Washington's inconvenient economic truths

As politicians plan for midterm elections, they're going to get all tied up about who gets credit for a recovering economy.

By Nina Easton, Washington editor

WASHINGTON (Fortune) -- Now that we're officially (if barely) out of the Great Recession, it's time for our nation's elected officials to get down to serious business -- that of taking credit, assigning blame, and calling each other liars.

The $787 billion stimulus package signed by President Obama is the picked-over carcass in the middle, with the White House claiming credit for millions of jobs "saved" and the Republicans accusing Team Obama of playing fantasy foosball with hard economic data.

But the stimulus package is mostly beside the point -- at least so far -- which poses an inconvenient political truth for both President Obama and his GOP foes. The real credit for a rebounding economy goes to the Federal Reserve Board -- chaired by a Bush appointee, Ben Bernanke, whose term was just re-upped by Obama.

Some credit for stabilizing the financial system can also be given to a wildly unpopular bank bailout launched by President Bush's Treasury Secretary and endorsed and sustained by President Obama's Treasury Secretary.

Try making those points to angry voters in next year's midterm elections.

No elected Democrat really wants to embrace TARP, no matter how much Tim Geithner has tweaked and re-tweaked the bank rescue program, and no matter how many billions banks have since returned, stapled with interest payments to U.S. taxpayers.

Likewise, Republicans are painfully aware that last summer's "tea party" rebellions had as much to do with public anger over these Wall Street bailouts as they did with opposition to government-run health care.

Some economists, like Stanford University's John Taylor, think TARP was an unnecessary disaster. Others, like Allen Sinai, president of Decision Economics, say the government missed an opportunity to drive a real turnaround as we stared into a financial abyss.

Instead of injecting capital into banks who were unlikely to lend the money back out in such a dismal credit environment, Sinai argues the government should have supported housing prices -- the root of the crisis -- by directly intervening in the mortgage market.

Still, most economists credit TARP, followed by Treasury's requirement for the big banks to raise private capital, with stabilizing the financial sector -- a prerequisite to the 3.5% GDP growth for the third quarter that was reported last week. (Even Sinai credits TARP with a small but measurable role in last week's good news.)

Says the American Enterprise Institute's Alex Brill, former chief economist to the House Ways and Means Committee: "There is a lot of fair criticism about how TARP operated. But the banking system is the grease in our economy. As a result of TARP, we're in a much better place today." Even though, as Brill acknowledges, "TARP is scary for a lot of politicians and voters."

There is similar disagreement among economists over the impact of the $787 billion stimulus bill that a Democratic Congress passed and President Obama signed last February.

Sinai calculates that the tax and income supports, along with aid to states and cities, were responsible for about 40% of the 3.5 GDP growth rate reported last week. (Though Sinai and other economists include in their measurements the Cash for Clunkers program, which clearly caused an uptick in auto manufacturing. But that month-long trade-in program has ended, and wasn't even part of the original Obama stimulus bill.)

Brill argues that Obama's stimulus had very little impact on GDP because very little money is getting out the government door. "The bureaucracy and red tape in these projects is systemic," he says.

And Stanford's Taylor argues in his blog that the Bureau of Economic Analysis tables released with last week's GDP numbers "make it very clear that the $787 billion stimulus package had virtually nothing to do with the improvement."

What's harder to ignore in this improving economic picture is the role of the Fed, which has effectively bypassed an ailing banking system to pump credit into the economy. The Fed's interventions have been manifold: through the commercial-paper market and short-term loans to banks; through supports for loans to small business, auto buyers, credit-card holders and student-loan borrowers; and through a commitment to buy up $1.25 trillion in loans tied to home mortgages.

"Where you see that is in home sales and housing starts," says Sinai. "The GDP numbers showed a nice increase in residential construction. Also, home prices have bottomed out. That's a secondary effect of the Fed's actions."

Of course, Fed monetary policy, which has kept interest rates at effectively zero, has also "had a significant effect on the economy," says Sinai, producing a stock-market rally that caused wealth gains, and boosting investor confidence. And a lower dollar, he notes, has helped exports, which showed a healthy increase in last week's GDP figures.

As the economy improves, economists will give a pat on the back to Bernanke -- even as they worry about inflation and what will happen when he takes his foot off the money accelerator. But don't look for 435 House members and 36 U.S. Senators seeking reelection next year to take to applause lines for Bernanke -- or his Federal Reserve Board.

The effect of TARP, the most widely publicized piece of last year's government response to the financial crisis, was to stir fierce populist sentiment. The Fed, a historically secretive and mistrusted agency, doesn't escape those passions. Libertarian Ron Paul of Texas, who has called for an end to the Fed, introduced a bill to audit the agency's monetary policy-making -- and 308 House members have since signed on.

This isn't a clean Republican-Democrat divide; it's a grass roots-elite divide. And the Fed's key role in America's economic recovery is one of those truths that just isn't convenient on any campaign trail right now. To top of page

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