UC Merced

UC Merced professor warns of stimulus mistakes

The federal government's effort to prime the U.S. economic pump must be focused and aimed at fostering long-term growth, a UC Merced economics professor said Tuesday.

Shawn Kantor, speaking at the Greater Merced Chamber of Commerce's quarterly luncheon, warned that some of the government's mistakes in dealing with the 1930s Great Depression -- which included record-high taxes and inconsistent approaches -- must be avoided at all costs.

"Modern research on the New Deal suggests it did very little to stimulate the economy during the Great Depression," explained Kantor, a scholar on the historic crisis. "In fact, it had an adverse effect because it created more uncertainty for businesses."

Similar mistakes, such as the threat to tax the AIG bonuses at 90 percent, are worrisome because they create the same unease in the private sector, Kantor said.

The government announced Monday that it's embarking on a public-private partnership to buy up to $1 trillion in toxic assets that are dragging down bank balance sheets, he noted.

But then it's also taking a combative approach by wielding taxes as a weapon. That will spook financial leaders, and they won't work with the Treasury Department, he suggested.

"So on the one hand they're saying, 'You're evil because you make lots of money,'" Kantor said, "but on the other hand they say, 'Well, we need you because we have to do this together to bail out the economy.'"

Along with such distractions as the AIG bonuses, Kantor said trade restrictions could hurt the country's ability to recover.

He also fears that the government will grow to a record size and become more involved than it's ever been.

During his half-hour presentation at The Branding Iron Restaurant, Kantor detailed the causes and impacts of the financial crisis.

Public and private decisions created a "perfect storm" of easy money, looser credit standards and the proliferation of risky financial instruments for investors.

Political pressure resulted in increased home ownership even for people who had no chance of ever paying off a mortgage, he said.

Those mortgages were bundled as sold as safe investments, which in turn freed up more money to lend to homebuyers.

For example, Lehman Bros. had lent $30 for every $1 it had before going bankrupt, Kantor noted.

The market bubble continued to grow until it was pricked by subprime borrowers missing mortgage payments, sending home values into a downward spiral.

On top of all this, AIG had sold insurance on the bundled mortgage investments, which is why the government has given it a $182.5 billion life jacket.

Despite Kantor's concern that government will overreach, he said reforms are needed to make sure there aren't situations where companies, such as AIG, are too big and intertwined to fail. Lawmakers need to act before the political will dissipates.

"Americans are really pissed off right now that we're spending billions of dollars -- trillions of dollars -- to bail out these companies," he said. "There has to be some kind of accountability built into the system."

Reporter Scott Jason can be reached at (209) 385-2453 or sjason@mercedsun-star.com.