Economy is the shadow that looms over 44th presidency

The financial crisis helped Barack Obama into power. Now it is his job to tackle it – and the success of his administration will be judged accordingly, says Stephen Foley

(AP)

Will President Barack Obama be a modern-day Franklin D Roosevelt, who pulled the US back up over the economic precipice, or will he be a disastrous copy of his predecessor, Herbert Hoover? In these historically grim times, and with the US facing its worst financial crisis since the Great Depression, the question is a haunting one. The ebb and flow of presidential fortunes are often at one with the ebb and flow of the economy, and the 44th president will be defined by his handling of the present crisis, and probably very quickly.

A crumbling housing market has left millions of Americans facing foreclosure, income inequality is at its greatest in 80 years, and a credit squeeze has pushed homes, student loans and even cars out of the reach of many families. It was all quietly adding up to an economic crisis, even before the bottom fell out of the financial markets in September, laying waste to retirement savings and threatening a surge in unemployment that will be apparent in figures out tomorrow. Now the Durst Organisation has had to squeeze a "1" on the front of its national debt clock, as it ticked over $10 trillion last month, a stark symbol of what economists have been warning for years, namely that the US has mortgaged its future to overseas lenders who could pull their money out at the slightest whiff of a budget crisis, or simply if they come up with a better idea for their investing their money (say, for instance, China's own growing economy).

And as if these are not concerns enough, the international community is demanding that the US and its new leader do more than get its own house in order. Jose Barosso, President of the European Commission, laced his congratulations with a call for the US to lead "a new deal for a new world". Business leaders, including Rupert Murdoch, warned that Mr Obama should not retreat into the protectionism that defined parts of his campaign.

President Obama will balance precariously atop an economic see-saw. On one side, there is an urgency to use government money to ease the financial hardship and to reflate the economy. There may be taxes foregone, perhaps even a reversal of the campaign pledge to raise taxes on capital gains for the investing class. There will certainly be new spending on job-creating public works projects, an idea that has long appealed to Mr Obama and his economic advisers from the University of Chicago. No one is advocating Hooverish austerity now. The question is how far one can safely move.

On the other side of the see-saw, Mr Obama's room for manoeuvre is crimped by the budget deficit, already expanded twice in the past few months to reflect the nationalisations of the mortgage giants Fannie Mae and Freddie Mac and the signing of the $700bn banking bail-out package. In some ways, it reflects the battle early on inside the Clinton administration between those who favoured public works to accelerate the economy out of the last Bush recession, and those – ultimately victorious – deficit hawks, who thought the first priority should be paying down debt.

Then, they had at their side Alan Greenspan, veteran chairman of the Federal Reserve, who preached fiscal rectitude to the novice president. Today, after Mr Greenspan declared himself "shocked" to discover the credit crisis had revealed a "flaw" in his laissez-faire world view, the hawks are back in the coop. Mr Greenspan's more doveish successor at the Fed, Ben Bernanke, has given a green light for a large economic stimulus package.

A green light, yes, but he has not dismantled the traffic lights. Faced with much lower than expected tax receipts because of the recession, President Obama could find that longer-term spending priorities, from subsidies for alternative energy, through universal health care to social security reform, have to be postponed. It may be that, faced with a heavily Democratic House and Senate, newly energised, the new President's biggest challenge will be dissuading them from pushing the ambitious agenda he espoused on the campaign trail. The markets, for certain, will be urging him to rein in a tax-and-spend liberal Congress, and for the markets, one should read those foreign investors who have bankrolled the US deficit.

President George Bush will begin redesigning the international financial architecture with a summit of 20 leading nations next weekend, even as the world looks to Mr Obama for his new economic team and a leadership role. Even then, it will be difficult to translate highfaluting talk of a new Bretton Woods into real results. The Democrat will be much more attuned to international regulatory co-operation than his predecessor, should some new ideas emerge, but the reality is that his focus, to prevent a repeat of the credit crisis, will be on shaking up and strengthening domestic regulation. All of which is for the longer term. If the new president even has the luxury of thinking medium-term, that will be an improvement on the present situation, where the federal government is being buffeted by short-term crises in the financial markets and often being forced to sign up to radical policies that it was dismissing just days previously.

The new president will inherit a banking and mortgage system that is in large measure under federal government control. Mr Obama will be more inclined to use the new levers available to ease the worst of the downturn for ordinary Americans. Mortgages can be renegotiated, foreclosures forestalled and new home loans showered about to help stimulate the housing market, but all of this comes with political pitfalls, and the potential for longer-term damage by suppressing economic innovation. If the economy recovers, the question of reprivatising these institutions will move swiftly up the agenda.

But few expect Mr Obama to much challenge the economic orthodoxy of free trade, although his union supporters are banking on a renegotiation of the North American free trade agreement they blame for shipping jobs overseas.

For now, the President-elect looks set to turn on the spending taps and hope against hope that this is enough to reliquify the economy. He could put his stamp on the issue before his inauguration in January by guiding the efforts of a lame-duck session of Congress which has already begun debating a stimulus package. Its contours – and therefore the outlines of Obamanomics – could begin to take shape within days.

Key appointment: Who will be Obama's Treasury Secretary?

With the markets more skittish than at any time in memory, and a $700bn cheque still to be spent on bailing out the banks, the most important recruitment decision facing the President-elect is who to pick as Treasury Secretary. Ironically, a candidate swept into power on a promise of change is being urged to consider some old-school names. Larry Summers and Robert Rubin, treasury secretaries in Bill Clinton's second term, have both been advising Barack Obama and are considered strong contenders.

Mr Rubin comes from Wall Street titan Goldman Sachs and now sits on the board of Citigroup. Mr Summers, an academic economist, is the current favourite but would be controversial, having been driven out of his job as president of Harvard in 2006 after saying genetic differences may explain why fewer women study science. Paul Volcker, chairman of the Federal Reserve under Carter and Reagan, is another Obama adviser in the frame, but his age, 81, may count him out.

Alternatives include the centrist Austan Goolsbee, Mr Obama's long-time economics chief who he knows from the University of Chicago, and Jon Corzine, the governor of New Jersey who was ousted from Goldman Sachs in 1998 by the current Treasury Secretary Henry Paulson. The public backlash over Mr Paulson's banking bailout now makes it unlikely that he will be invited to continue in the post but Mr Obama could reach out to another Republican, rising star Sheila Bair, who runs the banking regulator, the Federal Deposit Insurance Corporation.

Obama's in-tray: Domestic issues

Health care

Some 46 million US citizens – out of just over 300 million – have no health insurance, and Mr Obama's election promises a new push to offer coverage to everyone for the first time since Bill and Hillary Clinton's failed attempt to get a deal in the early Nineties. Leave aside the political difficulties of achieving consensus between insurers, pharmaceuticals companies and doctors' lobbies. The first briefing paper on this issue in the presidential in-tray will be headlined: Can we afford it right now?

Social security

The baby-boomer generation isretiring, putting a strain on the federal government's social security fund, which most economists predict will be insolvent before the middle of the century. That might sound like far enough away for the new president to tuck the issue at the bottom of the pile, but action is needed soon to cut the future benefits of those currently in the workforce, to raise the retirement age, and to begin related reforms of Medicare, on which increasing numbers of senior citizens will rely for paying medical bills.

Climate change

Environmentalists fear that the issue could be pushed down the agenda, thanks to the economic crisis. Mr Obama has promised to kick-start international negotiations, which could include widening carbon caps and trading schemes. The new president will also be pushing the US to do its part, with new money for alternative fuels. But he will also have to decide whether to disappoint green campaigners by pushing for more coal power plants and using offshore drilling as a stop-gap measure to reduce reliance on foreign oil.