with respect to the borrower's income and other characteristics is inadequate.
Poor performance of this two-fifths of originations has induced
a significant tightening of credit availability, with a noticeable impact on
home sales. I was aware that the loosening of mortgage credit terms for
subprime borrowers increased financial risk, and that subsidized home
ownership initiatives distort market outcomes. But I believed then, as now,
that the benefits of broadened home ownership are worth the risk. Protection
of property rights, so critical to a market economy, requires a critical
mass of owners to sustain political support.
A
A
s much as the economy's overall resilience heartened me, I was dis
tressed by the performance of the government. Red ink flooded back
in 2002: we ran a deficit of $158 billion, a deterioration of more than a
quarter trillion dollars from the $127 billion surplus of 2001.
President Bush continued to direct his administration toward fulfilling
the promises he had made during the 2000 presidential campaign: cutting
taxes, strengthening national defense, and adding prescription drug benefits
to Medicare. These goals had not been unrealistic in the light of large and
projected surpluses. But the surpluses were gone six to nine months after
George W. Bush took office. And in the revised world of growing deficits,
the goals were no longer entirely appropriate. He continued to pursue his
presidential campaign promises nonetheless.
Most troubling to me was the readiness of both Congress and the administration
to abandon fiscal discipline. Four years of surplus had made
thrift an increasingly scarce commodity on Capitol Hill. Surpluses are irresistible
to officials who thrive on the political "free lunch." I cannot count
how many letters I received from Capitol Hill in the 1990s outlining one
scheme or another to spend more or tax less, with the pay-go requirement
233
THE AGE OF TURBULENCE
satisfied by some sleight-of-hand financing obscurity, the purpose of which
was to hide the cost of the scheme. In the Congress, double-entry bookkeeping
had become a lost art.
It finally dropped the pretense. During the final year of the Clinton administration,
Congress had ignored its self-imposed discretionary spending
caps to legislate an estimated $ 1 trillion of additional spending over ten
years. Without this spending, the record $237 billion surplus in 2000 would
have been even larger. Then with George Bush came the tax cuts, unmatched
by decreased spending, and, in the wake of September 11, still
more openhanded spending.
Laws passed after 9/11 included needed increases for defense and
homeland security, of course. But our national emergency fiscal measures
also seemed to whet Congress's appetite for "pork"—spending programs
for constituents. An early example was a $60 billion transportation bill that
passed almost unanimously in December 2001. It allocated large sums to
expand airline security and imposed a tax on plane tickets to partly offset
the cost—sensible moves, arguably. Yet it also included more than $400
million of pure pork—highway funding taken out of the states' control and
earmarked by legislators for pet road projects back home.
I was even more offended by the farm bill the following May. It was a
budget-busting six-year, $250 billion handout that reversed hard-fought
earlier initiatives to scale back agricultural subsidies and open up farm trade
to market forces. The new package greatly increased subsidies on cotton and
grain, and heaped new subsidies on everything from sugar to chickpeas.
The chairman of the House Agriculture Committee, Texas Republican Larry
Combest, pushed for the bill, as did midwestern Democrats, like Senate
leader Daschle of South Dakota.
There is a remedy for legislative excess: it's called a presidential veto. In
conversations behind the scenes with senior economic officials, I made no
secret of my view that President Bush ought to reject a few bills. It would
send a message to Congress that it did not have carte blanche on spending.
But the answer I received from a senior White House official was that
the president didn't want to challenge House Speaker Dennis Hastert.
"He thinks he can control him better by not antagonizing him," the official
said.
234
THE NATION CHALLENGED
And indeed, not exercising veto power became a hallmark of the Bush
presidency: for nearly six years in the White House, he did not throw out a
single bill. This was without modern historical precedent. Johnson, Nixon,
Carter, Reagan, George H. W. Bush, Clinton—all had vetoed dozens of bills.
And Jerry Ford had vetoed everything in sight—more than sixty bills in less
than three years. This enabled him, even though faced with large Democratic
majorities in both houses of Congress, to assert a great deal of power
and steer the lawmakers in directions he thought important. To my mind,
Bush's collaborate-don't-confront approach was a major mistake—it cost
the nation a check-and-balance mechanism essential to fiscal discipline.
Budget discipline in Washington gave up the ghost on September 30,
2002. That was the day Congress allowed America's primary antideficit law
to expire. The Budget Enforcement Act of 1990 had been a monument to
congressional self-restraint. Enacted with bipartisan support under the first
President Bush, the law had played an important role in bringing the federal
deficit under control, thereby helping to set the stage for the 1990s
boom. In it, Congress imposed on itself strict discretionary caps and pay-go
rules that required new spending increases or tax cuts to be offset elsewhere
in the budget. Violating these provisions would automatically trigger
heavy penalties, such as across-the-board reductions in social programs
and defense—cuts any politician would take pains to avoid.
But the Budget Enforcement Act never envisioned years of surplus
(ironically, its goal had been to achieve a balanced budget by 2002). And in
the late-1990s rush to spend, Congress seized on technicalities to flout its
rules. As a longtime House staffer put it, "We were required to be 'deficitneutral'—
but there were no deficits!" Yet now, with the safeguards due to
expire, deficits were flooding back.
In mid-September I made the most strenuous plea I could for Congress
to retain this first line of defense. "The budget enforcement rules are set to
expire," I told the House Budget Committee. "Failing to preserve them
would be a grave mistake. For without clear direction and constructive goals,
the inbuilt political bias in favor of budget deficits likely will again become
entrenched.... If we do not preserve the budget rules and reaffirm our
commitment to fiscal responsibility, years of hard effort will be squandered."
The worst consequences would not be immediate, I acknowledged, but they
235
THE AGE OF TURBULENCE
would be severe. I warned, "History suggests that an abandonment of fiscal
discipline will eventually push up interest rates, crowd out capital spending,
lower productivity growth, and force harder choices upon us in the future."
My statement had circulated in advance. It was obviously not a message
the committee members wanted to hear. Of the forty-one members of
the committee, only about half showed up. I watched the congresspeople's
reactions as I read a passage invoking the historic bipartisan consensus that
had given birth to the Budget Enforcement Act. Mostly I was met with
blank stares. Worse, the question-and-answer session made it plain that few,
if any, of the legislators had any interest in perpetuating spending constraints.
Instead of addressing my proposal and the larger economic danger
to which it pointed, the questioners simply changed the subject. The discussion
focused almost entirely on tax cuts, present and future, pro and
con. And that was what dominated the sparse news reports of my testimony
the following day.
In the Senate, Pete Domenici, Phil Gramm, Kent Conrad, Don Nickles,
and other fiscal conservatives worked to retain the budget-balancing mechanisms.
But the political will wasn't there. All they managed was to put
through a six-month extension of a procedural rule that made it slightly
harder to pass legislation increasing the deficit. But without the Budget Enforcement
Act's mandatory penalties, the rule had no teeth. The budget
discipline that had served us so well was effectively dead.
After the Republicans scored a sweeping victory in the November
2002 midterm elections, the situation got worse. Glenn Hubbard, the chairman
of the Council of Economic Advisors, argued in a December speech
that it made little difference to the overall economy whether the budget
was balanced or not. "One can hope that the discussion will move away"
from the idea that higher deficits would push up long-term interest rates
and chill growth, he said. "That's Rubinomics, and we think it's completely
wrong." Leaving aside this gibe at the Democrats, what Hubbard said was
accurate in a short-term context. Securities markets have become so efficient
that current interest rates move only when new information brings
changes in expectations of future budget deficits and Treasury debt. Incremental,
immediate changes in the supply of U.S. Treasury obligations are
236
THE NATION CHALLENGED
generally quite small relative to the global supply of comparably safe long-
term debt instruments. Small changes in relative prices (that is, interest
rates) can induce investors to replace considerable quantities of Treasury
debt with equal amounts of high-quality corporate debt or foreign government
obligations. The converse is also true: such changes in debt or, by extension,
deficits are associated with surprisingly small changes in interest
rates. The size and efficiency of the global market for bonds competitive
with U.S. treasuries obscure the underlying long-term relationship between
federal deficits, debt, and interest rates.
Sometimes when an issue is complex, it is a useful exercise to take it to
an extreme. If it were true that deficits did not matter and tax cuts unmatched
by spending cuts were good public policy, then why not just eliminate
all taxes? Congress could borrow as much as it wanted and spend as
freely as it liked, all without fear that the government's rapidly accumulating
ocean of debt would erode economic growth. Yet as we have seen time
after time in developing countries, unbridled government borrowing and
spending produce hyperinflation and economic devastation.
So deficits must matter. The crucial question for policymakers is not,
Do they hurt growth? but How much do they hurt growth? In fact Hubbard,
whose econometric models show only a small impact on interest rates
from changes in Treasury debt outstanding, nonetheless recently wrote,
"Our findings should not be construed as implying that deficits don't matter.
Substantially larger, persistent, and unsustainable levels of government
debt can eventually put increasing strains on the available domestic
and foreign sources of loanable funds.... In the United States at the present
time, unfunded implicit obligations associated with the Social Security
and Medicare programs are particularly of concern." But the subtleties of
the economic debate got lost in the political realities. Congress and the
president viewed budgetary restraint as inhibiting the legislation they
wanted. "Deficits don't matter," to my chagrin, became part of Republicans'
rhetoric.
It was a struggle for me to accept that this had become the dominant
ethos and economic policy of the Republican Party. But I'd had a preview
of it many years before, in the 1970s, over lunch with Jack Kemp, then a
237
THE AGE OF TURBULENCE
young congressman from upstate New York. He complained that Democrats
were always buying votes by boosting spending all over the place. And
eventually the resulting deficits would land in the lap of a Republican administration
to solve. "Why can't we be a little irresponsible ourselves?" he
asked, startling me. "Why can't we cut taxes and give away the goodies before
they can?" And indeed, that's what was happening now. My sensibilities
as a libertarian Republican were offended.
In late December 2002 and early January I took the unusual step of
pushing senior economic officials in the White House to adopt a more rational
approach. I can't say my protests had much substantive effect, but
the White House must have realized that "deficits don't matter" sounded
extreme, because it adjusted its language by the time President Bush presented
his 2004 budget plan. "My administration firmly believes in controlling
the deficit and reducing it as the economy strengthens and our national
security interests are met," he declared to Congress on February 3, 2003.
He went on to argue that deficits for the moment were inevitable because
of the need for new tax cuts to stimulate growth and the need for new
spending to fund the war against terror. The next day John Snow, who had
recently succeeded Paul O'Neill as Treasury chief, struck a similar note.
"Deficits matter," he told the House Ways and Means Committee, but the
ones projected in the president's new budget were both "manageable" and
"unavoidable."
The new budget to me was a little more discouraging. Outlays totaled
more than $2.2 trillion, and the bottom line was a projected deficit of more
than $300 billion in both 2003 and 2004, and another $200 billion (using
rather rosy assumptions, I thought) in 2005. The proposal, predictably, provided
for substantial spending jumps for homeland security and defense.
