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Looking back at what worked and what didn’t can help us avoid pitfalls that hampered policymakers in the past and embrace the measures that made the biggest difference.
The following is a guest version of Unsanitized from Ganesh Sitaraman, Professor of Law at Vanderbilt Law School, and author of The Great Democracy; and Lev Menand, Academic Fellow and Lecturer at Columbia Law School, and senior advisor to the Deputy Secretary of the Treasury from 2015-1016.
With Congress debating a stimulus and bailout package to address the economic crisis sparked by the coronavirus, it is worth looking back at policy choices made during the last economic crisis to draw some lessons for navigating the current emergency. Starting in 2008, policymakers pursued a variety of crisis-fighting strategies, from investing in banks and automobile companies, to cutting taxes and green-lighting infrastructure investments, to re-regulating financial institutions and setting up new agencies to protect Americans from some of the harmful practices that helped precipitate and worsen the crash. Looking back at what worked and what didn’t can help us reprise successful strategies while avoiding pitfalls.
- Fiscal Stimulus Should be Big, Salient, and Recurring. The 2009 stimulus was big, but not big enough. Famously, Christina Romer, President Obama’s chief economic advisor, proposed a stimulus of greater than $1 trillion, but was rebuffed by political advisors who thought that amount would appear too large. The stimulus that passed was not only too small, but it was largely composed of withholding tax reductions. This tax cut went unnoticed by most people, compared to getting a check from the federal government. (Incredibly, that was by design.) For a stimulus to work well, people should know and feel that they are getting money in their pockets. Ideas like cancelling student loan debt, expanding Social Security payments, and direct transfers are therefore far better than payroll tax cuts. And as economic crises generally do not resolve themselves immediately, a stimulus should not be a one-time-only action. Indeed, after the last stimulus, the federal government adopted sequestration, a disastrous austerity policy that ran directly counter to continuing to spark growth and recovery. A stimulus should be sustained with recurring elements to restore confidence and ensure that recovery does not depend on the legislature reauthorizing expansionary policy every six months.
- Target Main Street. During the 2008 crisis, policymakers targeted the bulk of the bailout money at Wall Street financial institutions, rather than homeowners. The result was twofold. Wall Street recovered relatively swiftly, while homeowners did not; and the economy was rebuilt on a shaky foundation as homeowners struggled for years to get above water on their mortgages. Some at the time argued for rescuing homeowners, rather than big financial institutions, but their arguments went unheeded. This time, instead of homeowners, it’s small businesses and workers who are in trouble. Restaurants, bars, mom-and-pop retail, and other local enterprises are suffering from physical distancing. Workers are losing their jobs. Policymakers’ focus needs to be on proposals that will keep these businesses and individuals afloat. Stabilizing household balance sheets will address one of the roots of the crisis and lay the foundation for economic recovery.
- Reforms Should Make Structural Improvements. Both bailouts and a stimulus can be designed as one-time policies or can be designed to have structural implications to get the economy on a safer, stronger, more secure footing in case of a future crisis. Reducing withholdings—as the 2009 stimulus did—or the payroll tax cut that the White House proposed recently do not serve that purpose; in fact, they could weaken important safety net programs. Instead, policymakers should push for proposals like paid leave, and condition bailouts on higher wages and governance reforms. These kinds of changes strengthen the economy after the crisis subsides - and make it more resilient for when the next crisis hits.
- Bailouts Without Stringent Conditions are a Bad Idea. When the government bailed out financial institutions in 2008, it did so with few conditions. This created two sets of problems. First, rescued firms were free to use taxpayer funds to pay bonuses, rather than for shoring up the economy at the household level. And second, it re-established that these institutions were too big to fail, and gave them license after the fact to return to irresponsible, risky behavior. Thus, many of the biggest banks have grown since 2008 and pushed for deregulation, increasing the likelihood of future bank bailouts. Executives and investors did well during the boom years, knowing that the government would likely rescue their firms if things went bad. While some say that we should simply let irresponsible private companies fail, certain businesses are effectively public utilities for which continuity of service is of critical importance. Banks are essential to economic functioning, and in a crisis the government is typically the only source of new capital to keep them operational. Airlines, which face serious distress today, also provide basic infrastructure. Policymakers need to keep these businesses running but they do not need to bail them out unconditionally.
- Debt Restructuring Should Focus on Forgiveness. In a shrinking economy, facing growing deflationary pressures, some debts cannot be repaid. But default and foreclosure are hugely disruptive and damaging, and in the current environment, actively dangerous. During the Great Recession, policymakers adopted technical, complicated policies like the Home Affordable Modification Program (HAMP) to get at the ongoing mortgage crisis. But HAMP was difficult to navigate, slow to act, helped too few people, and disproportionately benefited big companies. HAMP was also inadequately sized. Mortgage debt overhang continued, holding back consumer spending and impeding the recovery. A better, simpler, and more effective response would alleviate suffering by simply forgiving debt and eliminating debt overhang,
- Technocratic Regulation Is Fragile and Often Ineffective. After the financial crash, Congress passed the Dodd-Frank Act, a law that reformed the financial system largely by requiring technocratic governance by administrative agencies, rather than through structural improvements to the design of financial institutions. For example, instead of breaking up the banks through a simple, clear Glass-Steagall regime, the Volcker Rule prohibited proprietary trading, but with some carve-outs. Companies heavily lobbied regulators on the specifics, ultimately stretching the rule to hundreds of pages of obscure language. A few years later, banks succeeded in rolling back several aspects of the Volcker Rule. Looking forward, policy reforms shouldn’t focus on either deregulation or technocratic regulation—they should focus on structural reforms that create the conditions for enduring economic stability.
- If it Functions as Money, it Should be Regulated as Money. The Federal Reserve recently announced it would back commercial paper markets, repo markets, and money market mutual funds, serving as a lender of last resort for issuers of these deposit-substitutes. This gives these firms the benefits of a public subsidy without imposing any of the prophylactic safeguards designed for bank deposits. Ordinarily, banks get the benefit of federal insurance through the FDIC, in return for being regulated and paying fees to the government. This prevents a “run” on the banks, and it was a critical part of the New Deal. In 2008, a run in the money markets helped deepen the financial panic and amplify the recession, and yet this market was never fully reformed. We shouldn’t make the same mistake twice. If the Fed is going to backstop these money-substitutes, they should be brought into the bank regulatory regime.
