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Debt-Free: Steps the US Can Take to Revive the Economy

There are several good steps the United States could adopt to stimulate the US economy that would not involve adding to the deficit or national debt.

There are several good steps the United States could adopt to stimulate the US economy that would not involve adding to the deficit or national debt.

One such idea was underscored by former chairman of the US Federal Reserve, Alan Greenspan, on NBC's “Meet the Press” (August 7), who pointed to the need to get a large chunk of the over $1 trillion dollars in cash currently being held by US banks out the door and into job-creating investments. These deposits are held partially as a result of last year's second round of unprecedented quantitative easing (QE2) launched by the Federal Reserve, which enabled the banks to obtain these deposits almost for free as the Fed has held short-term interest rates at nearly zero for over the past two years. Even getting two-thirds of the estimated $1.4 trillion in cash deposits out into the productive economy would offer a significant stimulus to the US while still leaving sizeable cash reserves for these banks. However, while Mr. Greenspan did not offer any specific way to incentivize these banks to lend out this cash, Robert Pollin and Jeffrey Thompson of the University of Massachusetts, Amherst, have offered detailed suggestions.

Pollin and Thompson have called for channeling $800 billion of such deposits into new investments in a move that would provide a huge boost to the economy. They suggest that state and local governments could change their rules for qualifying for procurement contracts to favor financial institutions and banks that are aggressively committed to injecting credit into local communities to finance job-generating investments. Currently, private financial institutions handle about $8 trillion a year of state and local government funds in various ways, including their spending accounts, pension funds and social insurance trust funds. This gives state and local governments significant leverage because these public entities are, in most cases, among the most prized customers for any individual bank.

Not only would this idea avoid any additional public spending, but it could be implemented quickly and easily, in most cases through an administrative decision rather than requiring the passage of new legislation. Massachusetts is one of the states which have already put in place such an effort, with an initial program to move $100 million in state deposits to banks with a strong record of making small business loans. The initial reaction by the Massachusetts banks has been so responsive that the state now anticipates expanding beyond the initial $100 million threshold.

Although the banks may reasonably complain that making loans to small businesses is too risky in the current environment, state and local governments could allay such concerns and facilitate such a program by expanding their existing loan guarantee programs. If managed properly, loan guarantees are a low-cost strategy for state and local governments to significantly reduce the risks of new private investment projects financed by bank lending. The loan guarantees can, therefore, provide the carrot of reduced risk, while the banks would also face the stick of governments threatening to withdraw business if the banks keep sitting on their cash hoards.

Other innovative ideas for stimulating the economy include a possible third round of QE by the Federal Reserve. But one of the shortcomings of the previous attempts was that some of the funds generated were invested outside of the US and into emerging market economies by those speculating in the “carry trade,” in which profits are derived from the difference between the low-interest borrowing in the US and higher-interest lending in other economies. Indeed, emerging market economies in the G20 criticized the US for this type of unintended leakage last year, as the inflows of such capital caused their currencies to appreciate. Therefore, in any possible QE3 round, measures should be put in place to incentivize institutions to invest such money inside the US.

Still additional measures could be considered. Currently, China spends 9 percent of its gross domestic product (GDP) on infrastructure, and Europe spends 5 percent, while the US only spends 2 percent of GDP. However, there is strong bipartisan support for Senate legislation for a highway bill sponsored by Sens. Jim Inhofe (R-Oklahoma) and Barbara Boxer (D-California), as well as for a new “infrastructure bank” sponsored by Sens. Kay Bailey Hutchison (R-Texas), John Kerry (D-Massachusetts), Lindsey Graham (R-South Carolina) and Mark Warner (D-Virginia). Both bills, if passed by Congress, could help create needed jobs at a time when the US suffers from both high unemployment as well as a $2.2 trillion infrastructure deficit. Although these measures would involve federal spending, waiting until further deterioration of the US infrastructure takes hold will only make such improvements more costly for the budget down the road. Therefore, taking action sooner rather than later would be a smart investment both in terms of preventing future higher deficits and creating jobs now.

In the mean time, the crisis of unemployment – and particularly the long-term nature of the unemployment – calls for a major upgrading of current Obama administration efforts to help the nearly 11 million homeowners who are “underwater” on their mortgages, meaning their properties are worth less than the amount they owe. The Obama administration's Making Home Affordable Foreclosure Prevention Program has fallen short of expectations. When it was announced in 2009, the goal was to arrange three million to four million loan modifications by the end of 2012, but only 609,000 have been achieved so far. However, the program was primarily meant for homeowners with risky mortgages; but the bigger crisis now emerging is with unemployed or underemployed homeowners. One new federal program, the Hardest Hit Fund, will provide $7.6 billion so that some states can administer their own programs for struggling homeowners. Of that, 70 percent will be directed to unemployed homeowners, but so far, only $455 million has been spent. Such programs could draw on the $46 billion of bailout funds the US Treasury has been allocated and be greatly scaled up.

Another proposal by the nonprofit PICO National Network would allow unemployed homeowners to postpone much or all of their mortgage payments for a year or more. But the Obama administration has been timid in the face of resistance from the mortgage industry, which is against allowing unemployed homeowners to extend payments for longer terms, and Republican lawmakers who have made clear they would like to get rid of anti-foreclosure programs altogether. But the historic nature of the current unemployment crisis in America requires the president to think bigger and take much bolder actions more in line with New Deal-era types of programs, such as those which helped veterans returning from WWII to secure home loans. This is not a business-as-usual moment and bolder initiatives can be enacted. Creative thinking and bold actions to enable millions of Americans to keep their homes would provide a major stabilizing effect on the otherwise deteriorating economic security of the nation and help stabilize a stronger economic base from which to build an economic recovery as higher employment resumes.