How to Clean Up Washington’s Mess

Republicans -- and the Fed -- have no time to waste.

By From the April 2010 issue

It was a sadder and wiser america that entered the year 2010. Voters had learned that the "messiah" who had ascended to the presidency a year earlier possessed no divine powers. He was merely a Chicago machine politician, and a very inexperienced one at that. But the Obama administration and its left-wing "progressives" were able to wreak considerable havoc in the space of a year. They sent the federal deficit soaring. Combined federal, state, and local borrowing in the capital markets climbed to near $2 trillion, a heretofore unimagined binge of governmental profligacy. The federal debt to foreign official lenders surpassed $2.4 trillion in November of 2009; China, previously the biggest foreign creditor, became nervous about the future value of the U.S. dollar, and hence was passed by Japan in holdings of U.S. Treasury securities.

The Federal Reserve was slavishly compliant with political demands, a posture that won gentle Ben Bernanke reappointment as chairman. Specifically, the Fed was over-exercising its singular prerogative to write checks on thin air to sop up large gobs of Treasury debt. That's a time-honored prescription for future inflation or economic stagnation or both, which we learned to call "stagflation" under Jimmy Carter in the late 1970s.

The two main authors of the 2008 sub-prime mortgage debacle, government-sponsored mortgage buyers Fannie Mae and Freddie Mac, were still humming along despite their misdeeds, only now under explicit federal control. Their huge losses, mostly the product of the Obama administration bailout of mortgage deadbeats, were adding many further billions to the taxpayers' tab beyond the $1.4 trillion on-budget bar bill.

With unemployment hovering around 10 percent, it was clear that the $862 billion "stimulus" program, enacted in early 2009 at the urgent insistence of Keynesians like the New York Times's Paul Krugman, had taught yet again an old but much ignored lesson: government can't stimulate the economy by robbing anonymous Peters to pay politically friendly Pauls. But even though it didn't work in 2009, the Obamanites have decided to try it again in 2010, discarding the tainted word "stimulus" and calling it a "jobs" bill with further billions of spending. It's gotta work some day, the Obamanites insist, because Krugman promised it would. Money, of course, is no object.

If the plan of the Obama-Pelosi-Reid junta in 2009 was to scare the hell out of potential investors in new job-creating ventures, they succeeded. They wanted to batter industry with a cap-and-tax bill to curb carbon emissions. The cap-and-tax scheme was a particular idiocy because its premise was that Congress could change the climate of the earth by passing a law. Fortunately, some anonymous whistle-blower managed to unearth e-mails that showed that researchers at Penn State and England's East Anglia university had been cooking the numbers to allow the United Nations to persist in its spurious claims that the planet itself was cooking. They had chosen to conceal the fact that their temperature readings had shown no global warming for years. Ho hum, just another episode of UN sponsorship of junk science.

It was a year of fakery in Washington that extended well beyond the global warming nonsense. The president promised that the middle class would pay "not a dime" more in taxes while at the same time plotting his cap-and-tax on the energy resources everyone uses daily. He had promised that the health care takeover would save money, a claim believed by no one, including the Congressional Budget Office, which forecasted a trillion in extra costs.

None of this was lost on voters. Independent voters who had swallowed the Obama Kool-Aid in 2008 began deserting him in droves. His first-year job approval rating fell further than for any president in modern history, to 48 percent from 65 percent, according to the reliable Rasmussen poll. The Rasmussen job approval index in mid-February, subtracting those who strongly approve (27 percent) from those who strongly disapprove (39 percent) was 12 percentage points, suggesting extreme polarization within the electorate. Most striking of all, 75 percent of voters polled said they were angry at the policies of the federal government.

Despite the role his megalomaniacal health plan played in his plummet back to earth, Mr. Obama nonetheless advised his co-conspirators, House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid, to "punch it through" Congress by whatever means available. That was an invitation to the Democratic Party to commit hara-kiri, an offer some members of Congress were reluctant to accept, no doubt because they doubted that even Nancy Pelosi could find cushy lobbying jobs in Washington for 200 displaced lawmakers, as she had promised those willing to fall on their swords.

Wait a minute! Maybe I am underestimating the market value of men and women with close familial relationships (in some cases literally) with the anonymous congressional staff gnomes who actually write 2,000-page bills sprinkled with special interest loopholes and "carve-outs." Those things are worth a lot of money. But at least the displaced legislators would lose the prerogatives of power.

If the democrats persist in following the progressives to their doom, that hara-kiri will come when the voters speak again in November. But then the question will arise: who's going to clean up the mess and how is it to be done? The answer is that it can be cleaned up if voters elect a sufficient number of reform congressmen and the surviving Democratic members and their Republican fellow travelers are scared straight by the election outcome. As in 1994, it might be possible to marginalize White House leftists, particularly if they keep saying stupid things, like praising the air security bureaucracy after it allowed an African terrorist a shot at blowing up a Northwest airliner -- or insisting that a government takeover of health care will cut costs.

A reform Congress would put first things first, namely getting the federal budget under control. The American people will have made it clear that turning the health care system on its ear is not one of their priorities and even less so is saving a planet that shows no sign that it is in need of saving from global warming. What they want is a stop to all the wild spending of money the U.S. doesn't have.

A new Congress willing to seriously address that question -- I'm assuming that the president will be marginalized by the November results as Bill Clinton was in 1994 -- will have a lot more to work with than some pundits think. I am talking about the powerful motive force generated by the 140 million people who go to work each day to earn a living for themselves and their families, of whom maybe 98 percent do it through honest toil. They include productive people in the public sector, such as teachers or firemen, but the vast majority work for privately owned firms or themselves. They perform billions of tasks, some routine but many of which require high skills and long training. The work they do is useful enough to their fellow men to earn a market reward, or in other words, an income.

In short, the "economy" is not some abstraction or a number on a chart, but the living, throbbing sum total of all this human effort. Bill Clinton, full of himself as usual, liked to boast that he was "growing the economy," but the main contribution politicians can make is to get the hell out of the way of people trying to make a decent living and climb up a few rungs on the income ladder.

Included in this vast work force are a substantial number of individuals who have the brains and daring to launch new business ventures. They are the main source of productive economic growth. One reason the U.S. economy has been struggling to recover from the shocks and failures of 2008 is that the brainstorms and borrowing excesses of Washington have sapped the confidence of investors and risk-takers. There are nearly 15 million people sitting on the sidelines who would like to have jobs, but while Nancy Pelosi yammers about "jobs, jobs, jobs," the legislation she and her colleagues have enacted or propose to enact is the main reason business confidence has evaporated and the great American job machine has stalled.

As Ronald Reagan and his supply-side advisers proved in the early 1980s, all you have to do is remove the fetters and the American economy will roar again. Reagan abolished the last vestiges of crippling price controls, restored the soundness of the dollar, and cut the punitive tax rates on higher incomes that prohibited capital accumulating for productive investment. The result was 25 years of relative prosperity. It will be tougher this time around, because there has been more damage inflicted by both Republicans and Democrats to the nation's financial underpinnings. But it can be done.

The first priority will be putting a lid on Washington and letting the economy breathe free of any further burdens of taxation, regulation, and political meddling. If government expansion can be contained, there is a chance that it can even be reversed and that the health of the private sector, which the progressives have viciously attacked, can be restored.

The first stage has begun with the spreading voter awareness of the direction the Obama-Pelosi-Reid junta and its followers were trying to lead the country. Polls, both of opinion and of actual votes in Virginia, New Jersey, and Massachusetts, have now made it clear that Americans don't want socialism. Washington, wrapped in its cocoon and smug with its grip on power, is usually the last to get the message. But the most politically vulnerable legislators are beginning to suspect the reason the cheers have ended and the boos have begun is because of a failure of product, not salesmanship. As a result, some have started to resist the junta's most egregious debaucheries.

The public sector still is expanding in size and in power but not with the aggression of a year ago. Government, once it gets rolling, is a powerful juggernaut. Public sector labor unions, which now dominate the labor movement, can swing elections. Their members are themselves in government and have a personal stake in seeing government jobs expand. Public sector compensation, on the whole, now outstrips the rewards of private employment, and public pensions threaten to bankrupt California, New York, and some other states. Large American corporations are now often a tail wagged by their lobbyists in Washington who promise to win them special favors. That's why the likes of Pfizer and WellPoint bought into the socialized medicine scheme. GM's and Chrysler's lobbies won a taxpayer bailout, with a lot of help from the UAW.

Washington is no longer the sleepy Southern town it was when I first visited it as a reporter in 1960. It has become the Emerald City. In crowded four-star restaurants lobbyists and their clients run up $100 bar bills in the blink of an eye. Ordinary hotel rooms can cost $700 a night. Everywhere you look, there are the trappings of money, money, money -- and most of it is contributed by the poor slobs out in the rest of the country trying to make a decent living, the kind of people in the private sector that the likes of Obama, Pelosi, and Reid love to denigrate. Breaking up this racket won't be easy. But when the money runs out, something will have to give. It will run out, as it already has in some of our most profligate states.

That will be the time when Americans will demand sane leadership once more. The Republicans are far better positioned than the Democrats to provide the young Turks for this job. Men like Governor Mitch Daniels of Indiana and Congressman Paul Ryan of Wisconsin have demonstrated that they can actually work arithmetic problems. Gov. Daniels has restored his state to a sound fiscal footing, and Rep. Ryan has designed policies that could help Medicare and Medicaid avoid a train wreck down the road while satisfying demands for a more efficient and comprehensive private health care system.

To restore the U.S. to economic health, a Congress of young Turks should make it clear that they intend to abandon failed government "jobs" schemes and adopt policies hospitable to private investment, which create real jobs. That will require, first of all, cutting the funding for the enviro-crazies who have seized control of the Environmental Protection Agency. The EPA's compulsion to regulate carbon dioxide, a natural product of the respiration of animals, plants, and oceans, is proof that it is no longer under sane management and is thus a threat to business and the economy.

Congress should announce that it will renew the 2003 Bush tax cuts before they expire next year, with no future expiration date. Anyone inclined to invest in a new job-creating venture will have some assurance that tax increases won't drive that venture into failure. The capital gains tax, which Obama wants to increase, is particularly crucial to this equation because it directly affects the rewards for a successful venture.

Congress should declare that the idea of a government takeover of all health care, beyond the 50 percent it already controls, is dead. Then the work can begin on modifications in the existing system that will not destroy it. Americans get excellent health care, quite possibly the best in the world in its quality and scope, and there are only rare cases of individuals falling through the cracks. The part most in need of fixing is the part the government already runs, Medicare, Medicaid, and Child Health, because its costs are not sustainable over time. There are plenty of good ideas for fixing this, many of them supplied by the assiduous efforts of Rep. Ryan.

The guiding principle would be to restore the market forces represented by consumer control, through such measures as greater use of health savings accounts and tax credits for individuals not covered by employer insurance plans. Good use could be made, for a change, of the federal power to regulate interstate commerce by making health insurance portable across state lines, a move that would expand competition among insurers. Curbing the ability of malpractice lawyers to reap bonanzas with spurious claims would be a must. It would first require breaking their political power in Congress and some state houses.

Finally comes the toughest nut to crack: stopping the government borrowing binge so that private borrowers could get better access to capital and fears of the dollar's eventual collapse would diminish. This is the crucial task. It would be aided by the other measures mentioned above in restoring business confidence and investment, which would bring about a rise in federal revenues. But achieving it would require more, specifically a kind of political pressure on the Fed different from what it has suffered throughout most of its history.

The idea of fed independence is a myth; it has always bowed to political pressure, and especially so over the last decade -- which is why we had a credit bubble that burst with such dire consequences. The kind of pressure needed now is roughly the opposite. The Fed should be following policies that encourage savings and investment, rather than borrowing and consumption. American households have been saving more since the crash, but householders are, on the whole, more prudent than politicians.

The Fed should stop supporting Fanny and Freddie, which it does by buying up their paper. The two mortgage entities should instead be liquidated so that they are no longer a massive burden on taxpayers. Private lenders will pick up the slack and will lend more prudently in the absence of those two receptacles for junk mortgages. The mortgage market and the housing market will return to a sounder footing, less subject to ruinous political manipulation.

The Fed should also abandon any further experiments in buying government debt directly from the Treasury. Its buying holds down rates on Treasury securities and thus encourages the spending excesses of Congress and the administration. This process, if continued, can only lead to inflation, which could be economically ruinous. The present government and Congress would scream to high heaven, but I'm assuming that the present malefactors won't be calling the shots after November.

The Fed also needs to do something about the trillion dollars in new money it has stuffed into the banks since the banking crisis began. This effluence already constitutes the fuel for inflation even without further Fed money creation, in the event of a cyclical economic recovery that appears to be struggling for birth. The Fed has talked of increasing the interest it's been paying on reserves held at the Fed, in order to encourage banks to hold them close, but it doesn't seem likely that the Fed could safely match the returns the banks would get in a recovering economy.

A better tack would be the old-fashioned way of mopping up reserves, by selling securities the Fed holds, including the trillion dollars of Fannie and Freddie mortgage-backed securities, back into the market. This is probably manageable in an economy restored to better health by the measures mentioned above, but monetary policy over the next few years is going to be touch and go because of the grand experiments the Fed has engaged in over the last two years and the view among politicians that money creation is some kind of magic elixir. It's a magic elixir that can blow up in your face, and has from time to time.

The greatest cause for hope at this juncture is the intelligence of the American electorate. This is not a nation of boobs. If you read the letters to the editor of the Wall Street Journal or the comments sections of some of our more serious blogs, you learn that there are a lot of people in this society who know more about economics than the people we elect to public office. They are now being heard from, through the Internet and other means. By and large, they reject the facile notions of Keynesian economics and its tendency toward unthinking government spending. They know, as good economists have known down through the ages, that you can't consume before you produce. The secret of recovery is to get government out of the way, contain its voracious appetite for a limited supply of capital, and let that great American productive engine, consisting of the private efforts of 140 million souls, do its work again.

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About the Author

George Melloan is a former columnist for the Wall Street Journal and author of The Great Money Binge: Spending Our Way to Socialism (Simon & Schuster, 2009).