Lehman, The Fed, And The Budget
Here's my column from today's Roll Call about what Lehman et al mean for the federal budget.
Lehman a Year Later: Some Budget Lessons Learned, Others Yet to Sink In
Sept. 15, 2009
It was just about a year ago that I returned from a blissful trip in Yosemite National Park to find that the financial world had completely changed. While my friends and I were primarily focused on breathing and blisters and I was doing everything possible to avoid the news (I even covered my eyes as I walked past the boxes that displayed front pages), Fannie Mae and Freddie Mac were seized, Lehman Brothers failed, and credit markets froze.
But Wall Street wasn’t the only thing that changed while I was gazing at Half Dome: The financial version of the nine-on-the-Richter-scale earthquake that occurred on Wall Street a year ago also meant big changes in the federal budget world. We just didn’t realize them at the time.
To say that some of the changes in the federal budget are now clear is almost laughingly obvious. We now know, of course, that current deficits are far higher than anyone had ever before dared to propose or project. We also now commonly recognize the record-high longer-term baseline deficits that were already in place when the massive federal response to Lehman, AIG, Citi and the rest was initiated.
Since then some other very important federal budget-related lessons have been taught and, hopefully, learned.
The most important of these is that, as much as most White Houses and Congresses might prefer it to be otherwise, dealing with economic emergencies is not the sole responsibility of monetary policy and the Federal Reserve. At least in the circumstances that presented themselves this time, there are definite limits to the ability of interest rate changes to reverse or even slow bad things from happening.
It also became increasingly obvious that, even when they’re successful, monetary policy changes seldom have the desired effect as quickly as many in Washington believed, or wanted to believe. Just because the Fed may move faster than Congress doesn’t mean the policy change will be effective any sooner.
We also now know that, and again contrary to what many had believed, actions taken by the Fed often directly affect the budget.
The lesson, therefore, is that, regardless of whether the response primarily is through monetary or fiscal policy, the budget is very likely to be a part of dealing with big economic disasters.
This will be especially true of a situation like the one we’ve been in the past year, when interest rates were already low and there were severe limits on what the Fed could do to spur economic activity. With consumer and business spending also constrained, fiscal policy was the only real option left to federal policymakers, and larger-than-life deficits were the result.
But we also know the budget will be affected even when the Fed has room to maneuver. In ways that simply weren’t commonly understood before, Federal Reserve borrowing and activities that reduce what it annually contributes to the Treasury change the bottom line for the rest of the government. For example, on-budget interest payments are likely to be affected for quite some time by the amount the off-budget Fed borrowed over the past year.
And all of this is in addition to what was commonly known and accepted about how economic downturns affect the budget: Even without any action by the president and Congress, revenues fall and spending increases.
What we haven’t yet learned is that when the economy is good, eliminating (not just reducing) the deficit and paying down the national debt have to be much higher priorities.
The reason is simple. If the budget is an increasingly important part of dealing with macroeconomic crises, Washington has to be in the best possible position to do the borrowing needed to implement the required fiscal policy response. Unless the appetite for U.S. debt is unlimited, or unless we’re willing to find out whether that’s really true at the worst possible time (that is, when getting the wrong answer could be catastrophic), federal borrowing when the economy is good has to be kept relatively low.
Had we continued to run the surpluses that occurred from fiscal years 1998 to 2001 and the national debt had been largely paid off by the end of this decade as we were promised it would be, the substantial additional borrowing the government has been doing the past year would not be the problem many consider it to be. Indeed, at this point Wall Street (excluding Lehman, of course) would be celebrating the borrowing because for the first time in years it would have had the first significant new supply of Treasuries to sell to investors desperate to buy them.
The problem is that making the debt a higher priority requires a current administration, House and Senate to suffer politically so that a future White House and Congress can reap the benefits. That’s almost completely at odds with today’s very short-term-focused budget politics where deficit reductions are demanded but the spending cuts and revenue increases needed to get that done are condemned because of (long-term economy be damned) the immediate negative impact on those who currently benefit from the programs or pay the taxes.
The combination of what’s been and what still needs to be learned leads to an extraordinary dilemma. On the one hand, we recognize that the budget will play a much larger role in dealing with economic crises than has been the case in the past. On the other hand, and despite what we’ve learned the past year, there still is little or no willingness to do what needs to be done to make it possible for the budget to used properly.
That could mean that the next economic disaster could be the toughest lesson of all.