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President-elect Obama campaigned on a platform of change. By golly, he's getting it. The economy can't find enough catastrophic changes these days. Wall Street's changed. Global trade has changed. Gas costs only a buck and change. Madoff investors have been reduced to spare change. I could go on.
I'm sure the new administration is already up to their ears in suggestions, but here are four more changes and ideas that should be considered to bolster the economy for the long term.
Have a long, hard talk with Ben Bernanke
The Federal Reserve's balance sheet has ballooned from $925 billion a year ago to $2.3 trillion today (here's a sobering look at how unprecedented this is). The rationale behind the surge is simple: In the past few months, the threat of deflation has come out swinging, prompting the Fed to double down -- lest the economy starts turning Japanese.
Nonetheless, there will come a day, however far off, when banks start lending again, consumers start spending again, and the perceived fear of inflation returns. If the Fed's balance sheet is still spilling money out of its pockets when that day arrives, the mother of all inflation episodes will be upon us -- no ifs, ands, or buts about it.
All hope doesn't have to be lost so long as Bernanke is Johnny on the spot removing excess liquidity before things start to pick up. Not during, not in the middle of, but before. That ultimately means raising interest rates while the economy's still limping. Politically unpopular as that may be, it's the only way to prevent a Japanese deflationary gauntlet from morphing into a Zimbabwean hyperinflationary war. Please, Ben, don't repeat Alan Greenspan's mistake of leaving rates too low for too long.
Up the gas tax
Raise taxes during a recession? Am I insane? Perhaps, but here's a parallel to draw: Cheap gas is a hidden stimulus that'll help consumers rebound in 2009, just as lower interest rates was the hidden "help" consumers needed to fuel their thirst for housing coming out of the last recession.
Getting addicted to anything artificially cheap can have disastrous consequences. Mortgages shouldn't have been made with a 1% teaser rate, and gasoline shouldn't cost $1.60 a gallon. Both are "stimulative" only until reality returns. And, boy, does reality ever return with a vengeance.
As Obama himself said, "Prices go back down, and suddenly we act like it's not important, and we start … filling up our SUVs again. And, as a consequence, we never make any progress." Sure enough, while overall sales at General Motors (NYSE: GM ) , Ford (NYSE: F ) and Toyota (NYSE: TM ) have fallen off a cliff, SUV and truck sales are making marked comebacks.
Price -- perhaps augmented with taxes -- is the only thing that'll wean us off an oil addiction. Europe figured this out years ago.
Get tough on bailout funds
There's something wrong when Warren Buffett -- capitalist of capitalists -- can get General Electric (NYSE: GE ) and Goldman Sachs (NYSE: GS ) to fork over preferred shares yielding 10% with 100% warrants to boot, while the government -- "lender of last resort" -- hands out preferred shares yielding 5% and warrants representing just 15% of the investment. I'm all for saving the financial system from systemic collapse, but when it's done at terms so lenient that relatively healthy companies like American Express (NYSE: AXP ) start lining up, the threat of moral hazard becomes terribly apparent.
I understand the counterargument here: Onerous interest rates on preferred stock depletes much-needed capital from companies like Citigroup (NYSE: C ) and AIG that were facing life-threatening cash crunches. So what's the solution?
Switch to common equity
While infusing cash and safeguarding taxpayers, the preferred shares injected into banks don't allow the flexibility needed to write off bad assets and make more loans. Banks can't stomach massive writedowns when they're capitalized with what is in essence an enormous liability to the Treasury and a spit of tangible common equity.
That's likely why Citigroup needed bailout part deux. Just weeks after getting $25 billion in preferred stock, its tangible common equity was still so minute that the fear of collapse was alive and well. Sooner or later, banks are going to need real, tangible, common equity, and that's what the Treasury should provide.
The downside is that common stock doesn't protect taxpayers as much as preferred stock does. So why not force banks to issue non-voting common stock at a fat discount to market prices? And lots of it. Make 'em pay up. Doing so addresses three key issues: It recapitalizes banks with the common equity they need, buffers against taxpayer losses, and ensures that only those that have exhausted other options come begging for help. Companies shouldn't be drooling over the prospect of bailout funds.
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