02/14/2008

News / Fast-Moving Economy Challenged Architects of Stimulus

For months, the government has been trying to get in front of the problems facing the economy, most recently with the stimulus bill President Bush signed yesterday.
But policymakers from the administration to Congress and the Federal Reserve are finding that the efforts that seemed proactive at the time are in fact too slow to keep up with the rapidly spreading crisis in financial markets and deterioration in the economy.

The bill Bush signed, which he called a "booster shot for our economy," will result in a tax rebate for adults with up to $75,000 in adjusted gross income or couples who make up to $150,000. Starting in late spring, the IRS will mail checks of $600 for most individuals, $1,200 for most couples and $300 for each dependent child.

When the first rumblings of a such a plan emerged in December, advocates described it as a way for the federal government to move aggressively to prevent a recession.

In the past two months, the political system moved quickly and with an uncommon degree of consensus. During that time, however, the unemployment rate spiked, job growth turned negative, and surveys indicated that big segments of the economy werecontracting.

As a result, former Treasury secretary Lawrence H. Summers said yesterday in an interview, the stimulus package is "an appropriate response rather than an energetic move ahead."

Many economists now see the stimulus measure not as an insurance policy against a recession but as a useful action to make sure that if there is a recession, it is a mild one. "It will prime the pump for consumers," said Harvard economist Martin Feldstein, who advised President Ronald Reagan. "If people respond to it, they'll start spending, it will increase confidence, and we'll be okay."

Summers called the collaboration between the White House and Congress "an example of government functioning considerably better than government has functioned on average in a long while."

The challenge facing policymakers is that the country's economic distress is being played out with unusual speed. As recently as mid-December, only a handful of indicators pointed to a significant slowing in the economy. Since late December, almost all of the indicators have.

And every time one corner of the financial markets appears to be healing, problems crop up somewhere else, often in a segment of the world financial system so obscure that even veterans on Wall Street find it unfamiliar. In November, the issue was "structured investment vehicles." In December, it was stresses in short-term money markets. Then came the possible downgrade of "monoline bond insurers" in January, and now, big problems in the market for "auction rate securities."

"The pattern is there's this new ugly thing crawling out from under the rock every month," said Ethan S. Harris, chief U.S. economist at Lehman Brothers.

The same pattern applies to the Bush administration's efforts to deal directly with the mortgage foreclosure crisis. In late August, Bush proposed changes to the Federal Housing Administration and also a change to tax law that made it easier to renegotiate a loan. At the time he drew praise for taking action to try to stem the number of foreclosures.

As the scale of the crisis has become more apparent, though, those measures have come to appear small-bore. By the time the administration introduced a plan to freeze interest rates on certain subprime mortgages in December, many in Congress were criticizing Bush for moving too timidly to deal with the housing crisis, a criticism that was repeated this week as the Treasury Department rolled out a plan for major loan servicers to delay foreclosures to renegotiate loans.

As Treasury Secretary Henry M. Paulson Jr. acknowledged Tuesday, "None of these efforts are a silver bullet that will undo the excesses of the past years."

The Federal Reserve has grappled with similar problems. In September, the central bank cut the short-term interest rate it controls by half a percentage point, more than investors were expecting. At the time, Fed leaders viewed the action as an exercise in "risk management," a bold signal that they were on the case and would act to prevent the problems in financial markets from spreading to the economy as a whole. The same philosophy was behind rate cuts in October and December that were made despite worrisome signs of inflation.

"More than usually, the potential actions the Federal Reserve discusses have the character of 'buying insurance' or managing risk -- that is, weighing the possibility of especially adverse outcomes," Fed Vice Chairman Donald L. Kohn said in a November speech.

In the time since then, however, it has become clear that those rate cuts were not buying insurance at all but rather just keeping up with worsening economic fundamentals.

"Whatever you thought might be the conditions when you made those decisions, the actual conditions have turned out to be worse," Harris said.

With an even more aggressive set of interest rate cuts in January totaling 1.25 percentage points, the central bank was once again trying to get in front of the problem. It was an open question whether even that move, the biggest one-month rate cut in the modern history of the central bank, would be enough to arrest the worsening economy and interrelated climate of fear in financial markets.

Some traders in financial markets are betting it won't. Prices in options markets indicate that investors believe there is a one in four chance that the central bank will cut rates by another full percentage point at or before its March 18 meeting.

"Those big rate cuts in January at the time seemed aggressive," Harris said. "Now as we see the evolving problems in the capital markets, the data coming in, it looks different. It might have been risk management a month ago, but now it's just good policy."

By Neil Irwin
Washington Post Staff Writer
Thursday, February 14, 2008; Page D01

Source: http://www.washingtonpost.com/wp-dyn/content/article/2008/02/13/AR2008021303260.html



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