Q&A: Larry Lindsey on Bailouts, Anthrax, and the Slump (extended)

Bush's economic guru sees delays in a V-shaped rebound

In the wake of the September 11 terrorist strikes, Treasury Secretary Paul H. O'Neill has been the public face of the Administration's economic team, helping to restore confidence in the shaken economy. But what about Mr. Inside, White House economic coordinator Lawrence B. Lindsey? From his vantage point as head of the National Economic Council, Bush's favorite economist has been working behind the scenes to get financial markets restarted and to cope with a flood of aid requests from hard-hit industries such as airlines and insurance. On Oct. 17, he took time out from his toils to talk with Washington Bureau Chief Lee Walczak. Here is an extended version of excerpts from their conversation that appear in the Oct. 29 issue of BusinessWeek:

Q: How have you and the National Economic Council been deployed after September 11?

A: One of the things that happens when you have a surprise event is that you don't have a script, so we all pitched in and dealt with the problems as they were coming in. We were getting calls from affected industries. In particular, our mission was to get the [financial] markets open. We also heard from the airlines and the auto industry with regard to their problems. We were trying to plug holes as they were opening up. We did the best we could.

Q: Airlines and, soon, insurance companies, are in line for government aid in the wake of the terrorist attacks. Does the line end there, as far as you're concerned?

A: There has only been one industry [that has received government aide], and that's airlines -- which were shut down by the government to get control of the skies again. This precipitated a tremendous loss of revenue. The logical thing was either to do without an air network or provide assistance. We thought the decision was quite straightforward.

Q: But aren't you also moving to help insurers by assuming much of the risk from future terrorist-based losses?

A: In the case of insurance, government did not pay a penny. The insurance companies are paying more than $40 billion to meet the claims of September 11. What happened is that there is now an inability to estimate the likely cost of a future incident, which [prevents] scientific pricing of risk. If you can't do that, the market collapses.

Q: So why aren't you charging the big property and casualty insurers something to recover part of the government's cost of risk assumption?

A: The point is, there is no insurance market for terrorism going forward. Banks require that to give a mortgage on a new property. We faced the dilemma of seeing the entire insurance market disappear, and with it, new construction. This is not something we can tolerate.

The question is, how does one resume some pricing of insurance? The only way you can get a price, with the probability unknown, is to constrain the loss to something we feel is quite manageable -- and to hope a reinsurance market reemerges. Once that takes place, our goal is to get the government out of the business. Under the President's proposal, that will be in three years.

Q: Do you envision similar special aid measures for any other industry, such as travel and tourism perhaps?

A: The question is whether a market is functioning and whether the lack of functionality causes [adverse] spillover effects. Airlines was a stark choice with huge spillover effects and was a natural place for the government to step in. And the plan we adopted [for insurers] was the only mechanism available to provide insurance to property owners. It is not a subsidy.

Q: Nonetheless, conservatives are unhappy with the drift to semi-big, hyperactive government in Washington. Are you feeling heat from the right?

A: No one is happy about what is happening. My first choice would never be to have the government step into airlines, insurance, or anything else. But we're at war, and in a war situation, the uncertainty causes some markets to break down. Where those markets break down, we have two choices: either to let the void persist or to have government step in and find a way of recreating the market.

Q: Given the current anthrax scare, do you think you may have to beef up the public health system to deal with the threat of bioterrorism?

A: The system is already in the public sector. It is something we are providing more funds for as part of the [initial] $40 billion emergency aid package [enacted after September 11].

Q: Aren't you also calling for another $1.5 billion for more vaccine production [see BW Online, 10/18/01, "Why Vaccines Are Our Best Shot"]?

A: Yes. And one of the problems with more production is the trial bar. Trial lawyers are threatening to sue in the case of anyone who gets a vaccine and has an adverse reaction.... We know that in the case of any vaccine, some small number of people will have an adverse reaction. Unless there is some liability cap on the rapaciousness of these individuals, the drug companies cannot prudently go forward. The same is true for property and casualty insurance.... The trial bar is the major threat to the resumption of sound economic activity, to construction, and to public health.

Q: Why is it taking Washington so long to come up with a bipartisan economic stimulus package?

A: This is just a small, Southern city, this is normal slow Southern pace [smiling].... Madison designed [the system] that way. Let's talk about the pace of the package. The [$75 billion] package the President has suggested is one that both parties can live with. It wasn't anyone's first choice but fell within everyone's range of the acceptable. Something very similar to that is going to emerge. As for timing, the first tax bill got passed in four months. That was record time, and we're talking about something on the order of four to six weeks for this tax bill. This is lightning speed by Washington standards.

Q: So when will lightning finally strike?

A: The House Ways & Means Committee is marking up a bill. When that passes the House, it will move on to the Senate. The process is moving forward.

Q: Did the House GOP's decision to go it alone with their own, bigger -- and more controversial -- bill really speed the process? Their bill is $100 billion, at least.

A: One of major reasons for the difference in sizes is different [budget] scores. The Administration uses the Office of Management & Budget's scoring. The same provisions were scored a lot higher by the [independent] Congressional Budget Office. Some of the baseline assumptions are a little different.

Q: Have differences between Democrats and Republicans been resolved over the issue of whether some business tax breaks should be temporary or permanent?

A: Well, the President asks that it be made permanent, the House passed a temporary measure for three years. That's enough to get the provision in place. Anyone who buys new equipment over that period will get more generous depreciation.

Q: Critics of the business breaks say you should be focusing more attention on stimulating consumer demand, because in this environment CEOs may not acquire new equipment, even with a little tax break. Your response?

A: It's both consumer demand and investment demand that have fallen. We are recommending packages for both. The main problem we confront is increased risk-aversion on the part of both households and firms. The standard economic answer for that is exactly what's being proposed, which is to lower the cost of investment. We have a text-book response.

Q: With all of this stimulus sloshing around the system, what do you feel the prospects are for a strong, V-shaped rebound next year?

A: I believe V-shaped is the most likely scenario. We have a timing issue. We had probably contained the damage from the excesses of the '90s prior to September 11. We probably would have seen a resumption of near-normal growth by the first quarter of next year. That has probably been put off a quarter.

Q: There has been a lot of rethinking of policy across the board after September 11. There has been a lot more coming together. Has there been a rethink on national energy policy?

A: My two greatest disappointments -- and frankly they are surprises -- are that the Senate has refused to take up an energy plan and trade-promotion authority. To me, the energy plan would be a natural response to what happened.... But we have bottled up the package.... The reasons have nothing to do with the national interest but with politics.

Q: Some Republicans are talking about filling the Strategic Petroleum Reserve up to about maybe a billion barrels. This would cost about $6 billion. The argument is that with oil relatively cheap, this would be a good time to do it.

A: There's merit in that. I also think there's merit in [drilling in] the Arctic National Wildlife Refuge. We don't have to pump it from the ANWR, but we ought to do exploration there. It would provide a natural Strategic Petroleum Reserve for us.

Q: On off-shore drilling, states' rights have tended to trump federal intentions. Given the state of national emergency, isn't it incumbent on the government to come back on that, perhaps offering new liability incentives?

A: Perhaps. The natural-gas issue is much more on the table and appropriate. What we need to pass is the energy plan that the Vice-President's task force worked out. We looked at the cost/benefit analysis of each of those steps, and they proved very beneficial. We wish they would pass that.

Q: There's an argument that a pause in trade expansion might not be such a bad thing, because of some of the demands of lesser-developed countries for concessions...

A: Any President needs trade-promotion authority in order to be able to negotiate any provision. And I would hope that the Senate would grant trade-promotion authority.

Q: You sound pretty upbeat about the long-term prospects for the U.S. economy. Chairman Greenspan today [Oct. 17] delivered a very mixed picture about the immediate term. What worries you right now, in terms of potential trouble spots in the U.S. economy?

A: There is increased uncertainty, and therefore increased risk aversion out there. It's quite natural. Over time, as we triumph over the terrorists, the world will become a permanently safer place. That risk will diminish, and risk aversion will return to more normal levels. That's ultimately what's got to happen here.

But it's going to take time, and the process of getting from here to there is not a straight line. There are going to be some bumps in the road. The bumps are not ones that are easily predictable. What we've done, in the case of airlines or insurance or whatever else, was find ways of maintaining fundamental economic infrastructure in the face of some real challenges. And we will continue to do so.

Edited by Douglas Harbrecht

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