- The Washington Times - Sunday, September 21, 2008




The next president of the United States will assume office in January 2009 in the midst of an ongoing economic crisis. He will need to take urgent action to address the acute problems in the housing market and the financial system.

Over the next two months, Sens. John McCain and Barack Obama will be engaged in the final stages of their electoral race for the White House. In the heat of the campaign, one must hope that the candidates do not lose sight of the fact that the next president will be inheriting the most difficult U.S. economic situation in the past 70 years. With a view to underlining the enormousness of the next president’s economic challenge, I offer below the sort of economic memorandum that he is likely to receive from his economic advisers as he begins preparing for his inaugural address to the nation on Jan. 20, 2009.

Mr. President, our in-depth assessment of the economy reveals a very much more disturbing picture than we had anticipated during the electoral campaign. Of particular concern are the abrupt weakening in the labor market, the acute stresses in the financial system (as underlined by the failure of several important regional and investment banks), the continued swoon in the equity market, and the plumbing of new all-time lows in consumer confidence.

This situation dictates that the economy must be at the front and center of your inaugural address. In this respect, you might wish to model your address on Franklin Delano Roosevelt’s 1933 inaugural speech in the sense of aiming at bolstering confidence and affording a bold new vision to the American people as to how this difficult situation is to be turned around.

If we have learned anything from the 1930s, it is that the world can ill afford a turning back of globalization at a time of global economic weakness.

At the heart of today’s economic crisis is the continued rapid decline in home prices at the national level. For not only do falling home prices erode the main source of the average American’s wealth and financial security, they also compromise the solvency of our banking system. That in turn is now causing the banks to aggressively cut back on lending at the very time that the economy most needs such support.

For 18 months now home prices have been falling at an annual rate in excess of 15 percent. Yet home prices show no sign of stabilizing. Unsold housing inventories are still at record levels and the foreclosure rate has risen to an annualized rate of more than 3 million homes. With more than one in three households now having negative equity in their homes, there is the very real danger that the foreclosure rate will continue to increase.

Simply allowing the housing bust to play out is not a viable policy option since it runs the real risk of creating adverse feedback loops that could be highly damaging to the economy. This is not meant to imply that there are easy policy options to putting a floor to the housing market bust. However, it would seem urgent that bipartisan support be found for building on last year’s Chris Dodd-Barney Frank initiative to reduce housing foreclosures, while serious thought should be given for a temporary revision to bankruptcy procedures as far as they affect homeowners. You might wish to model your initiatives in this area on the Home Owners’ Loan Corporation of the 1930s.

A second major economic policy area in need of immediate attention is fixing the broken U.S. financial system. Not to put a fine point on the matter, the U.S. banks’ egregiously bad past lending practices have resulted in a wide swath of the U.S. banking system being either insolvent or grossly undercapitalized. Japan’s sad experience during the 1990s would suggest that simply allowing the banks’ bad debt problem to fester is a sure recipe for losing an economic decade.

If bank lending is to be normalized, there would seem to be little alternative but for government intervention in the banks along the lines of the Resolution Trust in the 1980s savings and loan crisis. One should not minimize the likely considerable cost to the U.S. taxpayer of such intervention. However, the alternative is to have subpar economic performance for many years. In the interests of both equity and minimizing moral hazard, it is imperative that any government intervention in the banks be conditioned upon the wholesale replacement of the banks’ management and the total wiping out of the banks’ equity holders.

A further issue in need of immediate attention is trade policy, where a slowing global economy has spawned a disturbing resurgence of trade protection both at home and abroad, as underlined by the recent failure of the Doha Round. If we have learned anything from the 1930s, it is that the world can ill afford a turning back of globalization at a time of global economic weakness. The United States remains the only country in the world that can provide leadership for the maintenance of open world markets and your inaugural address provides the perfect opportunity for you to set the tone on this issue for the next four years.

I fully recognize that during the campaign we focused on the need for longer-run reform of our tax system, energy policy, our entitlement programs and our health care system. Important as these issues are, they should not be allowed to detract from the immediate task at hand of forestalling any deepening in our present economic crisis.

May I conclude by sincerely apologizing for not having broken the bad economic news to you earlier last year? However, I fear that had I done so you, might very well have lost your appetite for the job you have so single-mindedly sought.

• Desmond Lachman is a resident fellow at the American Enterprise Institute.

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