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A bully pulpit for Obama’s financial reforms

by Barry Eichengreen

BERKELEY, Calif. — President Barack Obama has not had an easy first year economically. He inherited a financial system on the verge of collapse. He was bequeathed an economy in recession and an unemployment rate destined to rise. And he faced a Congress and an economics profession with a tendency to confuse these real demons with imaginary ones. His strength has been not to allow the perfect to become the enemy of the good.

His $787 billion fiscal stimulus was good. To be sure, it was based on unrealistically optimistic assumptions about the depth of the recession, the strength of the recovery and the level at which unemployment would peak. It was too heavily tilted toward tax cuts that would tend to boost saving rather than consumption. Unaccompanied by a credible medium-term fiscal strategy, it unnecessarily excited the apostles of fiscal doom. Having said all that, the stimulus package gave the economy a necessary shot in the arm.

Obama’s efforts to stabilize the banking system, it almost pains me to acknowledge, succeeded despite themselves. I would have preferred bigger capital injections. I would have liked to see his administration use its leverage to replace the management responsible for creating the financial mess in the first place.

But the stress tests and targeted money from the Troubled Asset Relief Program — the path of least resistance taken — enabled the banks to earn their way back to solvency. However distasteful the uses to which those earnings have been put, they at least prevented the financial system from falling off a cliff.

Obama’s Quaker-meeting approach to legislating health care reform has produced, of all things, health care reform. For the end of the story we will have to wait and see what emerges from the House-Senate reconciliation process. But it will certainly prevent the insurance companies from denying coverage on grounds of pre-existing conditions. And it will subsidize insurance coverage for the poor. While it will presumably lack the public option, it’s still a real achievement.

The same middle-of-the-road approach can be taken in the second year to address the still-outstanding fiscal issues. Obama can reinstate pay-as-you-go rules and establish an independent commission to submit to Congress amendment-proof (and filibuster-proof) recommendations for tax and expenditure reform.

Obama will need to provide stronger leadership on financial reform. There are two reasons to doubt that the light touch used in the case of health care is appropriate for reforming financial regulation:

(1) Unlike health care, where we can afford to proceed incrementally, the need for comprehensive financial reform is pressing. If health-insurance exchanges don’t work, we can always reconsider the public option. But if the initial approach to financial reform doesn’t work, we face the prospect of another financial crisis every bit as serious as the last.

(2) Health care had effective proponents — in Congress, among consumers and even among some of its providers. Medium-term fiscal reform, for its part, will be pushed by bond-market vigilantes. But financial reform is too technical for nonspecialists. And the specialists, the financiers themselves, prefer a status quo that rewards them lavishly. This is one area where Obama’s consensual instincts do not serve him well. He needs to use his bully pulpit. He needs to mobilize the general interest effectively.

In his second year, Obama must, as he put it last summer in a speech to the National Association for the Advancement of Colored People, “aim higher.” He was elected not simply because he is a cool crisis manager, but because he had a vision for a more just society. He needs to flesh out and implement that vision.

The time for any old kind of public spending simply to support aggregate demand, if not already over, soon will be. The need then will be for more spending on education and training — the only thing that in the long run will make American workers more productive and reduce income inequality.

Similarly, the United States needs more productivity-enhancing infrastructure — roads, bridges and ports — not frills such as high-speed trains between Sacramento and San Diego, Calif. Only measures that create good jobs will reduce income inequality as in a normal advanced economy, not one where inequality approaches Latin American levels.

More spending on these items will require less spending on other things — or higher taxes. America’s consensus- oriented president needs to make that case.

Barry Eichengreen is professor of economics and political science at the University of California, Berkeley. © 2010 Project Syndicate (www.project-syndicate.org)