We have spent well beyond our means for almost 30 years. If we don’t tighten our belt now , we will strangle ourselves within a very few years. Personally, I think much higher taxes are needed and a decrease in spending, in particular, a dramatic decrease in the defense budget. We already spend more on arms than the rest of the world put together.

    We need also to save more in order to invest in our future and our children’s future. We have actually been spending their money, i.e., borrowing from the future. It is time to stop.