Money Down


By Brad A. Greenberg '04, Illustrations by Lou Beach

Published Apr 1, 2009 8:02 AM

Was Roosevelt Wrong?

Washington turned its focus to a roughly $800-billion stimulus package put forward by the Obama administration — and stridently attacked by Republicans and even some centrist Democrats. The package, now passed, intends to pump cash into various fields that would improve the overall economy.

But how big is big enough? The $700-billion bailout seemed colossal, and the economy has little to show for it.

"My fear is that we will adopt a big, but not huge, stimulus now — and it will be very difficult to end it, let alone reverse it, in the future," adds Brad Sherman '74, a Democratic congressman representing the San Fernando Valley, worrying that "we will climb out of this deficit slowly and emerge with a much larger federal deficit than we have now."

Economists also are concerned that Obama's plan is filled with more buckshot than bullets.

"Government policies work well when the problem areas are very narrowly defined. We know that government policies work poorly when it is a shotgun approach," Lee E. Ohanian, UCLA professor of economics, says.

Ohanian co-authored a paper five years ago that argued Roosevelt's New Deal actually lengthened the Great Depression by seven years. While the creation of the Federal Deposit Insurance Corporation was a targeted attack on bank runs, Ohanian contends that the National Industrial Recovery Act, a broad effort that included increased pay for workers in key sectors, slowed any drop in unemployment by making workers too expensive.

"Right now we are doing some of the same things," Ohanian says. "President Obama's principal economic stimulus plan is to increase federal spending on a range of activities, anywhere from putting more computers in classrooms to putting in green insulation in federal buildings. While those programs may have merit, they don't directly address the central problems that the economy faces right now. And it's not clear whether the benefits of those programs exceed the cost of running up the national debt by a trillion dollars, which is what we are probably looking at."

"Priority No. 1 should be re-regulating the banking system and cleaning that up," he continues. "Once that is done, we will be back on the road to a healthy economy. But if we don't reform the banking system, we will likely languish in a recession for some time."

Alumni experts agree that fixing the financial system is essential. One of them, Mark Rubinstein Ph.D. '71, the Paul Stephens Professor of Applied Investment Analysis at UC Berkeley's Haas School of Business, says he's particularly concerned about hedge funds. During the go-go years, their top executives made tens of millions of dollars annually by making risky bets and leveraging their assets.

A Bank in Reserve

"Imagine I am running one of these investment companies. I'm doing real well; I'm getting paid a lot; people think I'm doing a great job; they raise my compensation. If I think of it rationally, I realize that I only need a few years here," Rubinstein says. "So I take these risks that when it bites, it bites them hard. I lose my job, but the shareholders lose everything."

Rubinstein doesn't want the government to dictate how much hedge fund CEOs can take home or on what basis they can be compensated, but he thinks the Securities and Exchange Commission should make it easier for stockholders to get representatives on a company's board of directors. A stockholder-designed representative might give shareholders a greater voice by deterring executives from overpaying themselves and taking excessive risks.

For a more revolutionary approach to reforming the financial system, look to Roger Farmer. A professor of economics and vice chair of graduate studies in Westwood, Farmer wants the federal government to create a new central bank, separate from the Federal Reserve Board, that would buy and sell stocks to prevent them from rising or falling erratically.

"These big swings you see in the value of the stock market are evidence of what [former Fed chairman Alan] Greenspan called 'irrational exuberance,' " he observes. "If we directly control the value of those swings by having the central bank buy stocks if they go too low and sell stocks if they go too high, it has the potential to remove excessive swings in confidence, which are unrelated to fundamentals.

"I believe strongly in free markets, and that might sound to be at odds with the statement I just made," Farmer adds. "I'm not advocating that the central government or the Fed or Congress or any institution should be picking winners and losers. I'm not advocating supporting individual companies. I'm advocating the support of a broad index that includes every traded share on the market."

Why? Well, like so many other economists, Farmer worries that without restrictions, the U.S. economy could drop into the abyss.

"The market is a little bit like a herd of buffalo grazing a cliff, chewing on grass or cud or whatever," he says. "Sometimes the whole herd of buffalo heads toward the cliff together and jumps off. I don't want to stop them from grazing; I want to put a fence to stop them from jumping over the cliff."

If Farmer's proposal doesn't become reality, and it's much more likely it won't, the Anderson Forecast's Leamer has a simple suggestion for getting cash back into the U.S. economy.

"The plan that I was floating" — in the Financial Times, National Journaland The New York Times — "was to have Uncle Sam send $100 gift certificates back in November to every man, woman and child in the United States. And you would have to spend that for it to be of any value to you, because by Jan. 1 it would be worth nothing," Leamer says. "It gets people to go out and buy stuff, and it's also a mood stimulator because you've got this uncle who cares about you."