Stimulus may fall short without banking fix

WASHINGTON (Reuters) - Without a clear plan to rid U.S. banks of bad assets, a nearly $900 billion government spending and tax cut plan working its way through Congress may amount to pouring money down a black hole.

That message, articulated in recent weeks by such luminaries as Federal Reserve Chairman Ben Bernanke and International Monetary Fund Managing Director Dominique Strauss-Kahn, seems to be resonating with President Barack Obama and his economic team.

Next they have to convince Congress -- and ultimately the public, which is growing weary of the steadily rising tab for saving the economy from ruin. If Obama concludes that repairing the banks will require a great deal more money, he may have to spend a bit of his own political capital.

“If there’s not a restructuring of the banking system, then all the money that you can put into (monetary and fiscal) stimulus will just go into a black hole,” Strauss-Kahn told a panel discussion last week in Washington.

Bernanke put it more mildly in a January 13 speech in London: “History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively.”

The central bank chief, Treasury Secretary Timothy Geithner and top banking regulators are trying to figure out how best to get the U.S. economy functioning again, and fixing the banks is at the center of those discussions.

The Treasury is expected to provide a framework for its ideas early next week. Among the proposals under consideration are an insurance program to limit losses, a so-called “bad bank” that would buy troubled assets, and recapitalization.

The aim is get credit flowing normally. As long as banks are worried about mounting losses and struggling to raise money from the private sector, lending will be limited and so will economic growth.

Depending on how the administration proceeds, Obama may need to ask Congress for more money beyond the $700 billion financial bailout fund approved last fall, a program that has raised the ire of voters upset at bailing out Wall Street.

His advisers are trying to keep the price tag below the trillions of dollars that some economists say is needed to remove mortgage and consumer debts, but even a smaller request could provoke further howls.


Obama already is expending political capital to push a stimulus plan that has met with considerable resistance, mostly from Republicans. The House of Representatives passed a version that would cost more than $800 billion, but every Republican voted against it. The Senate is expected to pass its own costlier version this week.

The president has taken the unusual step of asking loyal supporters to help him convince voters the package is necessary. He e-mailed a request for people to host house meetings to explain the plan, and set up a Web site where people can volunteer or find a nearby meeting. (here)

“You can help restore confidence in our economy by making sure your friends, family, and neighbors understand how the recovery plan will impact your community,” Obama wrote in the e-mail, which was sent out on Monday.

He may have to launch another public relations campaign should the next stage of the bank rescue program require big spending. Perhaps by quelling voter rebellion, he may defuse some of the opposition in Congress.

Some officials believe Obama is in a better position than his predecessor to make the case for aggressive, unpopular spending programs. Not only does he bring a high approval rating, but if voters think Obama is simply cleaning up a mess left by former President George W. Bush, they may be more receptive to his call for bold action.

Economists have been cautioning that even the full dose of stimulus that Obama wants is not enough to patch the hole that the financial crisis has blown through the economy.

John Makin, a visiting scholar at the American Enterprise Institute, a conservative think tank, said the spending package would provide stimulus equal to less than 2 percent of annual output per year. That would not be enough to compensate for a drop in consumer and business investment spending that could reach 6 percentage points this year.

“If the financial sector remains out of operation, the impact of the fiscal stimulus will be even less,” Makin said.

“If, over the coming months, a series of steps can be undertaken to contain the financial crisis by re-enabling the banking system to provide credit to households and firms, hopes for a stabilization of output by early 2010 may yet be realized,” he added.

Editing by Jonathan Oatis