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Obama Starts Over


After a tough first year, the President's economic agenda and standing will be challenged again in 2010 by soaring joblessness, ugly budget deficits, and Obama fatigue among independent voters

Editor's Note: An earlier version of the related graphic, Where Obama's Friends Are, had an incorrect middle initial for Paul Nash at the FDIC. The pdf file has been corrected.

As President Barack Obama was preparing for a major policy speech on the economy in December, he erupted at his economic team. Budget Director Peter Orszag argued in a White House meeting that more emphasis should be put on reducing the deficit, while chief economist Christina Romer led a contingent advocating for a greater short-term focus on jobs. They were familiar refrains, and Obama was frustrated. "Why are we having this meeting again, the same discussion?" participants quoted him as saying. Welcome to year two, Mr. President. It won't require the same high-wire act as year one, when Depression 2.0 was staved off with a jumbo stimulus package, massive cash injections into the battered banking system, and bailouts of the auto industry. Instead, as he prepares to deliver his State of the Union address on Jan. 27 and his budget on Feb. 1, Obama has to clean up the damage done by the now-ended Great Recession: the budget deficits on the government's books and the sliding job market his aides were arguing over. Only after that will he be able to turn his full attention to his long-term "change" agenda.

For Obama, 2010 will be a year of finding 10% solutions. Last year's $1.4 trillion budget deficit is nearly 10% of the economy, and the unemployment rate is also stuck at 10%. And here's the dilemma: Cut the budget deficit by raising taxes or reducing spending and you risk slowing down the economy and pushing up unemployment. Spur job creation through tax credits for new hires or infrastructure spending and you blow out the budget.

"He's got a needle to thread," says John Podesta, an Obama confidant and head of the Center for American Progress, a Washington think tank. "He wants to try to get as much as he can done in 2010 on the economy while paying attention to the long-term debt problems of the country."

That job got a whole lot harder with Republican Scott Brown's surprise victory in the recent Massachusetts special election, robbing Obama's Democrats of their super-majority in the Senate and threatening the President's health-care overhaul push. The setback left Democrats questioning Obama's decision to focus most of the party's energy on health care, rather than focusing more on jobs and the economy. Now, with independent voters souring on Obama, vulnerable lawmakers are likely to be reluctant about casting votes on other controversial issues such as caps on carbon emissions, tax reform, and a revamp of entitlement programs ahead of November's midterm elections. The White House may have to pare this year's legislative wish list.

Obama, who frequently invoked Martin Luther King Jr.'s "fierce urgency of now" mantra during the Presidential campaign, doesn't have time to waste. The longer unemployment remains high, the more likely it is that discouraged job-seekers will drop out of the labor force. Government borrowing and debt, meanwhile, have reached "very worrisome" levels, says former Federal Reserve Chairman Alan Greenspan, risking a rise in long-term interest rates.

The President and his economic team have been brainstorming for months over how to solve the budget and job deficits and still move ahead with his broader economic agenda. One proposal: tapping the $700 billion bank bailout fund to help small business owners get credit. Another would lower the principal amount on underwater home loans, in which a house's value is less than the balance due.

"ERODING CUSHION"

Obama also wants to boost exports by easing restrictions on high-tech products that can be shipped abroad. He's considering more investment in broadband technology to expand its use for distance learning and rural health care. And he wants to provide tax credits to encourage retrofitting of homes to boost energy efficiency. "The most important part of our strategy for this year is to get the economy growing to create jobs through a combination of direct action, promotion of private investment, and promotion of exports," says Lawrence Summers, Obama's National Economic Council head.

No less than the fate of Obamanomics—the grand vision that the President laid out during the 2008 campaign—is at stake. Even if Obama manages to clinch his first big win—a national health-care plan that Democratic administrations since Harry Truman have failed to achieve—his ambitions don't stop there. He wants to set "a new foundation" for the nation's economy: a better-educated workforce, more energy-efficient businesses, and an auto industry less reliant on polluting fossil fuels. Obama wants economic growth that's driven by investment and exports rather than consumption and debt. And he wants economic rewards to be more widely shared and expansions to last longer.

Last year, Obama cloaked some of his aspirations in the guise of fiscal stimulus, seeding the $787 billion package with small down payments to get desired programs started. His cap-and-trade plan to limit carbon emissions has languished, but the stimulus package funded alternative energy projects and work on a "smart grid" to ease transmission of power from new sources. While major education reforms have waited, the stimulus legislation included $4.35 billion in state grants to promote teacher accountability and turn around struggling schools. As the health-care overhaul process droned on all year, a pilot program to digitize medical records was in the works, compliments of the stimulus measure.

Building a new economic foundation will be impossible if Obama fails to convince voters before congressional elections in November that the Democratic Party has what it takes to solve the budget deficit and employment gaps.

Charlie Cook, editor of the nonpartisan Cook Political Report, now projects that Democrats will lose 4 to 6 seats in the Senate and 20-30 seats in the House in November, enough for the party to maintain only a diminished hold on Congress. "There is still a little bit of a cushion for Democrats," Cook says. "But the cushion is eroding on a weekly basis."

Almost everything that happens in Washington this year will be influenced by the midterm races. Obama aides, for example, have discussed tackling Social Security reform, but are unlikely to do so in 2010. Orszag proposed a plan to fix the retirement program when he was in the private sector, and some outside advisers are eager for the President to take on the issue. Those inside the Administration, however, say any reforms would likely be phased in over the coming decade, with little immediate effect on the deficit. Any budgetary benefit, then, would not outweigh the political risk of alienating Obama's liberal base in an election year.

AN ANTI-WALL STREET MESSAGE

Ominously for Wall Street, the President's call for $117 billion in new taxes on large banks and his war of words with the industry—last week he called their bonuses "obscene" and belittled their lobbying campaign to stop the tax as "a sight to see"—signals a new phase of economic populism among Democrats looking for a winning theme in November. The anti-Wall Street message could become a factor as Congress works on an overhaul of financial regulation. Even Democratic leaders in the House, which approved a measure in December, are considering new executive pay restrictions.

The bank levy is one way the President hopes to signal his seriousness about the budget deficit. He is also likely to sign on to a bipartisan commission that would suggest tax increases and spending cuts to slash the deficit. Under a tentative agreement worked out with Congress, the President would issue an Executive Order to create a panel and lawmakers would vote on its recommendations.

There's little doubt that the White House, with no small help from Ben Bernanke and his colleagues at the Federal Reserve, has succeeded in engineering a recovery of the economy. Economists surveyed by Bloomberg in January put the chances of a double-dip recession at just 15%.

Yet the Obama team isn't ready to declare victory. While the economy may have bottomed out, it's a long way from making up the ground lost during the 1 1/2 year downturn. "When you are in the Grand Canyon you can be climbing uphill, but you are still in a canyon," Summers says.

The fear is that, as the structural forces of globalization and automation discourage employers from hiring, the hallmark of this recovery, like the last two in 1991 and 2001, will be stubbornly high unemployment. If that's the case, then the Administration's targeted employment schemes may not make all that much difference. "We could have the mother of all jobless recoveries," says Allen Sinai, chief global economist at New York-based consulting firm Decision Economics. Obama's economic team is betting that job growth will recover by spring. Government hiring will also give the job market a lift, albeit temporarily, as the U.S. Census Bureau gears up for its once-a-decade survey of the American public.

Following House passage of a jobs bill last year, Administration officials are working with Senate Democrats on their own measure, including expanding the Export-Import Bank's ability to support more companies looking to sell their goods abroad. The bank provided a record $21 billion in financing for overseas sales by U.S. companies in the last fiscal year and is slated to top that this year, says Fred P. Hochberg, president of the bank.

Officials are also looking at what they can do without congressional action. Under one plan that's been discussed, the Treasury would make part of the existing bailout fund available to community banks so they could tap it to provide credit to small businesses without being subject to pay and other restrictions laid down by Congress.

SPENDING STILL TOO TIMID?

Struggling homeowners may also be in line for extra help. Housing experts say the Administration is discussing a novel idea to encourage banks to write down the principal on mortgages, a step lenders have been loath to take because it requires them to declare a loss on the loan.

Some prominent liberal economists, including Nobel-prize winners Paul Krugman of Princeton University and Joseph Stiglitz of Columbia University, say the Administration is being too timid. They argue that the hole in the jobs market is so big, another massive jolt of stimulus is needed.

Others warn there are limits to how far the government can go. A paper presented this month by Carmen M. Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University concluded that economies throughout history have tended to slow sharply after government debt levels hit 90% of gross domestic product. The U.S. is around 85%. "We're in a very treacherous area," Greenspan says. "We're now eating into the buffer between the federal debt held by the public and our capacity to borrow. That has never happened before."

The Administration is aiming to stabilize the debt ratio by reducing the government's annual budget deficit by 2015 to about 3% of the overall economy, in line with annual growth of gross domestic product. To get there, the President will have to take significant steps, including cutting politically popular programs.

Obama, though, is constrained by his past promises and actions. He took a huge swath of potential revenue off the table by promising not to raise taxes on families making less than $250,000 a year. Meanwhile, his decision to put more troops on the ground in Afghanistan means he can't count on reduced military outlays as the U.S. withdraws its forces from Iraq. After a bruising fight over health-care reform, Congress will have little appetite to revisit the topic to wring more savings out of Medicare and Medicaid.

INTEREST-RATE FRICTION

The President also can't count on the same help that Bill Clinton received from the Fed and the bond market when he cut the deficit in the 1990s, says Princeton University professor and former Clinton economist Alan S. Blinder. The tightening of the fiscal screws back then allowed the central bank eventually to ease monetary policy and paved the way for a dramatic 2.5 percentage point reduction in long-term interest rates that boosted growth and jobs. That can't happen this time with the short-term interest rates that the Fed controls already close to zero—as easy as it gets.

Blinder, a former vice-chairman of the Fed, is betting that the central bank will raise rates at midyear. If so, that could cause friction between the Fed and Democratic lawmakers who want interest rates to remain as low as possible—at least until they get reelected in November—to make it easier for businesses to obtain credit and create jobs.

Obama has hinted that he wants changes in the entitlement programs and tax policies that drive the deficit. During the campaign, he did what Democratic primary rival Hillary Clinton would not, gingerly touching the third rail of American politics with a proposal to bolster the Social Security system's long-range finances by lifting the cap on earnings subject to the payroll tax.

The struggle over health care has dragged into the congressional election year, squeezing out the chance of doing something on Social Security. The focus is now on the deficit-reduction commission, which at best would prepare the ground for action after the midterm elections. Public pension reform looks promising to policy analysts because it requires relatively simple tweaks to taxes, benefit levels, and retirement ages. But the politics look harder in a capital consumed by bitter partisanship and with the electorate uneasy about its own finances.

"If you want to do these megaprojects, it's best to do them at a time when the economy is humming along, because people feel good about the economy and they are willing to take a risk. When the economy is not doing well and they're worried about their job or out of a job, then they're a lot less risk-prone," says House Budget Committee Chairman John M. Spratt Jr.

But Obama won election by inspiring a wave of enthusiasm that brought large numbers of new voters to the polls. Even if it means taking political risks, his best chance of renewing the coalition that brought him to office is to continue to aim high, says Democratic strategist Tad Devine. "I think you can mobilize that electorate with an agenda that's forward-looking. In all these issues—deficit, entitlements, climate change—they are very future-oriented."

As Obama begins his second year in office, he again faces challenges the U.S. has not seen for generations. If he can spur the job market without increasing government spending, he may be able to defuse voter anger and limit Democratic losses in November. If not, his shot at delivering on the big changes he insists are necessary for America to make the 21st century its own may slip away for the rest of his term.

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Steve Ballmer, Power Forward
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