The Democrats' Recession

The market has fallen in six of eight days since Barack Obama won the election. The Dow Jones Industrial average has fallen from 9,625 to 8,497, a 12 percent decline. The NASDAQ and S&P 500 have experienced similar declines.

The Wall Street Journal and others have labeled the drop the “Barack Market,” reflecting the higher taxes on everything from capital gains and dividends to income and increased regulations. They are right, but they are thinking much too narrowly. Much, if not all, of any recession and economic problems is due to Democratic policies.

The media focuses on the drop in housing prices, consumer purchases or stock prices as the cause of economic problems, problems that they view as unrelated to Democratic policies.

The financial problems seem obvious. Democrats have been the ones pushing for federal regulations that forced financial institutions to make risky loans either though the threat of penalties from the Federal Reserve or through subsidies from Fannie Mae and Freddie Mac. They protected Fannie Mae and Freddie Mac from regulations.

While Barack Obama claims that he fought for more financial market regulation, the regulations that he wanted would not have stabilized the markets -- quite the contrary. He supported regulations that went after so-called predatory lenders who were charging “too high” an interest rate to poor, risky borrowers. Forcing banks to charge even lower interest rates to these risky borrowers would have meant even more problems, not fewer ones.

The regulations that mandated little or no down payments to risky borrowers posed little problem as long as housing prices rose, but when house prices started to fall, it meant that many people just walked away from mortgages that were worth more than their houses.

Obama himself played a role in creating these problems, and not just because he supported these Democratic policies. Take his policy where judges will be able to step in and rewrite home mortgage contracts -- unilaterally reducing the amount that homeowners owe and reducing their interest rates.

How would such a policy affect the willingness of banks to lend money for new mortgages? It likely even affected the market before the election. If you thought that Obama could win, would you want to loan money for people to buy homes if a judge could lop off a $100,000 from what is owed and cut interest rates? Lenders don’t even know how much the government would possibly reduce what would be owed. Many lenders this year simply didn’t want to take such incredible risks.

What does that do to the price of houses? Obviously, when people have a hard time borrowing money, there are fewer buyers and prices go down.

What about Obama’s campaign promises earlier this year to double the capital gains tax? Surely that hits stock prices hard. If you were planning to sell stocks next year, it means that the Federal government would take an extra 15 percent of what you earned. So shareholders started selling their stocks months ago just because they thought that there was a chance Obama could win and impose this policy. (How much he has promised to increase this tax has changed over time.)

Despite some tax protections for capital gains on houses, many would still get hit by Obama’s increased capital gains tax rates, driving down the price of houses.

Even the higher unemployment rates and the small drop in GDP during the third quarter are squarely laid at the Democrats' door, though the Republicans can be blamed for not having had more nerve to fight against the policies.

New unemployment claims were flat or falling during the year until early July. The overall unemployment rate had also leveled off at 5.5 percent in June.

What changed during the summer? Those who filed for unemployment insurance after July 6 got 50 percent more unemployment insurance benefits. Economists, even Democratic economists who worked in the Clinton Administration, know that if you subsidize unemployment, you get more of it. Indeed, the typical estimate indicates that a 50 percent increase in benefits will increase the unemployment rate by a little over 1 percentage point.

Not surprisingly, the unemployment rate has gone up from 5.5 percent in June to 6.5 percent today.

But higher unemployment also means that fewer people are working, and that what the economy produces will decline. A one-percentage point increase in unemployment is claimed to be associated with about 2 percent drop in GDP.

The GDP in the third quarter of this year fell at an annual rate of 0.3 percent – the drop is more than explained by the increased unemployment rate produced by the larger unemployment insurance benefits and indicates that the economy would have otherwise grown.

The ultimate irony is that despite these Democratic proposals and policies, the Republicans are blamed for the economic problems, as a Republican president has been in power. Of course, Democrats also share power now, as they have controlled both houses of Congress. Bush even appointed a Democrat to be Secretary of the Treasury, Henry Paulson, in an attempted olive branch to the Democrats. Paulson filled important slots at Treasury with other liberal Democrats.

Paulson’s hysteria about the economy a month ago has undoubtedly caused consumers to cut back some on spending -- a hysteria that most economist questioned at the time. But Paulson’s wild spending spree, nationalizing banks and other companies, fits his and his aides' Democratic views.

President Bush might give talks saying, “History has shown that the greater threat to economic prosperity is not too little government involvement in the market, it is too much government involvement in the market.” It invokes Reagan’s statement that "Government is not the solution to our problem; government is the problem." But Reagan wouldn’t have let Democrats have unfettered control of the U.S. Treasury Department.

Bush bears significant blame for letting Democrats control the debate. He bears significant blame for letting Paulson push and run the bailout. But that takes nothing away from the current economic problems being something that has Obama’s and the Democrats’ names all over it.

*John Lott is the author of Freedomnomics and a senior research scientist at the University of Maryland.