A Domestic Surge

Thomas Friedman says we need an immediate surge of overwhelming force:

We Found the W.M.D., by Thomas Friedman, Commentary, NY Times: ...This financial crisis is so far from over. We are just at the end of the beginning. ... If I had my druthers right now we would convene a special session of Congress, amend the Constitution and move up the inauguration from Jan. 20 to Thanksgiving Day. Forget the inaugural balls; we can't afford them. Forget the grandstands; we don't need them. Just get me a Supreme Court justice and a Bible...

Unfortunately, it would take too long for a majority of states to ratify such an amendment. What we can do now, though, said the Congressional scholar Norman Ornstein,... is "ask President Bush to appoint Tim Geithner, Barack Obama's proposed Treasury secretary, immediately." Make him a Bush appointment and let him take over next week. This is not a knock on Hank Paulson. It's simply that we can't afford two months of transition where the markets don't know who is in charge or where we're going. At the same time, Congress should remain in permanent session to pass any needed legislation.

This is the real "Code Red." As one banker remarked to me: "We finally found the W.M.D." They were buried in our own backyard - subprime mortgages and all the derivatives attached to them.

Yet, it is obvious that President Bush can't mobilize the tools to defuse them - a massive stimulus program to improve infrastructure and create jobs, a broad-based homeowner initiative to limit foreclosures and stabilize housing prices, and therefore mortgage assets, more capital for bank balance sheets and, most importantly, a huge injection of optimism and confidence that we can and will pull out of this with a new economic team at the helm.

The last point is something only a new President Obama can inject. ... I have no illusions that Obama's arrival on the scene will be a magic wand, but it would help.

Right now there is something deeply dysfunctional, bordering on scandalously irresponsible, in the fractious way our political elite are behaving - with business as usual in the most unusual economic moment of our lifetimes. They don't seem to understand: Our financial system is imperiled. ... The stock and credit markets ... have started to price financial stocks at Great Depression levels, not just recession levels. With $5, you can now buy one share of Citigroup and have enough left over for a bite at McDonalds.

As a result, Barack Obama is possibly going to have to make the biggest call of his presidency - before it even starts.

"A great judgment has to be made now as to just how big and bad the situation is," says Jeffrey Garten, the Yale School of Management professor of international finance. "This is a crucial judgment. Do we think that a couple of hundred billion more and couple of bad quarters will take care of this problem, or do we think that despite everything that we have done so far ... the bottom is nowhere in sight and we are staring at a deep hole that the entire world could fall into?"

If it's the latter, then we need a huge catalyst of confidence and capital to turn this thing around. Only the new president and his team, synchronizing with the world's other big economies, can provide it.

"The biggest mistake Obama could make," added Garten, "is thinking this problem is smaller than it is. On the other hand, there is far less danger in overestimating what will be necessary to solve it." ...

There are lots of uncertainties right now. For example, very few of the econometric estimates we have cover time periods where the conditions we are seeing today were in effect, so there is uncertainty about the right values to use in calculations concerning the size of the stimulus (will Okun's law still hold if firms have excess capacity allowing them to increase production without adding many new employees?). Many of the estimates are also based upon the assumption that the unemployment rate will reach 3.5% above normal (without intervention), but that number is not known with certainty either. You can use that uncertainty to tell a "maybe it won't be so bad so let's not panic and do a large stimulus" story, but the uncertainty also works in the other direction and things could be worse than expected (or the stimulus less could be less powerful than expected). Since the loss function is asymmetric - doing too little is more costly than doing too much - we need to be sure that the stimulus is large enough to provide some degree of insurance against unexpectedly bad outcomes. And the sooner we do this, the better.