News & Views from 465 California Street

The Democrats’ Debt Trap

Clint Reilly
Jan
12
2010

Politics runs on its own clock. Only 12 months ago, I was triumphantly predicting decades of Democratic dominance in Washington. Today, I worry about President Obama’s re-election prospects in 2012 and whether Democrats will retain their strong majorities in the House and Senate.

What happened?

The massive federal expenditures orchestrated to rescue the nation from economic collapse are now boomeranging politically. Republicans are using the $12 trillion national debt as a cudgel, beating Democrats over the head as the midterm elections approach.

Charlie Cook – ace predictor of congressional races – now says Democrats will probably lose 30 seats this November.

It’s not unusual for an incumbent president’s party to lose seats two years into the first term. Ronald Reagan lost 26 Republican seats in the 1982 midterms. In 1994, Bill Clinton lost more than 50 seats and Republicans won control of the House and Senate for the first time in 40 years.

Both Reagan and Clinton faced grinding recessions during their first years in office. But the economy recovered over the subsequent two years, just in time for both of them to be comfortably reelected – Reagan by 17 million votes and Clinton by 8 million.

So, President Obama may well see his own polling numbers – and re-election prospects – improve dramatically if the recession ends, the national job picture brightens and the country’s GDP continues to grow.

But what if it doesn’t?

The economic debacle that President Obama now faces is radically different than the much less cataclysmic recessions of the 80s and 90s. This time, our financial system teetered on the brink as trillions of dollars of wealth was erased by bad mortgages, credit default swaps, commercial loans and the underlying value of the assets which secured them.

Financial behemoths were bailed out to save consumers from being subsumed in a tidal wave of bankruptcies. Without the government’s infusion of taxpayer capital, most big banks would probably have gone bankrupt.

Instantly, tens of millions of average Americans saw their entire net worth wiped out – not just in the stock market and their 401ks, but also in their homes.

Having borrowed against their houses to finance purchases beyond their means, many Americans discovered that they were left with all the debt and none of the equity.

In a recent interview with Barron’s, economist Richard Koo compared the U.S. predicament to Japan’s long recession of the 1990s, when commercial real estate prices plummeted 87 percent from their peak.

Koo coined the phrase “balance sheet recession” to describe the fact that most Japanese households felt bankrupted by the fall of property values and stopped borrowing and spending money in order to repair their personal balance sheets.

The suspension of consumer activity staggered the world’s second-largest economy. Only massive deficit spending by the Japanese government on public works and other stimulus programs saved Japan from falling into an economic abyss.

On the occasions when Japanese deficit hawks forced the government to reverse course and cut spending, the economy faltered almost immediately. This fitful pattern produced what economists now call “Japan’s lost decade.”
The lesson for America coming out of the worst recession since the Great Depression is clear: It’s unlikely that consumers will return to their debt-fueled, free-spending ways; many will be cautiously rebuilding their household net worth for many years to come. Therefore, the federal government must continue deficit spending to keep the economy alive.

This makes the midterm election calculus tricky for Democrats. Can they possibly maintain the political will for the greater borrowing, more stimulus and even higher deficits necessary to keep the nation from lapsing into a double-dip recession? Or will they be cowed by losses in November and retrench?

Turning off the federal spigot may prolong the recession into 2012, which would likely seal President Obama’s fate and spell the end of the Democrats’ congressional majority.

Democrats might be caught in a debt trap: damned if they do, damned if they don’t.

Comments (2)

  • Deficit spending doesn’t always work. You failed to mention the deficit spending of over a trillion dollars-and going up by the minute– since 2001 on the two wars?

    We have a silly system: we in CA send our tax money to the federal government and then expect our pols to bring back the bacon (aka “pork”)as much as possible. You might want to write on this topic. Federal taxes should be collected and spent only on truly national programs, e.g., defense, federal courts, etc. All federal money for education, subsidies, favorite pay-back projects of big money donors to congress people, (both Feinstein and Boxer do this all the time) etc., should be abolished.

    Ernest A

    Posted by: Ernest A. | January 12th, 2010 at 11:01 am

  • Hi Clint,

    I usually agree with you on most matters but must admit to a few
    hiccups in your latest column.

    My impression is that people are not blaming Obama for the banking
    debacle. The bankers are helping in this by continuing to hand out
    obscene bonuses. People hate that!

    Let me say that I am a lifelong Democrat. I remember my Dad riding our
    horse across the snow-covered fields of eastern Pennsylvania in 1932
    to vote for FDR. I was a devoted Obama fan. I donated, made phone
    calls, sent e-mails, voted and urged others to vote.

    Right now I feel disappointed and betrayed, and I believe those
    feelings are mirrored in others who voted for Obama with high hopes.
    He has gone back on too many of his campaign promises. We still have
    not closed Guantanamo. We still have the absurd “don’t ask don’t
    tell.” His Justice Department is in court DEFENDING Bush wire-tapping
    policies. He went to Copenhagen proposing an absurdly minimal cut in
    emissions. It’s looking like his so-called “health care reform” will
    be worse than what we have now, with the insurance and drug companies
    even more firmly in charge. What’s worse, it’s an insult to our
    intelligence to brag about “covering more Americans” when those
    Americans are FORCED TO BUY COVERAGE from the same old profiteering
    insurance companies.

    People are beginning to notice that Obama, in way too many cases, has
    appointed the foxes to guard the henhouse – Geithner, Summers,
    Vilsack, and a host of others. Many of us wonder why Obama chose to
    bail out the BIG banks and let the smaller ones go belly up. We wonder
    why our money went to the banks, rather than to distressed homeowners
    where it would have gone back into the economy instead of being
    creamed off in bonuses for bankers.

    The one area Obama HAS stood firm on is an escalation of the war in
    Afghanistan, notwithstanding history or current facts on the ground.
    We can’t afford a decent health-care system because it might increase
    the deficit, but we can take on another decade of war, at a current
    estimate of $9 Billion per month?

    IMO, these are the factors that are going to come crashing down on the
    Dems in November. I’m guessing that we will have the lowest voting
    turnout we’ve had in years, that people will simply stay home, having
    been given the clear message by the Democrats that we ordinary people
    don’t count.

    Tell me I’m wrong. I need a dose of optimism!

    L.M. A

    Posted by: L.M. A. | January 12th, 2010 at 4:11 pm

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