Time for FDR

Crisis Creates Opening for FDR-Like Overhaul of U.S. Economy
By Matthew Benjamin and Rich Miller

Nov. 3 (Bloomberg) -- Bill Clinton, said his onetime adviser Dick Morris, never got a chance to prove he was a great president because he never faced a big crisis.

No one will be able to say that about Barack Obama or John McCain.

Like Franklin Delano Roosevelt and Ronald Reagan, the new president will get a rare opportunity to leave a sweeping and long-lasting imprint on the U.S. economy. FDR's response to the Great Depression created such enduring institutions as Social Security and federal deposit insurance. Reaganomics, born of the 1981-82 recession, ushered in a quarter-century of lower tax rates and deregulation.

``Great leaders see in a crisis an opportunity, and not just an opportunity to perform crisis management,'' says presidential historian Richard Norton Smith.

There will be no shortage of opportunities in 2009. The U.S. is facing the deepest recession in more than 20 years, the worst financial crisis since World War II and a wave of foreclosures.

No matter who wins the election tomorrow, the new president is likely to create a vastly larger economic role for the government. He'll also permanently alter the relationship between financial markets and Washington, finish the job of reshaping the U.S. banking system begun under Bush, and -- like it or not -- will probably go down in history as the biggest deficit spender ever.

Helping Homeowners

McCain, 72, would spend $300 billion to help homeowners in danger of foreclosure while adding new consumer protections and rules on executive pay. Obama, 47, would have government invest in energy and manufacturing while creating a super-regulator to watch over markets to prevent another catastrophe.

Whichever candidate wins, the first order of business will be to get lending restarted and revive the economy.

Unemployment may rise as high as 8 percent over the next year from September's 6.1 percent, while gross domestic product could contract at an annual rate of as much as 4 percent in the last three months of 2008 and again in the first three months of 2009, says Allen Sinai, chief economist at Decision Economics in New York.

``The U.S. is in the middle of a long and deep recession,'' he says.

Both candidates are open to another fiscal-stimulus effort, following the $168 billion package President George W. Bush signed earlier this year. Democratic Senator Obama, of Illinois, proposes a $50 billion plan with checks for consumers as well as spending on school repairs, roads and bridges.

Not Nearly Enough

That wouldn't be nearly enough to prevent a deeper decline, says Jan Hatzius, chief U.S. economist at Goldman Sachs. An effective amount would be between $300 billion and $500 billion, reflecting ``the need to offset the sharp drop in spending relative to income by U.S. households and businesses,'' Hatzius wrote in an Oct. 24 note.

The new president may also need more taxpayer money to alleviate the credit crisis than the $700 billion Congress approved Oct. 3 in a plan Treasury Secretary Henry Paulson helped engineer.

``We have to recapitalize the banks,'' says Edmund Phelps, winner of the 2006 Nobel Prize for economics and a professor at Columbia University in New York. ``I don't imagine that there's enough money in the first Paulson plan to be able to do all that needs to be done in that direction.''

To deal with rising foreclosures, Republican Senator McCain, of Arizona, would direct the Treasury to purchase endangered mortgages and replace them with government-backed loans.

`Intensely Focused'

Obama is also looking at ways to help homeowners renegotiate mortgages. ``He is intensely focused on this, and he has a little task force working on this right now,'' former Treasury secretary and Obama adviser Robert Rubin said on CNN last week.

Already, the costs of rescuing the economy are driving government borrowing to previously unimagined levels.

The government posted a record budget shortfall of $455 billion in 2008, and analysts forecast the gap will balloon to more than $1 trillion in 2009 as expenses mount. Bailouts of mortgage lenders Fannie Mae and Freddie Mac and insurer American International Group Inc. may prove costlier than originally estimated, and Washington faces more demands for help from other insurance companies, state governments and U.S. automakers, including General Motors Corp.

Nothing Positive

``There's nothing happening here that's positive for the budget, nothing,'' says Stan Collender, a former analyst for the House and Senate budget committees and now a managing director at Qorvis Communications in Washington.

Beyond economic triage, the candidates each promise to impose new rules on markets. ``We are going to get a major overhaul of financial regulation no matter who wins,'' says Martin Baily, a scholar at the Brookings Institution in Washington and chairman of the White House Council of Economic Advisers in the Clinton administration.

McCain says he would create a ``safety and soundness'' regulator to watch over financial institutions and halt their operations if they become a threat to the system. He would add consumer protections, especially for home mortgages, and push for new rules on executive compensation and corporate governance.

``He's laid out a comprehensive vision of an America that is very different from the past eight years,'' says Douglas Holtz-Eakin, McCain's top economic adviser.

Streamline and Modernize

Obama wants to streamline and modernize the agencies that oversee the financial industry and give the Federal Reserve unprecedented ability to monitor institutions' books. He would also create a financial-market oversight commission responsible for identifying risks before they get out of control.

``The current crisis requires ambitious economic policies, not just to deal with the financial crisis, but to deal with the underlying root causes of our economic challenges,'' says Jason Furman, the Democratic candidate's top economic aide.

Both candidates also plan a major overhaul of the tax code, made necessary by the 2010 expiration of most tax cuts passed under Bush.

McCain, like Reagan in the 1980s, would permanently reduce the burden for all taxpayers, including the wealthy. His plan would extend the 2001 and 2003 Bush tax cuts, increase deductions for taxpayers with dependents and reduce estate taxes. He also proposes the first major cut in the top corporate tax rate -- to 25 percent from 35 percent -- since 1986.

Tax Cut or Credit

Obama's plan would provide a tax cut or credit for all workers with household incomes below $200,000, while raising taxes on those earning more than $250,000.

Obama would further involve the government in the private sector with investments in manufacturing research and clean- energy projects, which he says could create new industries and additional jobs.

``The next president is going to have to have two financial SWAT teams,'' says Barry Eichengreen, professor of economics and political science at the University of California, Berkeley. ``One to stabilize the crisis and staunch the bleeding, the other to focus on the issue of how to sustain long-run economic growth.''

To contact the reporters on this story: Matthew Benjamin in Washington at mbenjamin2@bloomberg.net; Rich Miller in Washington rmiller28@bloomberg.net

Last Updated: November 2, 2008 19:00 EST