The Auto Bailout Is Going Off the Road

GM just announced it was laying of 21,000 more of its workers, as a means of assurring the Treasury Department the company is worthy of more bailout money. A Treasury official was quoted as saying approvingly that the goal is a "slimmed-down" GM.

What? Having General Motors or Chrysler cut tens of thousands of jobs in order to be eligible for a government bailout reminds me of "saving" Vietnam by bombing it to smithereens. Aren't we giving these companies billions of taxpayer dollars to save jobs? If not, we're just transferring money from taxpayers to GM and Chrysler bondholders and shareholders.

I agree with those who say the United States needs an auto industry. But there's no point spending tens of billions of taxpayer dollars for an auto industry that's a tiny fragment of what it was before. We could achieve that objective by doing nothing.

Besides, as I've said before, the "American auto industry" shouldn't be defined as auto companies whose headquarters are in the United States. The true "American auto industry" is Americans who make automobiles. At the rate the Big Three are shrinking even as they’re bailed out, foreign automakers with American plants may soon employ more Americans than the Big Three do. The Big Three have gone global anyway. A Pontiac G8 shipped by GM from Australia contains far less American labor than a BMW X5 assembled in the United States. General Motors' European subsidiaries include Opel and Saab. Ford also has operations around the world. It even owns Volvo.

The purpose of any auto bailout ought to be to help American auto workers keep their jobs, regardless of whether they work for GM or Toyota or anyone else. Or if they lose their jobs, help them get new ones that pay almost as well. Yet we’re doing exactly the opposite: We're paying GM and Chrysler billions of taxpayer dollars to keep them afloat while they cut tens of thousands of American jobs and slash wages. There's no good reason why taxpayers should foot any of this bill unless the Big Three agree to keep their workers employed while they try to turn themselves around.

Will Ken Lewis Get Canned, and Will Americans Have a Say in the Corporations We Now Own?

I don't know whether Bank of America shareholders will oust Ken Lewis from his chairmanship this week. I don't know if Treasury Secretary Timothy Geithner will eventually do it, either. What really worries me is I don't know who would actually be responsible for doing the deed, or by what criteria.

When it comes to keeping top corporate executives in line we usually entrust the job to shareholders -- or, as a practical matter, boards of directors that are supposed to represent shareholders' interests. When it comes to keeping top public servants in line we generally trust voters -- or, as a practical matter, the elected officials who represent them. But when, as now, the public has committed large amounts of its money to particular companies in the private sector, we're in a quandary.

The $45 billion we've sent to the Bank of America should give the public some say over whether Mr. Lewis remains in his job because he is now accountable to us as well as to his shareholders. But to which group should he be more accountable?

And: Is Mr. Lewis's main job still to make money for his shareholders, or does he now have a higher public responsibility to lend more money to Main Street? Was that public responsibility also paramount last fall when Federal Reserve Chief Ben Bernanke and Treasury Secretary Hank Paulson told Mr. Lewis to proceed with the Merrill-Lynch merger -- and when, according to Mr. Lewis's sworn testimony, he believed they didn't want him to disclose Merrill-Lynch's financial losses to B of A shareholders or anyone else?

It's not even clear who represents us as members of the public. Next month, AIG holds its annual shareholders meeting. Are you attending?

Maybe you should. The $170 billion we've committed to AIG so far amounts to nearly 80% of its shares. Some private shareholders are pushing for a vote to oust an AIG board member and to further restrict executive pay. But these dissident shareholders represent only a slice of the 20% of AIG's private owners.

AIG has three public trustees, each of whom is being paid $100,000 a year. Should they vote with the dissidents? There's no way to know, because the public trustees have no charter or mission statement to guide them, and they don't seem to report to anyone, either.

The question of public representation keeps growing. Now that our loans to Citigroup have been turned into common stock, you and I and other members of the public are poised to become Citigroup's biggest shareholder, holding about 36% of its voting shares. But who represents us, and how should they vote?

The Obama administration apparently wants to do more of these debt-for-equity swaps. They're a means to get more capital to the banks without returning to Congress to ask for more money -- which Congress would be very reluctant to provide. But the swaps also expose the public to more risk. At least loans have to be repaid.

Share prices, as we've seen, sometimes go down. Yet without a means for representing the public's interest in the governance system of these banks, we can only rely on the Treasury secretary to keep a watchful eye over the ongoing decisions of every bank. That's unrealistic.

Even if our public interests were being represented, it's not clear exactly what they are beyond getting repaid or possibly making a bit of a profit. Presumably taxpayer dollars are being committed because of some larger public purpose. Yet companies are designed to make profits, not to fulfill public responsibilities.

Suppose the government, representing the public, instructs the Wall Street banks it now controls to lend more money to Main Street. But top bank executives believe they can better raise share prices by using the money for new investments, bigger dividends, or to lure and retain "talent?" The executives have a duty to do what the government tells them to do, but they have an even larger fiduciary responsibility to their shareholders to raise share prices.

Suppose the government instructs AIG to clean up its balance sheet, but AIG's executives think they can make more money by inventing new off-balance-sheet derivatives? The executives' primary job is to make money for their shareholders. The fact that the public now owns 80% of AIG doesn't change that.

Suppose we tell General Motors Corp. -- about to become partly ours -- to shift its fleet to more fuel-efficient cars. Yet its executives know that as long as gas prices are low, Americans remain infatuated with highly profitable SUVs and pickup trucks? GM executives would have a perfect right, if not a duty, to disregard what we as citizens tell them to do in favor of what shareholders want them to do.

Democratic capitalism entails two systems by which people with significant power are held accountable. One is capitalism, by which companies and their executives are accountable to the market. The other is democracy, by which public agencies and their leaders are accountable to voters. Americans may disagree about how much we want of one or the other, but most people understand we need both systems of accountability. When we confuse the two, we run the danger that people with great power may escape accountability altogether.

That's the problem right now. Bank of America's Ken Lewis is fully accountable to no one. AIG's public trustees have no charter or public mission to guide them. GM is trying to satisfy the Treasury and its shareholders simultaneously, and is doing neither very well. Even as the public takes larger ownership stakes in big Wall Street banks, the public has no systematic means of expressing its growing interest, whatever it is.

Perhaps government had no business meddling in the private sector to begin with. AIG, the big banks and the auto companies should have been forced to work out their problems with their creditors, or else be put into temporary receivership until their profitable units or nonperforming loans could be sold off. Perhaps any company that's judged too big to fail is too big, period. Antitrust laws should have been used to break these giants up before they got so big.

These arguments may be relevant to the recent past and possibly to the future, but they're beside the point right now. The immediate challenge is to sort out public from private responsibilities and to create clearer lines of accountability.

At the least, when government takes an ownership stake in a company, the pubic should be represented on that companies' board of directors in direct proportion to the size of its stake. Those public directors should be appointed by the president. In exercising their oversight function, they should seek guidance from the president and his top economic officials. And their votes on critical issues before the board -- such as whether to fire Ken Lewis -- should be made public.

How Obama Can Succeed in the Next Hundred Days and Beyond

Before Inauguration Day, President-elect Barack Obama said he wanted to hit the ground running. Instead, he hit the ground sprinting and hasn't stopped.

Consider: A $787 billion stimulus package. A 10-year budget including universal health insurance and a cap-and-trade system to combat global warming. Subsidies to help distressed homeowners stay in their homes. Public-private partnerships to clean up the big banks. A bailout of the auto companies. New regulations to clean up Wall Street. A G-20 meeting to harmonize global economic policies. A proposal to regulate greenhouse gas emissions. A thaw in relations with Cuba and Venezuela. Overtures to Iran. A start to immigration reform. Even a dramatic rescue from pirates.

And this is just the first 100 days.

He also has done this without breaking a sweat. Obama is the serene center of the cyclone - exuding calm when most Americans are petrified about paying the monthly bills, offering assurance when everyone in the world is worried about loose nukes falling into the wrong hands.

All this activity has made the right angry and the left uneasy. But a whopping 65 percent of Americans think highly of him. And no president since John F. Kennedy has received such an enthusiastic welcome around the globe. By almost any measure, his presidency so far has been a triumph. (I give him only a C-plus on his economic policies so far, but that's mainly because of a provisional F on the bank bailout. See below.)

Yet Obama's success has rested on several delicate balancing acts. Whether he continues to succeed will depend on how well he shifts his balance in the months ahead.

Short-term or long-term economics?

The stimulus and bank bailouts have required the government to pump almost $1.5 trillion into the economy and the Federal Reserve Board to dramatically expand the money supply. This makes sense in the short term. With almost 1 out of 6 Americans either unemployed or underemployed - and consumers and businesses still tightening their belts - government has to be the spender of last resort. But as the economy recovers, Obama will have to rein in government deficits. If he does this too early, he risks prolonging the deep recession. Yet if he waits too long, he risks wild inflation.

Progressive vision or conservative governing?

Obama's 10-year budget presents the most ambitious and progressive vision of any president since FDR. But when it come to governing, Obama has been cautious and incremental. His stimulus was smaller than even conservative economist Martin Feldstein recommended. He has been unwilling to take over the banks. He won't push Congress on the Employee Free Choice Act. His mortgage relief program is modest. He doesn't want to prosecute CIA torturers. Yet if he wants to be a transformative president, he's got to move boldly. Universal health insurance will be his first big test.

Dominance of domestic or foreign policy?

So far Obama has focused on the home front, as he should, given the economy's plunge. But he's confronting a major foreign-policy challenge in Pakistan. And other challenges are emerging in Iran, North Korea, Russia, China and stateless regions of the world. So the big question here is whether foreign policy will come to define his presidency, notwithstanding his domestic ambitions. Presidents don't have much control over this. FDR's first two terms were defined by the Great Depression; his last was dominated by World War II. Lyndon Johnson wanted to create the Great Society but got bogged down in Vietnam. George W. Bush didn't know that his administration would be defined by Iraq.

Policy emerging from contending arguments or strong "czars"?

At first it looked as if Obama was hiring a "team of rivals" who would battle out hard policy problems. This management style allows a president to hear and consider contrary points of view, but it can also be chaotic. Yet Obama seems to be opting for strong White House "czars" instead, such as Lawrence Summers on the economy, Carol Browner on the environment and Rahm Emanuel on politics. This approach saves presidential time and focuses responsibility, but it can suppress contrary views. And it's often those contrary views that presidents need to hear to avoid major errors.

Working with Republicans or taking them on?

By temperament and inclination, Obama prefers to reach across the aisle and court Republican support. Yet so far this tactic has been notably unsuccessful. Republicans have moved almost in lockstep against him. They're already gearing up for the 2010 midterms, staging anti-tax rallies and laying the foundation for a major assault on his presidency. They fantasize about repeating the coup Newt Gingrich pulled off in November 1994. At some point before then, Obama will have to take off the gloves.

Making nice to Wall Street or kicking its butt?

Almost $600 billion has been poured into big Wall Street banks with nothing to show for it. They're still not lending to Main Street, still paying their top executives princely sums, and still issuing dividends and looking for acquisition targets. Yet apart from a few rhetorical blasts at a few Wall Street executives, Obama has so far shown remarkable solicitude to the banks because he thinks he needs their cooperation to get credit moving again. At some point, though, he'll have to get tough.

So far Obama has found a workable balance in all these domains. But all require increasingly fancy footwork, and some rebalancing will be needed. The central question for the next 100 days is how deftly he finds new footing.

The Great Credit Card Battle To Come

The next front in the banking wars will be over credit cards. Some of the nation's biggest bankers -- including representatives of Citigroup, JP Morgan Chase, and other recipients of billions of taxpayer dollars -- are meeting today with the President to ask him back off his move to reform credit-card lending practices.

What's happening to credit card lending is a smaller replay of what happened to mortgage lending. For years, banks used every gimmick possible to get the public to use their cards -- regardless of the credit worthiness of the customer. They lured borrowers with low "teaser" rates. They told borrowers they could get by paying minimum balances.

And now that tens of millions of Americans are poorer than they used to be, the credit-card bubble is bursting. Credit card delinquencies are soaring. At the Bank of America, the largest U.S. lender by assets, 7.8 percent of credit-card accounts were delinquent in February by more than 30 days, up from 5.9 percent last August. Yesterday, Bank of America reported a $1.8 billion first-quarter loss in its credit-card services unit.

As delinquencies mount and profits shrink, card lenders are raising fees and interest rates, including rates on existing balances. They're also charging higher fees when customers exceed their credit limits, and shortening the duration of the teaser rates. When a customer makes a payment in excess of what's owed, card companies now routinely apply the excess to balances with the lowest rates rather than those carrying the highest rates. And banks disclose very little of relevance: For example, most customers have no idea how long it will take them to pay off their balances if they make minimum repayments, or what interest they're actually paying on their balances.

As more and more Americans find themselves in the credit-card squeeze, they're complaining loudly. But the bankers have their own loud lobbyists on Capitol Hill, whose voices haven't been muzzled despite the giant bank bailout. Last month, the Senate Banking Committee reported a bill that bans rate increases for existing balances, among other things. But the vote was close -- 12 in favor, 11 opposed -- and its future in the Senate is uncertain. A House bill advanced yesterday, sponsored by Representative Carolyn Maloney, Democrat from New York, has only a fifty-fifty chance of succeeding. Meanwhile, the Fed is working on a set of watered-down reforms scheduled to go into effect a year from July, but that's way too far off to avoid the pending battle.

Enter Obama. The Treasury holds lots of cards given how dependent the big banks are on its solicitude. Meanwhile, the public has grown weary and suspicious of the bank bailouts. Knowing how unpopular the bailouts have become, the Administration is considering how to get additional capital to the banks without going back to Congress for the money. One big idea is to convert taxpayer-provided bank loans into bank equity -- even though the swap puts taxpayers at greater risk (after all, loans have to be repaid, but equity can continue to fall).

That's why getting tough on the banks' credit card lending practices has such appeal for the Administration, politically. It puts the White House on the side of the people rather than Wall Street, on an issue that the public is becoming more and more upset about. And the Administration's push could be enough to get reform legislation through Congress.

The bankers will tell Obama today that any new contraints on credit card lending will cause the banks to reduce the amount of credit card lending they do, which will hurt the economy. But it's a weak argument because it presupposes that any lending is good for the economy -- even lending to people who don't know what they're getting into and can't repay the loans. It's the same argument banks used two years ago, when precient observers warned that constraints had to be placed on mortgage lending practices. What may hurt the economy in the short term, we now know, may save it from even larger pitfalls to come.

A Report Card on Obamanomics, Approaching One Hundred Days

The Administration is coming up to that magical 100-day mark, at which point measures are taken of how a new president is doing. As a university professor I'm accustomed to giving grades. So here's my report card on Obamanomics so far:

The 10-year budget gets an A. It's an extraordinary vision of what America can and should become, including universal health insurance and environmental protections against climate change. And the budget takes a little bit more from the rich and gives a little bit more back to the poor and lower middle class, which seems appropriate given that the income gap is wider than it's been since the 1920s. I'd give the budget an A plus except for its far-too-rosy economic projections.

The stimulus package gets a B. Good as far as it goes but doesn't go nearly far enough. $787 billion over two years sounds like a lot of stimulus. But the economy is operating at about a trillion and a half dollars below its capacity this year alone. And considering that the states are cutting services and increasing taxes to the tune of $350 billion over this year and next, the stimulus is even smaller.

The last grade is for the bank bailouts. I give them an F. I'm a big fan of this administration, but I've got to be honest. The bailouts are failing. So far American taxpayers have shoveled out almost $600 billion. Yet the banks are lending less money than they did five months ago. Bank executives are still taking home princely sums, their toxic assets and non-performing loans are growing, and the banks are still cooking their books. And now the Treasury is talking about converting taxpayer dollars into bank equity, which exposes taxpayers to even greater losses.

So that's the report card. An A on the budget, B on the stimulus, and F on the bailout. On the whole (given how I weigh grades) that gives Obamanomics a C-plus. Not bad given the magnitude of the problems Obama inherited. But by the same token, not nearly good enough.

Where Government Spending Should be Trimmed -- And Why It's Necessary to Fast-Track Universal Health Care

It's no accident that as Congress returns this week from its two-week recess and begins debate on the $3.5 trillion budget plans for the fiscal year starting in October -- which may or may not include a provision that fast-tracks Obama's health care proposal by allowing it to pass the Senate with a mere majority -- the President has summoned his cabinet for a first meeting, at which he'll call for more cuts in domestic spending.

Symbolism counts in Washington, and Obama's request that his cabinet officers come up with $100 million in spending cuts will be played up by the White House as the beginning of a major effort to trim unnecessary government spending. It's part of the President's effort to reach out to Republicans (and calm the nerves of "blue-dog" Democrats) worried about all the money the Administration has spent and still wants to spend -- $787 billion on the stimulus, $700 billion committed to the bank and auto bailouts, and, most importantly, $3.5 trillion for the next ten years, including universal health care. Throw in the cost of a cap-and-trade system to control climate change and you're talking big money.

But Obama would be mistaken to take more than symbolic steps at this point. The economy is still in a depression because consumers and businesses won't or can't spend, and exports are dead because the rest of the world is in even worse shape. Government spending on a large scale is necessary now, and will be next year as well.

Over the longer term, Obama must be careful not to put entitlement programs on the chopping block as part of a "grand bargain" to elicit Republican support for health care and cap-and-trade. Social Security is not in dire straights; it can be made flush for the next 75 years by ever-so-slightly lifting the ceiling on the portion of income subject to Social Security payroll taxes (and if Democrats are reluctant to do that on incomes over $100,000, then they could do so on incomes over $250,000).

Medicaid and Medicare are in trouble because health care costs are rising so fast, which argues for health-care reform rather than cuts in these important programs. Yet if health-care reform has any prayer of controlling the rising tide of health care costs, the plan must allow beneficiaries to opt into a public insurance plan -- something Republicans and the health-care establishment are determined to fight. So it's critically important that the Senate wrap health care into a reconciliation bill that can be enacted by a majority vote in the Senate.

Obama should fast-track health care and stop trying to court Republicans. Every House Republican and all but three Senate Republicans voted against the stimulus; all Republicans in both houses voted against the budget. During the recess they hosted "tea parties" claiming that Americans are over-taxed. Over the weekend, House minority leader John Boehner called the idea of carbon-induced climate change "almost comical."

Republicans are already off and running toward the midterm elections of 2010, even starting to run ads against House Democrats in close districts. They seem hell bent on on becoming a tiny, whacky minority -- the party that denies evolution, denies global warming, denies Americans need a major overhaul of health care, and denies the economy needs anything more than a major tax cut to get it moving again.

A Short Citizen's Guide to Kooks, Demagogues, and Right-Wingers On Tax Day

No one likes to pay taxes, so tax day typically attracts a range of right-wing Republicans, kooks, and demagogues, all of whom tell us how awful we have it. Herewith a short citizen's guide (that is, a citizen's guide that's short rather than a guide for short citizens) responding to the predictable charges:

1. "Americans pay too much in taxes." Wrong: The United States has the lowest taxes of all developed nations.

2. "The rich pay too much! The top ten percent of income earners pay over 72 percent of all income taxes!" Misleading: The main reason the rich pay such a large percent is they've become so much richer than the bottom 90 percent in recent years. If you look at what they pay as individuals -- the percent of their incomes over and above the highest rate below them -- you'll see a steady decline over the years. When Republican Dwight Eisenhower was president, the marginal rate on the highest earners was 91 percent (after deductions and tax credits, closer to 50 percent); by 1980 it was still up there, at 70 percent (an effective rate of closer to 45 percent); under Bill Clinton, it was 38 percent (an effective rate closer to 28 percent).

Look at the after-tax earnings of families and you'll see what's really going on. Between 1980 and 2000, the after-tax earnings of famlies at the top rose more than 150 percent, while the after-tax earnings of families in the middle rose about 10 percent. The Bush tax cuts of 2001 and 2003 raised the after-tax incomes of most Americans by a bit over 1 percent -- but raised the after-tax incomes of millionaires by 4.4 percent.

3. "The bottom 60 percent pay only 3.3 percent of the taxes!" Misleading again. Most Americans are paying more in sales taxes than they ever have. Property taxes have also been rising at a steady clip. And Social Security taxes have also risen (thanks to the Greenspan Commission), while earnings over about $100,000 aren't subject to Social Security taxes. So-called "sin" taxes (mostly beer and cigarettes) have also skyrocketed. All of these taxes take a bigger bite out of the paychecks of people with lower incomes than they do people with higher incomes.

4. "Obama is raising your taxes!" Wrong. Obama is cutting taxes for 95 percent of Americans, by about $400 per person a year -- not a whopping tax cut, to be sure, but not a tax increase by any stretch. Only the top 2 percent will have a tax increase, but even this tax increase is modest. Basically, they go back to the rates they were paying under Bill Clinton (their deductions will be limited to 28 percent, which is only fair). And they won't start paying this until 2011 anyway.

5. "The huge debts we're wracking up will cause your taxes to rise!" Wrong again. When it comes to the national debt, as I've said before, the relevant statistic is the ratio of debt to the gross domestic product. The only sure way to bring that debt down and make it manageable in future years is to get the economy growing again -- which requires that, in the short term, the government spend a lot of money (because consumers and businesses won't). In the long term, the biggest source of concern is rising health-care costs. And that's something Obama and Congress are aiming to tackle.

6. "We have a patriotic duty to stand up against Washington taxes!" Just the opposite. We have a patriotic duty to pay taxes. As multi-billionaire Warrent Buffett put it, "If you stick me down in the middle of Bangladesh or Peru or someplace, you'll find out how much this talent is going to product in the wrong kind of soil. I will be struggling thirty years later." President Teddy Roosevelt made the case in 1906 when he argued in favor of continuing the inheritance tax. "The man of great wealth owes a particular obligation to the state because he derives special advantages from the mere existence of government."

An acquaintance from law school, now a partner in one of Washington's biggest and wealthiest law firms, explained to me one day over lunch how he and his partners use tax rules to create offsetting taxable gains and losses, and then allocate the gains to the firm's foreign partners who don't pay taxes in the United States. That way, they keep the losses here and shelter their income abroad. I noticed he had an American flag lapel pin. "You're supporting our troops," I said, referring to his pin. "Yup," he replied, entirely missing my point.

True patriotism isn't cheap. It's about taking on a fair share of the burden of keeping America going.

We Need More Stimulus, Not More Bailout

With only $110 billion remaining in the TARP bailout fund, all signs are that Tim Geithner is preparing to return to Congress seeking more bailout money. He’ll bring along the results of his bank “stress tests,” which will probably show many that big banks are still technically insolvent, along with bankruptcy scenarios for General Motors and Chrysler, and a couple of CEO scalps – he’s already got GM’s. Congress won’t be happy but in the end it will cough up another 300 to 500 billion.

Geithner believes the only way to rescue the economy is to get the big banks to lend money again. But he’s dead wrong. Most consumers cannot and do not want to borrow lots more money. They’re still carrying too much debt as it is. Even if they refinance their homes – courtesy of the Fed flooding the market with so much money mortgage rates are dropping – consumers are still not going to borrow more. And until there’s enough demand in the system, businesses aren’t going to borrow much more to invest in new plant or machinery, either.

That’s the big issue – the continued lack of enough demand in the economy. The current stimulus package is proving way too small relative to the shortfall between what consumers and businesses are buying and what the economy could produce at full capacity. (According to today's report from the Commerce Department, retail sales fell in March, as did prices paid to U.S. producers.)

Worse yet, the states are pulling in the opposite direction. States cannot run deficits, which means that as their revenues drop in this downturn they’re cutting vital services and raising taxes to the tune of $350 billion over this year and next. This fiscal drag is wiping out about half of the current federal stimulus.

If Geithner gets Congress to give him more bailout money, Congress won’t be in any mood to do what it really needs to do – which is to enlarge the stimulus package. Voters are already worried about too much government spending. At most, the administration is going to get only one more bite at the congressional apple. Make that more stimulus rather than more bailout

Why We're Not at the Beginning of the End, and Probably Not Even At the End of the Beginning

Are we at the beginning of the end? Mortgage interests are now so low (the average rate on 30-year fixed mortgages was 4.87 percent Thursday, slightly higher than the 4.78 percent last week, but still the lowest level since 1971) that President Obama has begun urging Americans to refinance their homes so they can save money and start spending again. Presidential aide Larry Summers says the country is likely to see positive economic signs in the next few months. Wells Fargo Bank rallied stocks and surprised analysts Thursday when it predicted a strong $3 billion first-quarter profit, citing surging mortgage originations. And executives at the nation's biggest three banks -- JPMorgan Chase, Bank of America, and Citigroup -- say their operations were (at least by some measures) profitable in the first two months of this year, mainly because a resurgent debt market and equity trading lifted earnings in the investment banking divisions.

But we're not at the beginning of the end. I'm not even sure we're at the end of the beginning. All of these pieces of upbeat news are connected by one fact: the flood of money the Fed has been releasing into the economy. Of course mortage rates are declining, mortgage orginations are surging, and people and companies are borrowing more. So much money is sloshing around the economy that its price is bound to drop. And cheap money is bound to induce some borrowing. The real question is whether this means an economic turnaround. The answer is it doesn't.

Cheap money, you may remember, got us into this mess. Six years ago, the Fed (Alan Greenspan et al) lowered interest rates to 1 percent. Adjusted for inflation, this made money essentially free to large lenders. The large lenders did exactly what they could be expected to do with free money -- get as much of it as possible and then lent it out to anyone who could stand up straight (and many who couldn't). With no regulators looking over their shoulders, they got away with the financial equivalent of murder.

The only economic fundamental that's changed since then is that so many people got so badly burned that the trust necessary for consumers, investors, and businesses to repeat what they did then has vanished. Yes, banks will lend to highly trustworthy borrowers, and the low-hanging fruit of highly trustworthy borrowers is the first they'll pick. But there's not much of this kind of fruit to go around. And yes, some consumers will refinance and use the extra money they extract from their homes to spend again. But most will use the extra money to pay off debt and start saving again, as they did years ago. Most consumers continue to worry about their jobs, and for good reason.

Some of the big banks will claim to be profitable, but don't bank on it. Neither they nor anyone else knows what their assets are really worth. Besides, the big banks are sitting on over $500 billion over taxpayer equity and loans. Who knows how they're calculating profits? Most importantly, there's still a yawning gap between the economy's productive capacity and what it's now producing, and absolutely nothing will turn the economy around until that gap begins to close.

I spent the better part of an hour yesterday evening debating Larry Kudlow on his CNBC program, along with Arthur Laffer and two other financial analysts, all of whom were sure that the stock market had hit bottom and was now poised for a major recovery. I admire cockeyed optimism, and I understand why Wall Street and its spokespeople want to see a return of the bull market. Hell, everyone with a stock portfolio wants to see it grow again. But wishing for something is different from getting it. And cockeyed optimism can wreak enormous damage on an economy. Haven't we already learned this?

Why It Makes No Sense for States to Cut Services and Raise Taxes Now

With the real economy continuing to shrink, and unemployment or underemployment now claiming almost one out of six American workers, the economy will almost surely be more than $1 trillion short of its capacity this year, and another $1 trillion short next year. That means the $787 billion stimulus package covering 2009 and 2010 won't nearly do the trick-- even if every federal dollar of it stimulates $1.5 dollars in private spending (about the most that can be expected). Don't count on the bank bailouts to stimulate much of anything except fat paychecks for bank executives and directors. Unless or until Americans get their jobs back and feel more secure about the future, they won't borrow.

Sinking or vanishing American incomes are also causing tax revenues to drop. That's not much of a problem for the federal government, which can run deficits. But most state governments are required by their state constitutions to balance their budgets. Even though the states will be getting some stimulus money, their revenues are falling even faster.

The result? States continue to cut back vital services. They're chopping K-12 school budgets, whacking after-school programs, cutting back on child health, reducing aid to the homeless, and cutting other social services that are more important now than when the economy is doing well. And when they aren't cutting services, the states are raising taxes. At least ten states are considering major increases in sales or incomes taxes -- including Connecticut, Illinois, Massachusetts, New Jersey, Minnesota, Oregon, Washington, and Wisconsin. California and New York have already instituted multibillion-dollar tax increases that went into effect earlier this year.

All told, state service cuts and likely tax increases will total about $350 billion over 2oo9 and 2010. This is nuts -- exactly the opposite of what government needs to be doing. That $350 billion is a huge fiscal drag on the U.S. economy. It essentially negates almost half of the federal stimulus.

Let's hope the Obama administration returns to Congress soon for a second stimulus -- a large chunk of which should help the states maintain vital services and avoid tax increases, and that Congress heeds the request. (And let's hope the administration makes this pitch to Congress before it tries to get more money for the bailouts of Wall Street, the automakers, life insurers, or any other industry whose bondholders and shareholders should be taking the hit rather than taxpayers.)

Why You Should Work for a Hedge Fund

Just because I lost a big chunk of my total retirement savings over the last year doesn't mean I should be upset that 25 hedge-fund managers reaped a total of $11.6 billion during the same interval, according to Institutional Investor's Alpha Magazine -- including $2.5 billion for James Simons of Renaissance Technologies and $2 billion for John Paulson. (To be included on the list, you had to take home more than $75 million.)

I do admit to being irked that some of what these guys earn is taxed at a 15 percent rate because the earnings are treated as capital gains, while I'm just about to be walloped by the Internal Revenue Service come April 15.

But what causes me severe heartburn is that these are exactly the sort of investors Tim Geithner is trying to lure in to buy troubled assets from banks, with an extraordinary offer financed by you and me and other taxpayers: If it turns out the troubled assets are worth more than these guys pay for them, they could make a fortune. If if it turns out the assets are worth less, these guys won't lose a thing because we taxpayers will bail them out. Plus, they get to pick only the highest-rated of the big banks' bad assets and can review them carefully before buying.

What a deal. Why can't you and I get in on this bonanza? Because we're too small. The government will designate only about five big investor funds -- run or owned by the richest of the rich -- as potential buyers. Hedge funds fit the bill perfectly.

There's a beautiful symmetry here. The hedge fund managers who raked in billions last year wouldn't have done nearly as well had taxpayers not bailed out Wall Street to begin with. According to John Taylor, a hedge fund manager who tied for ninth on Alpha's list, many funds would have gone belly-up had the government not acted. "Thank god for the government, because if they hadn't intervened, we wouldn'thave had anybody to trade with," he told the Times.

So you and I and other taxpayers have kept these hedge-fund honchos flush enough to be able to reap the bonanza that Geithner now wants to bestow on them for cleaning up the mess they and others on Wall Street made -- a bonanza to be financed by you and me and other taxpayers, who are taking on all the risk.

I read this morning that Larry Summers earned nearly $5.2 million in the last two years working one day a week for D.E. Shaw, one of the largest hedge funds of all. I can't help admire Larry for sacrificing all the money he could be making now had he not chosen to work for the government.

Will Geithner Fire Corporate America?

Tim Geithner said on Sunday's Face the Nation that the Treasury might fire the heads of big banks that depend on financing from the federal government, just as it summarily deposed Rick Wagoner, the former CEO of General Motors -- and before Wagoner, the heads of AIG, Fannie Mae, and Freddie Mac. "Where that requires a change in management and the board, then we will do that," said Geithner.

I suppose it's comforting to know our government stands ready to fire corporate executives and directors whenever taxpayer money is on the line. But I suspect Geithner's new tough line is mostly designed to reassure a public that's lost all faith in the wisdom of bailing out Wall Street.

For the sake of the argument, assume he's sincere. What criterion will an axe-wielding Geithner be using? If precipitous loss of shareholder value is enough to "require a change in management and the board," presumably every CEO and director of every big bank now being bailed out should be fired, starting with Ken Lewis of Bank of America.

If the criterion is diversion of taxpayer money to uses other than Congress intended when it first authorized the $700 billion bailout, the list of soon-to-be-fired CEOs is a bit shorter but still large. Surely it includes all the bailed-out banks that continue to fly their executives around the world in company jets, award them extraordinary pay packages, and run junkets at fancy resorts. Citigroup's Vikram Pandit (who collected $38.2 million for his taxpayer-subsidized services in 2008) comes immediately to mind.

Why stop there? Perhaps Geithner intends to fire executives and directors of any company that's dependent on taxpayers and is now losing money. Just think of the corporate house-cleaning this will mean. Hundreds of agribusiness executives are now at risk as are scores of military contractors. Hell, the whole pharmaceutical industry depends on taxpayer support (research subsidized by National Institutes of Health, sales subsidized through Medicare and Medicaid), and it's doing badly, so their executives and directors will be gone soon, too.

All told, about one out of every five large American companies depends on government contracts, and a majority of these firms are losing money right now. So ... off with their heads.

It's a Depression

The March employment numbers, out this morning, are bleak: 8.5 percent of Americans officially unemployed, 663,000 more jobs lost. But if you include people who are out of work and have given up trying to find a job, the real unemployment rate is 9 percent. And if you include people working part time who'd rather be working full time, it's now up to 15.6 percent. One in every six workers in America is now either unemployed or underemployed.

Every lost job has a multiplier effect throughout the economy. For every person who no longer has a job and can't find another, or is trying to enter the job market and can't find one, there are at least three job holders who become more anxious that they may lose their job. Almost every American right now is within two degrees of separation of someone who is out of work. This broader anxiety expresses itself as less willingness to spend money on anything other than necessities. And this reluctance to spend further contracts the economy, leading to more job losses.

Capital markets may or may not unfreeze under the combined heat of the Treasury and the Fed, but what happens to Wall Street is becoming less and less relevant to Main Street. Anxious Americans will not borrow even if credit is available to them. And ever fewer Americans are good credit risks anyway.

All this means that the real economy will need a larger stimulus than the $787 billion already enacted. To be sure, only a small fraction of the $787 billion has been turned into new jobs so far. The money is still moving out the door. But today's bleak jobs report shows that the economy is so far below its productive capacity that much more money will be needed.

This is still not the Great Depression of the 1930s, but it is a Depression. And the only way out is government spending on a very large scale. We should stop worrying about Wall Street. Worry about American workers. Use money to build up Main Street, and the future capacities of our workforce.

Energy independence and a non-carbon economy should be the equivalent of a war mobilization. Hire Americans to weatherize and insulate homes across the land. Don't encourage General Motors or any other auto company to shrink. Use the auto makers' spare capacity to make busses, new wind turbines, and electric cars (why let the Chinese best us on this?). Enlarge public transit systems.

Meanwhile, extend our educational infrastructure. So many young people are out of work that they should be using this time to improve their skills and capacities. Expand community colleges. Enlarge Pell Grants. Extend job-training opportunities to the unemployed, so they can learn new skills while they're collecting unemployment benefits.

Finally, accelerate universal health care.

The Administration's proposed "Responsible Wall Streeter Tax Credit"

The Administration is about to launch a new plan designed both to stimulate the economy and clean up Wall Street at the same time. The "Responsible Wall Streeter Tax Credit" will provide Wall Street executives and traders a credit against their 2008 income taxes in an amount equal to their individual share of responsibility for the nation's financial collapse.

The Congressional Budget Office estimates overall losses from the collapse to be about $7 trillion but figures only about 10 percent of that sum will be claimed by Wall Streeters seeking the tax credit because of the reluctance of some executives and traders to take responsibility for the financial mess. That would put the cost of the new program at about $700 billion -- roughly the amount the federal government is now paying to bailout the Street.

In effect, the plan redirects the bailout money to these honest executives and traders who fess up and take responsibility. It's a win-win-win. They get to clear their consciences, which is a first step to clearing up their balance sheets. At the same time, they get big tax breaks which will cause them to spend more, and thereby stimulate the economy. And the plan won't cost taxpayers a dime more than we're already spending on the bailout, since the bailout money will go to these honest executives and traders.

One potential glitch: Many Wall Street executives and traders don't pay enough income taxes to take full advantage of the tax credit. Their earnings come in the form of capital gains, taxed at 15 percent, or they're parked in the Netherlands Antilles and other tax havens. The only way around this is to make the RWSTC fully refundable. That way, executives and traders who don't pay enough income taxes to get the full benefit of the credit will be able to collect it anyway, in the form of a direct cash subsidy from the federal government.