Dream of Californication

California has long led the country. Now, it's totally dysfunctional.

The reasons for California's problems are well-known. Democrats won't cut spending; Republicans won't cut taxes. Legislative lockjam prevents action even in the best of times, and in the worst results in governance catastrophe the like of which are almost impossible to imagine in a modern country.

Is the rest of the country so far off?

Consider: the government has barely raised taxes in decades. Bush I's decision to raise them, and go back on a pledge, is widely thought to have cost him a re-election. Clinton raised some, but Bush reversed those and extended them further. Better to raise the deficit. Obama's campaign took as a central plank that taxes would not rise for the middle class. Relative to the status-quo at the end of the Clinton years, this was actually a tax decrease for the vast majority of Americans. It is becoming virtual political suicide to raise taxes on anyone except the rich--and even they complain bitterly.

Meanwhile, spending is growing out of control. Huge outlays are certain to happen on healthcare, education, and energy. Health care reform promises to curb costs, but the missing step--the one between mandating coverage for all and lowering health care bills--is totally absent. No doubt the White House's technocrats have ideas, but Congress shows no signs of letting them pass. Even the Republicans are raising all hell about 'rationing' health care--even for government funded care, which makes no sense. Iraq is more peaceful, so the Defense budget is down a bit, but Afghanistan is still going. It's soon going to be time for America's decennial war--my bet's on an irregular war within Pakistan.

Obama's term so far highlights the crisis that the legislative branch has fallen into. One might reasonably think that after winning a decisive mandate, the Democrats would find it easy to pass their favored bills. One would be mistaken. Excepting Regan's first few years, no President in recent memory has managed to pass his favored bills. Clinton's major legislative achievements are all things Republicans would love--NAFTA and welfare reform. Bush could not privatize Social Security or pass health care reform even with his majority. And now Obama can barely get Congress to cut the number of GM dealers. The one agency that acquitted itself well during the financial crisis has been the Fed, a fact largely arising from the fact that it is not accountable to Congress. The more democratic our institutions, the worse they perform.

Congress can do two things well: spend and bail out. From Wall Street to Detroit, federal funds sustain corporate America, and corporate America in turn finances Congress. In other countries, we call this crony capitalism. The deficit is huge this year--which isn't a horrible thing--but projections in the future show trillion dollar yearly deficits trailing off into the future.

True, it's hard to predict the future. But suppose the economy fails to get better as scheduled. Say we've all been living beyond our means for the past years, and need to readjust to a more sustainable level of living. Unemployment will lag growth, and the rich will not contribute to the federal pot. Then we'll face poor government revenue, spending that can't decrease, and taxes that can't go up. The legislature can't do anything productive. We'll face government debts that will get harder to pay.

In other words: California. Of course, if America starts to look like California, where will California be?

Blood in the Streets

The big news is that the Treasury is rolling out $700 billion to buy troubled assets of financial institutions to clean the pipes, if you will, of credit markets.  This number is apparently large enough that the financial consuls Bernanke and Paulson feel the need to consult Congress on the issue.  

This measure is troubling in a few ways.  One, it threatens to prolong the crisis by hiding mortgage problems in the government's books.  As I've mentioned before, the danger is the potential for a Japan-style prolonged recession.  This plan saves the worst offenders, while doing little to force banks to deal with their losses and move on.  Moral hazard remains a big issue. 

Two, it's not the best use of taxpayer money.  Yes, this deal could pay for itself over time, but there are better ways to command the government's influence properly.  Zingales and Krugman are both against the deal and have some interesting alternatives.  Krugman would rather the government act as Sweden and nationalize firms to float them at a later date--treating the government as sort of a private equity buyout firm of last resort.  Zingales would use the government to coordinate moves such as eliminating dividends, raising equity, and debt restructuring.

The nice aspect of these deals is that they leverage some of the strongest capacities of government: Coordination, transparency, and liquidity.  Friedman and company tend to categorically despise all government action (except of course on financial intervention), but there are clearly many different sorts of intervention.  Personally, I don't care as much about the raw amount of government spending as the form that government regulation assumes.  Paulson's plan calls for a massive government bailout without holding firms accountable.  Other plans envision a light government footprint paired with reasonable interventions playing on government's strengths to force firms to solve their problems themselves.