My Economic Wish List

The House plan doesn't spend fast enough.

ALAN S. BLINDER

While wiping my desk lamp the other day, a genie appeared, offering me -- you guessed it -- three wishes. I first asked him to restore my portfolio to its former glory. He demurred: "No, I only grant wishes for the national economy. And I only do things that real policy makers can do -- no magic for this genie. But think big. We're in a mess."

Chad Crowe

So here's what I wished for:

- Stimulus that works. My first wish is that Congress quickly pass a large stimulus bill that exhibits intelligent design. The overall number being discussed, in the $800 billion plus range, seems reasonable to me even though some economists are clamoring for much more. My wish relates to the package's composition.

My first worry is the spend-out rate -- stimulus is, after all, about shortening recessions. Given the choice, I'd prefer an $800 billion stimulus with $600 billion spent in the first 12 months to a $1 trillion stimulus with $300 spent in the first 12 months.

A report by the Congressional Budget Office issued on Jan. 26 estimated that only 15% of the appropriated funds in the House bill would be spent this fiscal year, and another 37% in the next. That's not bad as these things go, but it's still too slow. The Senate version is larger and spends slightly faster.

Peter Orszag, the new director of the Office of Management and Budget, has stated that three quarters of the whole package -- including the tax cuts -- should be spent within 18 months. Genie, please grant Mr. Orszag his wish.

Advocates of more spending should also worry more about the quality of the projects and the government's ability to manage them effectively. The numbers are huge. For reference, total appropriated federal spending (excluding entitlements) is now running just under $1 trillion per year, and well over half of that is for national security. Thus, a $300 billion increase in annual civilian spending would boost that part of the budget by about 70%.

What government, or what company for that matter, can manage a rapid 70% budget increase without some waste, fraud and abuse? With legions of journalists waiting to write about exactly that, I worry that their stories might give the very idea of stimulus a bad name.

So where does this lead? To fast-acting spending, like projects that are really -- I mean really -- shovel-ready. To federal grants that forestall state and local government cutbacks and tax increases. To payroll tax cuts, rather than business tax cuts. And to other tax cuts and transfer payments for people who live hand-to-mouth -- expanded unemployment benefits and health insurance for the unemployed being two excellent examples. And if you really want to think big, I've suggested turning state sales tax rates negative for a year or so, with the federal government making up the lost revenue.

- Serious foreclosure mitigation. My second wish is that we finally get serious about fighting the tsunami of foreclosures. We've tried to refinance delinquent and imperiled mortgages through voluntarism and on the cheap, to no avail. Now we must get real and recognize that we need powerful incentives, perhaps even some coercion, and a good chunk of public money.

What might this mean, concretely? There are many foreclosure-mitigation plans; two or three arrive in my inbox every day. More than a year ago, I advocated reviving the Depression-era Home Owners Loan Corporation, which purchased mortgages at discounts and refinanced them. But that's not going to happen and, frankly, we have now procrastinated so long that I'm prepared to board any train that will leave the station. And, thank goodness, the Obama administration is promising quick action. However, four broad criteria strike me as important.

First, significant principal reductions must be part of the solution, especially where mortgages are underwater. Relying on interest-rate reductions and stretching out payments isn't enough. But principal reductions require cash to fill the gaps -- so banks, investors and the public purse will all have to take hits. A government tab in the $100 billion-$200 billion range seems plausible right now. But the longer we wait, the larger the bill will grow.

Second, the refinancing plan should not make missing several mortgage payments a prerequisite for assistance. We don't want to encourage more delinquencies.

Third, I have reluctantly concluded that Congress will have to realign some property rights to free mortgages from the legal straitjackets created by complex securitizations. As things stand now, responsibility for refinancing imperiled mortgages rests with servicers, who face extremely lopsided incentives. Refinancing mortgages to lower principal amounts earns them small fees and exposes them to big lawsuits. Congress must give servicers safe harbor from lawsuits or transfer the refinancing responsibility to other parties.

Fourth, I fear that smart refinancing will have to be done one mortgage at a time. A cookie-cutter approach applied to large numbers of mortgages is superficially attractive -- it's faster and less labor-intensive. But ignoring old-fashioned underwriting standards (e.g., how much can each homeowner afford?) will produce nonviable mortgages for some, undeserved windfalls for others, and widespread complaints of unfairness -- not to mention legal challenges.

- Lower credit spreads. My third and final wish is directed to the Federal Reserve: Shrink those enormous interest-rate spreads (over Treasurys). To cite just one stunning example, junk bonds yielded about three percentage points more than Treasurys before the crisis. That was too low; the historical average spread is five to six points. But they now yield more like 15-20 points above Treasurys. What business can afford to borrow at such rates?

About three months ago, the Fed made an unannounced but important shift in its basic approach to combating the crisis. It started to move away from the institution-by-institution approach toward what I call the market-by-market approach. By the former, I mean dashing in with an ad hoc rescue package for the company du jour, often on a Sunday night, with no consistency, inadequate transparency, and no apparent master plan. By the latter, I mean reviving moribund markets by coming in as a buyer, guarantor or collateral-taker of last resort.

The Fed cut its teeth on the market-by-market approach in commercial paper where, at first, it was almost the only buyer. Now there is substantial private activity, and spreads over Treasurys have come way down. Next, the Fed tackled the ailing market for Fannie Mae and Freddie Mac debt. Those spreads, too, have fallen.

So the approach seems to work. And notice these two important differences: The institution-by-institution approach offers band-aids, not cures, and its episodic nature leaves markets scratching their heads over the rules of the game. The market-by-market approach makes a start on a cure and offers a transparent rulebook.

Next up is the Term Asset-Backed Securities Loan Facility (TALF), a federal program that will soon be lending against assets backed by credit-card receivables, auto loans, small business loans, and student loans. I believe the Fed will subsequently extend this treatment to other asset classes, either by expanding the TALF or by creating new facilities -- which is my third wish.

Even taken together, these three mutually reinforcing policy initiatives do not constitute a complete cure for what ails us. But if we put them all in place, I believe we'll be well on our way out of the mess. Genie, are you listening?

Mr. Blinder, a professor of economics and public affairs at Princeton University and vice chairman of the Promontory Interfinancial Network, is a former vice chairman of the Federal Reserve Board.