Obama's uphill task on US economy

By Steve Schifferes
BBC News, Washington

Unemployment is rising as the slowdown bites

As Senator Barack Obama celebrated his striking electoral victory, he spoke of dreams.

But he now faces the reality: the most difficult economic climate for an incoming president since Franklin D Roosevelt was elected at the height of the Depression.

And just as in 1932, the economic crisis could worsen in the 75 days before President Obama takes office on 20 January.

He faces three key economic challenges:

• how to ensure the stability of the financial system
• how to deal with the looming recession
• how to pay for his ambitious plans in health, education and the environment

The credit squeeze

Despite the $700bn bail-out package, the US financial system is still weakened by the credit crunch.

A collapse in the housing market has contributed to the slowdown

The injection of $250bn into the banking system may have staved off any more imminent banking failures, such as the collapse of Lehman Brothers, but it has not revived lending.

Indeed, the contraction of lending for housing appears to be spreading to other areas, such as credit cards and car loans.

Despite the Federal Reserve having cut US interest rates to 1%, interest rates on mortgages remain high as lenders fear the consequences of default.

Help for homeowners?

The new treasury secretary will have unprecedented discretion as to how to spend the remaining $450bn bail-out fund to alleviate the situation.

It may well be that the Obama administration decides to use more money to directly aid distressed homeowners, and less to buy up distressed bank assets, than the current treasury secretary, Hank Paulson, wants to do.

But such a move could raise difficult issues of fairness among people who are struggling to pay mortgages which are not in default.

It also unclear how much the new government might want to allocate to help people whose retirement income has been hit by the sharp fall in the stock market.

Barack Obama has already said he believes the long-term source of the problem was excessive deregulation of the financial sector, and moves are already afoot in Congress to tackle this issue (and indeed the Bush administration has its own Treasury plan).

But there are political minefields - balancing regulatory responsibilities between states and the US government and deciding whether to work with other nations in designing international rules for an increasingly globalised financial sector.

The real economy

There is even worse news for President-elect Obama on the real economy.

The US economy began shrinking in July, and that decline is expected to accelerate over the next year.

Consumer spending, which makes up two-thirds of GDP, is falling even faster, as consumer confidence has plummeted.

Particularly hard-hit are manufacturers of big-ticket items such as cars. Sales at the US's biggest carmaker, GM, plunged 45% in October compared with the same month last year.

And unemployment has continued to rise, up by 700,000 this year to 6.1% of the workforce.

Stimulus plan

Many of the industries affected, such as the carmakers, are already seeking more help from Congress and the new administration, and the new president will have to decide whether to aid them further.

It may cost billions to bail out the motor industry

The President-elect is already committed to a relatively small-scale stimulus package, which could include tax cuts and aid to states.

But if the slowdown deepens, should reviving the economy involve giving money to individuals - who may save it rather than spend - or funding big public projects, which might generate more jobs but take longer?

The Democrats in Congress would also like to increase payments to the unemployed, who currently get unemployment benefits only for six months.

The rising toll of manufacturing jobs could intensify protectionist pressures from the unions to take a tougher line on trade deals, perhaps even trying to renegotiate the North American Free Trade Agreement.

Tax cut promise

President-elect Obama will inherit a budget deficit of nearly $500bn - the biggest ever in absolute terms - and it is expected to double as the recession cuts into tax revenues, and the cost of the financial bail-out rises.

Nevertheless, the new president will come in with high expectations and ambitious plans to improve America's healthcare, education, infrastructure and environment.

And he has promised a tax cut to the 98% of Americans who make under $250,000 a year.

Although Mr Obama hopes to finance the cuts by increasing taxes on the wealthy (when the Bush tax cuts expire), the revenue from this will only emerge later in his term.

This money is also expected to help pay for Mr Obama's healthcare reforms, which aim to reduce the number of people (currently 45 million) without health insurance.

The economic squeeze could lead the new president to delay implementing his plan to require all children to have health insurance, instead electing to extend the government-subsidised child health insurance system until the economic climate improves.

Mr Obama is hoping to raise money for his green investment programme by auctioning permits for carbon trading, but this is still an uncertain and untested market in the US.

And he is hoping that he can work with the states in rebuilding the infrastructure of crumbling roads and bridges, but financial difficulties and problems in borrowing money may delay such plans.

Indeed the government may be forced to bail out some of the bigger industrial states.

And then there is the long-term budget challenge, the future gap between revenues and spending for the two biggest government programmes, social security and Medicare (which provide pensions and medical care for older people) as the baby-boomer generation retires.

These programmes are likely to turn from surplus to deficit by the end of the Obama presidency, and have proved politically very difficult to fix. The growing cost of medical care, in fact, threatens to derail government spending both in the long term and short term.

Tackling the budget gap may prove one of the trickiest problems for the new president.

All in all, how Barack Obama responds to the formidable set of economic challenges could well determine how he is remembered in history: either as an FDR who changed the US political landscape for a generation, or as a Jimmy Carter, whose failure to tackle the economic challenges of the 1970s led to a one-term presidency and the election of Republican Ronald Reagan.