February Newsletter, 2009

How much $$$ per taxpayer?

Question: "If we just gave all the bailout money to taxpayers, how much would we each get? I've seen $25,000, $300,000, $1 million - what's the real answer?" -- Miranda Marquit, Logan, Utah

Answer: $9,513.76

To arrive at that figure, CNNMoney.com took the total of the bank bailout, $700 billion, and added that to the $787 billion estimated cost of the stimulus bill, the American Recovery and Reinvestment Act. That totals $1.487 trillion.
We then divide that number by 156.3 million, which was the total number of U.S. filers in 2008.

So: $1.487 trillion divided by 156.3 million equals $9,513.76 per U.S. taxpayer.

Why can't we split the money among taxpayers?

Question: "I often hear, 'If they want to stimulate the economy, why don't they give every taxpayer $10,000?' People would buy cars, go on vacation, pay for college, buy TVs, etc. That sounds great to me. Would it work?" -- Colleen Hargis, Springfield, Mo.

Expert: Lakshman Achuthan, managing director, Economic Cycle Research Institute

Answer: "The government could give money to you or me, and that would create demand, which could be a very good way to break the recession. But you and I are not very confident about the economy, and if you think about what I'll do, there's a good chance I'm going to save it.

But the government is looking to have that money get spent and to have it multiplied somehow. Our economy is based on people spending money. So people saving money doesn't help.

For an individual, I would say it's a good idea to build up your savings and to tighten your belt, because there's so much uncertainty about how long the recession will last.

But the advice you give to policymakers when you want to revive the economy is to get people to spend money.

So I don't think that it would be a good idea to give everyone $10,000. That would preclude some very important triage from happening, such as funding unemployment insurance or getting state and local government financing needs met.

However, I would like the stimulus that comes out to have some support for households."

Expert: David Laibson, professor of economics, Harvard

Answer: "Some economists believe that transfers to individuals will not stimulate the economy, since the recipients will save a large fraction of those transfers. The evidence is mixed.

In the short-run (a few months) it is true that a large percentage of the transfer would be saved. However, over the next two years, low-income households would spend most of the transfer.

A stimulus package should include both government spending and household transfers, particularly transfers and tax cuts for low-income households."

Give consumers debit cards instead of checks?

Question: "The popular response to splitting the bailout money amongst taxpayers instead of the banks is that the recipients will save it, not spend it. Would a government-backed 'debit card' or 'gift card' be an alternative? I feel that it would because it would *have* to be spent and couldn't be saved, as cash could be." - Will Durnan, Scottsdale, Ariz.

Expert: Garett Jones, associate professor of economics, George Mason University

Answer: "That's a great question, and it gets to the heart of what a recession is.

Certainly, the government could send out $10,000 debit cards, and the debit cards could have an expiration date so that everyone would have to spend all the money quickly. But would this be a good policy? If the goal is to raise demand for consumer goods today, then yes, it would help a little.

But in this recession as in most, the biggest fall in spending isn't caused by consumers cutting back: It's caused by businesses cutting back. The big puzzle of recessions is why business spending collapses. Handing debit cards to consumers probably won't do much to get businesses buying more machines, more software and more buildings.

In this recession, as in most, it's the collapse in investment that needs the most fixing. So in order to get economists on board with debit cards, you'd have to show that all this extra consumer spending would somehow cure the collapse in business spending. And there isn't much evidence for that idea.

Another important point: While some cash-strapped Americans would quickly use the debit card to spend a lot more than otherwise, most Americans would probably just use the debit card instead of spending their own money.

Let me use an example from my own life: I go to Starbucks a lot. For Christmas, my mom put a Starbucks gift card in my stocking. Did this encourage me to go to Starbucks more often? Maybe a little, but mostly what it did is get me to pay for my coffee with the Starbucks card rather than with my own cash.

Milton Friedman noticed this 'gift card effect' back in 1957. He predicted that one-time tax rebates wouldn't spur much extra consumer spending because most people would just save most of the rebate.

Since then, economists have decided he was mostly right.

So whether we call it a 'rebate' or a 'debit card,' the effect will be about the same: Outside of the most cash-strapped families, the debit card won't spur much spending."

Save the banks by giving consumers cash?

Question: "Economists say giving consumers money does not stimulate the economy. But if everyone took their $10,000 and put it in the bank, wouldn't that, in effect, bail out the banks by giving them money that they could loan to businesses, thus stimulating the economy?" - Timothy P Korytko, Columbus, Ohio

Expert: Garett Jones, associate professor, George Mason University

Answer: I've been opposed to the bank bailout since day one. But remember, this is a loan to the banks, not a handout.

Even though the bailout is a bad idea, the goal of the bailout is still good: To make sure that the nation has some large banks that can connect savers with borrowers. Big banks can arrange big deals that small banks just can't. Big banks don't always make the right decisions, but it's hard to imagine that squeezing 20 small banks into a room with 3M is the way to fund a new R&D project.

During his career as an economics professor, Fed Chairman Ben Bernanke convinced most economists that one of the worst side-effects of the Great Depression was the destruction of the banking sector. His research reminded us that without a healthy banking sector, people have to rely on friends and neighbors and their own savings to grow a business. When a small business owner has a good idea, friends and neighbors probably don't have the cash to "scale up" her garage-based business. Without the big banks, we probably face a poorer, less innovative future.

Also, keep in mind that, at least on paper, the TARP money isn't a gift to these banks: TARP money bought actual shares in these banks, shares that pay a 5% dividend every year. Congress can always decide that the banks can keep the money--Congress can decide whatever it wants, for better or worse--but as of today the TARP money is less like a gift card and more like a loan.

So if Congress just lent every American taxpayer $10,000, demanding $500 per year in interest, it's possible that this would solve some of our nation's economic problems, but it wouldn't really strengthen our crippled banking sector.

That said, if you really want a TARP-style loan, you may be able to get one. The federal government actually offers TARP-style terms through lots of government programs: Student loans, small business administration loans, FHA housing loans, etc. Lots of money, low interest rates, fairly flexible repayment.

So if you really want to get a TARP-style bailout--complete with government bureaucrats nagging you about repayment--you can head right out and get a federal loan yourself. The person on the phone harassing you to make your monthly payment will be a call center employee, not Congressman Barney Frank, but at least you'll know how Citibank feels these days.

Where does the money come from?

Question: "I am confused about *how* the government is bailing us out of debt. Where does the stimulus money come from? Is the government just printing more?" -- Kimberly Wand, New York City

Answer: No. The presses are not running overtime. A spokeswoman from the Bureau of Printing and Engraving said the agency's print order has not increased.

In any case, that's not how the government injects money into the economy. Instead, the government sells Treasury bills - very short-term debt obligations - on the open market. When the government sells those securities, it scores cash for the reserves.

That's the chief way the government will try to fund the proposed $815 billion stimulus package, says Kim Rupert, fixed income analyst at Action Economics.

There is no limit to the amount of debt the government can sell, but Rupert warns that there is no guarantee the government will find enough buyers to absorb the supply. If the market finds better ways to invest its money, the government won't be able to raise more funds for its efforts. Instead, it would have to increase taxes.

For right now, however, the economic slowdown has spurred a strong appetite for Treasurys, which are considered safe places to put money during a downturn.

So could all this extra money accelerate inflation? Economist opinions differ.

"It's a tremendous package, so down the road it should cause inflation," Rupert said.

But Jeff Madrick, senior fellow at Schwartz Center for Economic Policy Analysis and author of the November 2008 book The Case for Big Government, said the danger is remote.

"The recession is already so deep that extra money in the system will not cause inflation in the foreseeable future, or even in the long term," he said. "As the economy tries to recover, there will be too much unemployment and too many unused factories and stores for inflation to accelerate."

Less money for consumers?

Question: "If we are in a credit crunch and unable to get loans, how will the government borrowing money help? Won't they just compete and take the loan that I need to open a business? -- Brian Williams, Baldwin City, Kan.

Expert: David Laibson, professor of economics, Harvard

Answer: "For the foreseeable future, lenders trust the U.S. government to repay its debts. There is also a flight to quality, so the federal government can borrow at very low interest rates. This public borrowing may crowd out some private borrowing, but the crowd-out effect is thought to be small right now.

Indeed, the government borrowing/spending might actually encourage private borrowing by boosting the economy and making private borrowers more credit-worthy."

Expert: Garett Jones, associate professor of economics, George Mason University

Answer: "Yes. As Euguene Fama and John Cochrane of the University of Chicago keep emphasizing, every dollar that someone lends to the government is a dollar that can't be lent to a private business. And on the supply side, every worker working for the government is a worker who can't work for the private sector.

Of course, in our current recession, some of those dollars - like some of those workers - will wind up unemployed unless the government 'hires' them. So if our government knew how to find unused dollars and unused workers, a big stimulus might work out great.

But in an economy where more than 90% of workers are employed and where the supply of bank loans is growing every week, it's hard to imagine that the government is going to find a lot of idle money and idle workers.

So on both the finance side and on the worker side, a big stimulus package could easily shrink the private sector, just as it did during World War II.

At least on the worker side, Congress could help to fix this: They could mandate that 90% of all jobs created by the stimulus be given to workers who have been out of work for three months or more. Then citizens could be pretty sure that the people taking these stimulus jobs aren't just shifting over from the private sector.

Of course, Congress won't do that - government contractors would be knocking down the doors of every member of Congress if they did."

Balance the budget?

Question: "Is stimulus or balancing the budget more important for our country's future? It seems like consumers are being blamed for overspending and yet now the government wants to overspend its budget." -- Dominique Reneau, Conifer, Colo.

Expert: Garett Jones, associate professor of economics, George Mason University

Answer: "The U.S. ran massive deficits during World War II, much larger than we expect to see during this crisis. Yet the two decades after WWII were very good times for the U.S. economy. So large, temporary deficits are completely doable.

What matters is maintaining a commitment to repaying the debt - and for over 200 years, the U.S. government has never missed a debt payment. The U.S. government has broken a lot of promises to a lot of people, but it's never broken a promise to its debt holders.

Let's hope it stays that way."

Expert: David Laibson, professor of economics, Harvard

Answer: "There is a significant chance that our economy has entered, or will enter, a self-reinforcing feedback loop. For example, a decline in the value of the stock market causes households to rein in their spending, which causes businesses to lose sales, which causes the stock market to fall even further.

If such cycles continue, our economic problems may become even more severe. The stimulus package is designed to break such cycles. The package is desirable, even though the need for the stimulus and the effects of the stimulus are both not clear.

At the moment, it is better to err on the side of overreaction, given the scope of our current problems and the potential for them to get even worse."

Government bankruptcy?

Question: "Can the government go bankrupt? Could what is happening in Iceland happen to us?" -- Sean Rice, Denver, Colo.

Expert: Michele Boldrin, professor of economics, Washington University in St. Louis

Answer: "It is possible, but not very likely. Countries don't go bankrupt normally. Their treasury department does.

It would happen the same way it happened in Argentina: The government would be unable to fulfill the agreements that they had made, they would stop making payments on their interest and they would default on their debt.

But the moon falling is about as likely as this happening.

Despite the problems, we are still a very rich country. We still have cars and other resources. We're not any dumber than we were before. We still have all those riches we had before.

Japan is still operating at a 190% debt of GDP, while we are approaching 80% to 85%. So by those standards we are doing well.

It is the view right now that we have to spend a large amount of money right away because the ship is sinking. The idea that there is some solution that can be seen in the next six months is dangerous, but we won't go bankrupt unless people begin to panic."

Why wasn't TARP enough?

Question: "Shouldn't TARP have been enough for the banks to at least recoup a majority of their losses and stabilize their balance sheets?" -- Matt Sedlak, Littlestown, Penn.

Expert: Michele Boldrin, professor of economics, University of Washington in St. Louis

Answer: "There are two answers, the quick, nasty one and the longer more detailed one.
The quick, nasty one is that the losses were bigger than the money we put in. The longer answer is that not all of the money was used to cover the losses; some of it was used to pay for bonuses and things like that.

But the truth is that if we put in $500 billion, we'd still be about a trillion short. The TARP approach is to basically avoid any kind of major bank failure. But some losses are real and we just have to accept that we had invested money into things for years that we assumed were worth X. But it turns out they were worth quite a bit less - and that 'quite a bit' is gone.

For example, when bad investments are made, you have to make future readjustments. Like with mortgage lending. There was a substantial amount lent out to build homes and remodel them: $11.7 trillion, to be exact. The banks put that on the balance sheet as profit for when it is paid back. But now people are not able to pay it back, so what looked like profit isn't. So in order to balance out that loss, you would have to put money in to cover it, but there isn't enough money being put in to cover the losses.

The current idea is that we take money from those that didn't assume and give it to those who did so that they hurt a little less and we all stay afloat."

What happens if the stimulus fails?

Question: "It seems like TARP and the other measures taken so far haven't worked, at least not as well as they were expected to. What's happens if the stimulus plan fails? Is there a backup plan? How long will it take before we know whether it's working? -- Jesse Saba Kirchner, Santa Cruz, Calif.

Expert: Mark Gertler, professor of economics, New York University

Answer: "The scenario policymakers are trying to avoid is Japan of the 1990s, where there was persistent stagnation for nearly a decade. Our policymakers are much more aggressive than the ones in Japan at the time, and they've learned a little bit from the Japanese experience, so it is very unlikely that we would have anything like the Great Depression.

But it's key that the political process not break down.

If we have a political deadlock that limits any action from being taken, or more specifically, if the current stimulus package degenerates into a fight over different pork barrel projects, that could send us from a recession toward a depression.

I think everybody agrees that some action has to be taken. There is debate over the mix of the action - and it's an honest debate - because we're not sure how these policies are going to work.

My own view is that I would put equal weight on stimulus and fixing the financial system. If either of those get bogged down in the political system, that's where we see the potential for a Great Depression."

Expert: Garett Jones, associate professor of economics, George Mason University

Answer: "If stimulus fails, then we'll let the Fed cure most of the recession, just as we should be doing anyway.

During the Great Depression, economists said that only a big government stimulus could save the economy. But Milton Friedman and Anna Schwartz came along in the 1960s and convinced most economists - both Keynesian and monetarist - that the real way to cure the Great Depression would've been to grow the money supply instead.

Ben Bernanke has taken Friedman and Schwartz's lesson to heart, and so he's grown the broad money supply - currency, checking, and savings accounts - by 10% over the last year.

Friedman always taught that money impacts the economy with 'long and variable lags' of a year or more, so we won't start seeing the effects until this fall, at the earliest. But that's well before most of the Obama stimulus will be hitting the economy anyway.

So even as we debate and discuss the pros and cons of a fiscal stimulus designed by Congress, Bernanke and his colleagues at the other end of the Mall are already creating a more reliable stimulus: Money growth."

Robbing Peter to pay Paul?

Question: "Part of the economic crisis is supposed to be that there was too much easy credit and debt. Now the government is talking about going another $850 billion or so into debt. How do you pay off debt with debt?" -- Kevin Devaney, Randolph, N.J.

Expert: Mark Gertler, professor of economics, New York University

Answer: "Well, the debt is ultimately paid off either by raising taxes or through economic growth.

First, let's distinguish between the Treasury and the Federal Reserve. The Treasury is responsible for collecting revenues. The two ways they get funds is through taxes and by borrowing.
What the Federal Reserve is charged with doing is setting market interest rates and making sure that the financial system is stable.

Government debt is paid off by the Treasury taking in more money in the future. But that doesn't completely require that tax rates go up. If economic growth goes up, then revenue will go up.

But, in the end, it can mean that the taxes are just being pushed off to another generation."

Retirement-account withdrawls?

Question: "During the debates for president, both McCain and Obama talked about a possible retirement plan withdrawl up to $10,000. What happened to this? We have not heard anything about this since the debates." -- Duane Huttenlocher, Maricopa County, Ariz.

Expert: Craig Copeland, senior research associate, Employee Benefit Research Institute

Answer: "President Obama said in October that people should be able to withdraw money from their retirement accounts penalty-free, but it hasn't been something he's focused on post-election.

The original proposal from Obama was scored by the Congressional Budget Office, and they said it would be a huge hit to the federal budget. So, without any offsetting cuts, it was not thought to be a good idea - especially when the government was spending so much money on TARP.

Obama did temporarily stop requiring seniors to withdraw a certain amount of money from their retirement accounts once they reach 70 1/2. He didn't want to force people to withdraw money when they had already lost so much, but that's temporary.

There's nothing in the stimulus that would allow you to take penalty-free withdrawals from your retirement plan unless you meet the current qualifications. We could do that if Congress passed a law, but unless you are 59 1/2 or older, or are going to use the money for a first-time home purchase, or a few other reasons, you must pay a 10% penalty and then pay taxes on the income you withdraw.

One reason against allowing people to withdraw is that you put the money in for retirement savings, and if you take it all out now, you lose not only the money you withdraw, but also any returns you would have gotten on that money over the next 10 to 15 years.

But in some cases, if you don't get your finances in order, the future earnings may not matter as much. It's a tough choice, and what to do depends what your choices are right now. But generally, I've never seen the government allow you to put savings in that are not taxed, and then allow you to take it back out without it being taxed. I don't see them ever taking out that penalty.