How Gridlock in Washington Endangers the Economic Recovery

The political gridlock that just was elected to office could make things worse. By definition, gridlock means the status quo is preserved, because nothing can be done to change it. The status quo is a mess, and preserving it is exactly what we don't need. Let's look at some of the key economic issues.

Real estate. The real estate market and its associated mortgage crisis were the origins of the Great Recession. When the credit carousel stopped turning in 2008, trillions of dollars of losses cascaded on banks, investors, homeowners and ultimately taxpayers. Financial crises such as this work themselves out through the allocation and realization of those losses. Losses must be taken by someone or they will continue to hover over the economy, discouraging consumption and investment, and hindering recovery. Over the past two years, some of the losses have been taken, by banks writing down loans and other assets, investors seeing lower prices on mortgage-backed investments, homeowners suffering falling home values, and taxpayers subsidizing all of the foregoing. But there remain tons of unbooked losses, and also the painful problem of what to do with Fannie Mae and Freddie Mac (i.e., to what extent will taxpayers provide future subsidies to the housing market). Liberals can't envision a U.S. housing market without federal support, and conservatives can't stomach perpetuation of such massive subsidies and bailouts. The current chaos and confusion in the real estate market, amplified by the burgeoning foreclosure mess, will continue. The process of loss allocation and realization will continue, but in the haphazard, ad hoc, unfair and lunatic way it now operates. Consequently, real estate and housing will stay sick puppies, dragging on economic recovery.

Fiscal Policy. The Bush tax cuts will be extended for almost everyone. If the Republicans have their way, they'll be extended for everyone. But doing so will conflict with a cherished Republican goal of shrinking federal deficits. In theory, deficits could be reduced by cutting spending. In fact, the newly elected coalition government in the U.K. is taking this approach. But Britain's parliamentary system of government enables such decisive action. America's Constitutional limitation and division of authority acts in the opposite direction, permitting the electorate to choose a chief executive and chambers of the legislature from different parties. Gridlock will preclude major spending cuts. Fiscal policy will remain the mosh pit it is today and deficits will lurch on.

Even in situations where Congress can act, it won't have easy choices. Federally funded unemployment benefits for the long term unemployed will expire at the end of this month. Congress has three weeks to act. Extending benefits would help keep the economy muddling forward. Cutting off benefits would help reduce the deficit (although not by much, maybe a couple billion, which in context is peanuts). But it will also increase the doom and gloom among the electorate. Lengthening the line at the food bank won't spur consumer spending, even if passbook savings accounts pay 0.00001% per annum.

Monetary Policy. The Fed, being somewhat insulated from politics, will continue with monetary policy, and its recent announcement of $600 billion of quantitative easing reflects a clear, if not unanimous, choice to provide more stimulus. Congressman Ron Paul, cynosure of libertarians and Tea Partiers, and soon to be the chairman of the House Subcommittee for Domestic Monetary Policy and Technology, has already announced that he plans to scrutinize the Fed closely, questioning the fundamental premises of its policies and actions. Paul travels leagues farther than mainstream Republicans in challenging conventional monetary policy, subscribing to the gold standard and doubting the wisdom of central banking at all. Chairman Bernanke can look forward to providing the subcommittee with the pleasure of his testimonial company on a regular basis. The Fed's renewed program of quantitative easing will face head winds from the direction of Capitol Hill.

The last industrialized nation to suffer a financial crisis and recession like America's was Japan. The Japanese government reacted indecisively, often sinking into dysfunction because each of its options was painful and it was reluctant to impose the costs of washing the crisis' losses out of the economy. So it allowed the losses to linger, dampening economic recovery to this day. The gridlock soon to settle into Washington could easily lead to similar dysfunction, letting the economic recovery meander. The Japanese central bank lowered interest rates to essentially zero and also conducted quantitative easing. But, in a dark omen for the Fed, monetary policy in Japan wasn't enough.

If the government is capable at all of restoring prosperity, a question not without doubt, it will have to act with unity of purpose and decisive amounts of fiscal stimulus as well as monetary accommodation. That ain't gonna happen. Have an umbrella ready for the next two years because storm clouds are gathering. And recall that old timers who lived through the Depression would often carry a roll of hundreds of dollars in their pockets, simply because cash money felt good. When times are tough, cash talks and just about everything else walks.