This is a rush transcript from "Special Report," December 24, 2010. This copy may not be in its final form and may be updated.


BRET BAIER, HOST OF “SPECIAL REPORT”: Welcome to Washington. I'm Bret Baier. This is a special Christmas Eve edition of “Special Report.

We'll be talking about some of the interesting stories that took place this past year. We have a distinguished panel of Fox all-stars with us tonight, an expanded panel.

Steve Hayes, senior writer for The Weekly Standard; A.B. Stoddard, associate editor of The Hill; Juan Williams, Fox News contributor; and syndicated columnist, Charles Krauthammer.

First up: the American economy and whether it is headed for a crisis like the one in Europe.


SEN. MITCH MCCONNELL (R-KY), MINORITY LEADER: Americans are watching the economic drama that's playing out in Europe. They expect us to read the signs of the times and work together to make sure that we avoid a similar crisis here. That we don't walk into the same problem through lack of will or political courage.

PRESIDENT OBAMA: If there's one thing we can agree on, it's urgent work of protecting the middle class families, removing uncertainty for America's businesses, and giving our economy a boost as we head into the New Year.

LARRY SUMMERS, NATIONAL ECONOMIC COUNCIL DIRECTOR: The constraint on our economy now and for the next several years will be the lack of demand.

ADM. MIKE MULLEN, JOINT CHIEFS CHAIRMAN: I said several times publicly, I think the biggest threat we have to our national security is our debt.

SEN. TOM COBURN, R-OKLA.: It's kind of like we're on the Titanic here in America. And everybody says, "The bar’s open. We'll just have a party the next two weeks."

ALAN SIMPSON, DEBT COMMISSION CO-CHMN: This is it. No more fun and games, smoke and mirrors, alchemy, trickery, cunning, CYA, demagoguery, and making promises we can't possibly keep.


BAIER: Where are we with the economy in? As we look historically of the recovery from the 2009 recession, President Obama's effort versus the effort of 1981 from that recession by President Reagan, you can see at the end there, right now, the unemployment rate stands at 9.8 percent. And that graph shows you the difference of the recovery in these two times in our history.

With the panel -- what about the status of the economy and what this administration has done? Charles?

CHARLES KRAUTHAMMER, SYNDICATED COLUMNIST: Well, it looks as if we're experiencing something that's rare in our history, chronic unemployment which is rather common in Europe, around 10 percent. And we have not had the rebound like the one that we had in 1981. I think everybody understands in part, that is -- in part, it's because of the nature of the collapse, it was a financial collapse. And it takes years to rebalance the books -- consumers, businesses, and the government actually have to say, we can't spend for a while if we're going to actually become solvent.

But I think the looming problem, the one that McConnell talked about and we heard Alan Simpson describe with this usual color is the overhanging debt and three days after Simpson said that, Obama announced an extra trillion dollars added onto the American debt, as a result of the tax cut deal. I'm hoping that was an exception, because otherwise, we really are headed the way of Ireland and Greece.

BAIER: Juan, as you look at the national debt over the last 40 years and we have a graphic that shows all of the different increments, 2010 is a scary picture when you look at $13.88 trillion. And you heard a lot of people in that intro talking about it.  What's going to be done in the next Congress to deal with it?

JUAN WILLIAMS, FOX NEWS CONTRIBUTOR: Well, that is -- I guess, I was going to say $3 million or $3 trillion, I don't know how big the number you want to be these days. You know, it's astronomical.

But what you heard from Admiral Mullen, what you heard from Larry Summers, are dire predictions of what's to come if we don't deal with it.  And these are serious people talking about both military and economic consequences for failure to cut back. But when we cut back, and this is -- I think this is what we see when we look to Europe, when you start to impose the necessary changes in terms of spending, the people who have been benefiting from these entitlements react violently. There is real anger and the question is whether or not that comes to the United States.

BAIER: A.B., we're looking at some of the protests over in Europe and it has been violent.

A.B. STODDARD, THE HILL: You hear, obviously, the Republicans speaking a lot more about the dire consequences of our accumulated debt and the need to address it and address it soon. You don't hear -- President Obama talks about it, but in much more general terms and he doesn't talk about it with the urgency that the Republicans are talking about it because, he, at the same time, always trying to convince us that the economy is recovering and there are green shoots continuing to manifest. And he's trying to convince the voters that we're out of danger. So, he tends to not be as realistic I think about the debt situation as Republicans.

The challenge to Republicans as they work and the challenge to President Obama as they try to work together on this issue, of course, is the 70 percent of Americans who are not interested in cutting defense or any entitlement spending which makes up, you know, obviously, most of the budget, and most of them don't know that. And so, trying to have a conversation with the voters and educating them about the pain to come hasn't started and it will be incredibly painful.

BAIER: Even with the umbrella, the protection of the deficit and debt commission coming out with its recommendations -- does this administration, Steve, have the stomach to make these tough choices and to push for them going forward?

STEVE HAYES, FOX NEWS CONTRIBUTOR: No. I think if they did, they wouldn't have felt the need to have a debt and deficit commission which is put in place precisely to give the president cover so that he doesn't have to make the kinds of decisions that elected officials are elected to make.  That's the fundamental problem.

On the broader economy, in the short-term, I think, the economy looks like it's the struggling recovery, looks like it's picking up some speed. I think that the fact that the tax cut compromise passed, it won't be terribly stimulative, but it also won't further shackle the economy in a way that having tax -- additional tax hikes would have.

But the longer term problem is the spending. It's all about spending.  It's less about tax cuts. We have a -- we have a problem in Washington with the way money is spent. And it's not just Washington; it's in the states, too.

BAIER: If you were to guess much of that deficit debt commission proposal actually makes its way to the president's desk, Charles, what would you say?

KRAUTHAMMER: There are two issues: entitlements and tax reform. On entitlements, I think you actually can't have a deal on Social Security, on Medicaid and Medicare impossible because the health care plan that Obama had passed which he'll defend freezes it all in place. But I think you can do it along the lines of the recommendation of the committee on Social Security. And what you can't have is a cleaning of the code of the tax code like in 1986. It won't happen overnight.

But I think you could have agreement on that over time. Probably not in the next two years. But it has to be done because it is not only unfair but it's a huge drag on the economy.

BAIER: More on this when we talk about the next Congress coming up. Later: Republicans are running full steam ahead in the effort to repeal health care. But, first, President Obama says the U.S. is on track in Afghanistan. The all-stars talk about the war after the break.



OBAMA: I want to be clear: this continues to be a very difficult endeavor. But I can report that thanks to the extraordinary service of our troops and civilians on the ground, we are on track to achieve our goals.

The door remains open to diplomacy, should Iran choose to walk through it. But the Iranian government must demonstrate a clear and credible commitment and confirm to the world the peaceful intent of its nuclear program.

STEPHEN BOSWORTH, U.S. SPECIAL ENVOY TO NORTH KOREA: This is obviously a disappointing announcement. It is also another in a series of provocative moves by the DTRK. That being said, this is not a crisis.

MARK TONER, STATE DEPARTMENT SPOKESMAN: North Korea's behavior has been very, very bad, provocative, and belligerent. And, again, we're not going to get into -- buying into this cycle of rewarding that kind of behavior.


BAIER: So, now, let's turn to foreign policy and we'll start with the war in Afghanistan. We're back with the panel. Steve, the president this past year surged troops, 30,000, into Afghanistan, put General David Petraeus on the ground to run that operation. How -- we've heard the review -- how do you think its going?  And where does it go from here?

HAYES: Well, we've certainly made progress on the ground. There are parts of Afghanistan that are secure today that were not secure when the president made his announcement December a year ago.

However, the president, when he announced his surge, also announced the July 2011, beginning of a drawdown. If you talk to people on the ground, uniform military, diplomats, whomever, they will tell you that the deadline is -- if not extraordinarily damaging, if not lethal to the project there. And I think that's the big question the administration has to deal with in the coming year. The -- 

BAIER: You don't think they effectively dealt with it yet? I mean, there has been talk about 2014, there's -- 

HAYES: No, they sent mixed signals. Hillary Clinton was talking about 2014; Robert Gates was talking about 2014 and then, Robert Gibbs, from the podium at the White House, as the year came to an end and said, no, we're sticking to 2011. So, they've -- I think sowing the seeds of ambiguity on the question and ambiguity is the one thing that Afghanistan can't have on the ground.

BAIER: A.B., is there a problem for the administration on the left in Congress, supporting this war?

STODDARD: Oh, certainly. I think that 2014 is the date or the window, the approximate date. But they're going to have this sort of pretend moment where in July of next year, they begin to take a few people out and begin what they would like to call a drawdown. It is a -- it is a political date. It's going to come at an interesting time when the Republican nominating process for president is heating up.

President Obama would like he's -- you know, they're escalating into Pakistan now and into Waziristan, and they're trying to make some gains so that they can show some gains by next July. You're going to have pressure from the Republican presidential contest on one side on this issue. At the same time that you'll have pressure from the liberal left, angry over so many issues abandoning him on this war in the middle of next year.

He's boxed himself in with that date. I don't think it's a real hard date. It's a pretend date. But it certainly is a political one and it will increase pressure on him to show some gains by then.

BAIER: Juan, talk about the ambiguity, there are a lot of people who look at the Iran policy for this administration and question where it's going. The president has said numerous times, even recently, that the door is still open for Iran, despite the fact that that country and its leadership continues to thumb its nose at the world.

WILLIAMS: You know the big news here in recent weeks has actually been WikiLeaks. And WikiLeaks reveal that so many of the Arab nations really want the United States to take action against Iraq, that they have no sympathy for what's taking place in terms of the behavior of Ahmadinejad or the religious clerics over there. They see it as a threat to their well-being.

And for so long, it's been capped in terms the world politics as -- oh, my gosh, here's Iran standing against Israel, and somehow Israel might strike Iran and this would set off a powder keg in Middle East and the United States has therefore exercise some leverage and try to get other nations involved with sanction or potential blockades of oil to Iran. Now, all of a sudden, I think it's shifted and it's clear that Iran is a threat to Middle East. It's a threat to world security.

And also that Russia and potentially even China have an interest in joining with the United States here. The question is: Does it happen? And does U.S. policy act in such a way as to take advantage of this moment?

BAIER: Charles?

KRAUTHAMMER: I don't think there's been a shift in the Arab attitude.  Everybody has known that they wanted America to act. I don't maybe see a shift in the Russians and the Chinese who haven't helped us terribly much.

The real shift is in the Obama administration. It wasted two years in this open hand and negotiations which got slapped again and again. And I don't think there's anybody, including the president, still naive enough who believes that there's any way in which the mullahs will be negotiated out of their nuclear program.

What's happened, however, and it's almost miraculous. It's a story that has not been reported enough is that in these two years or at least in the last year, there has been a cyber attack. We don't know exactly who did it. Probably CIA, or Mossad or a conglomerate, which has set back amazingly sophisticated attack on the nuclear facilities in Iran, which has set the program back probably two years. So, in a way, it makes up for the wasted two years of this administration.

And now is a time I think the administration is shifting into harder sanctions and beginning to think about what would happen if there's an Israeli attack.

BAIER: Quickly, on North Korea, a lot of news towards the end of the year. What happens there?

HAYES: A lot of news towards the end of the year. I actually think the Obama administration has handled it pretty well.

They have resisted the temptation which the Bush administration fell victim to for basically the last two years, engaging the North Korean leadership one-on-one, into bilaterally or through the six-party talks in such a way that increases the legitimacy of what is criminal and rouge regime and gives them say that they wouldn't otherwise have. I think they have been smart to do it. We'll see what he does.

BAIER: Our panel's predictions for 2012, plus a look back at the midterms and who will be calling the shots next year in Congress. That's next.


BAIER: The political big story of 2010, of course, was the midterm election last month. Republicans stormed the gate of the Democratic- controlled Congress, capturing majority in the house and falling just a few seats short in Senate.

Republicans picked up 63 seats to finish with 242 seats. In the House, Democrats have 193, giving the GOP a 49-seat advantage. Over in the U.S. Senate, the Democrats held a 58 to 42 edge, doing in if you include the two independents that caucus with them. Republicans picked up five spots to cut the margin to 53-47 for next year. Out here, it's how some of the main players reacted after all the votes were in.


SEN. JOE MANCHIN, D-W.V.: We acknowledge that Washington is broken. When you look -- and I said this on the campaign trail so much -- when you look and you see putting the party first or putting your personal agenda or political agenda second and the country last, it doesn't work.

MARCO RUBIO, U.S. SENATOR-ELECT R-FLA.: We make a great mistake if we believe that tonight, these results are somehow an embrace of the Republican Party. What they are is a second chance -- a second chance for Republicans to be what they said they were going to be not so long ago.

SEN. RUSS FEINGOLD, D-WIS.: My heart is not weary. It's light and free. I've got nothing but affection for those who have sailed with me. I hope and I intend to continue to work with all of you in the future as much as possible.


FEINGOLD: So, it's on to the next fight. It's on to the next battle.  It's on to 2012.


BAIER: OK. We'll see -- winners and losers in 2010 there.

Let's talk about the big Republican gains and what they mean for the next Congress and the president.

Back with the panel. Steve, new blood in Congress. It will shake things up a bit.

HAYES: Certainly. I mean, I think you've seen that 2010 was the year of the Tea Party. And you saw it in the lame duck session; I think when you have Republicans making arguments where they were wary of the response from the Tea Party. And I think they should -- they are right to be wary.

But Marco Rubio ran campaign in Florida that was a national campaign in many respects and he made an argument that was critical at virtually every step of the way of Democrats and Republicans. In doing so, he captured the views of, I think, a lot of independents and Republicans who have grown disaffected with what they saw from the Republican Party from 2006 to 2010.

BAIER: A.B., a big change? A sea change in how Congress operates?

STODDARD: I think that Republicans in the lame duck session were responding a bit to the pressure from the Tea Party. But the Tea Party was largely silent. And it is -- you know, so; you had Democrats held the votes -- 

BAIER: Although they piped up in the omnibus spending bill when it was ruled out in the Senate.

STODDARD: Yes. But I was surprised we didn't hear more. They are a movement, a leaderless movement without an organization or a set agenda.  So, it was an interesting time and a lot of retiring members delivered a lot for President Obama. They won't be here next year -- retiring Republicans as well as Democrats.

I think it will be -- the Tea Party freshmen coming to town who really want to cut government, who want to cut spending, who don't want to vote to raise the debt ceiling. There are some tremendous fights ahead. It will be an incredible challenge for the Republican leaders to try to govern with this force. But, of course, they need them -- they need them now, they need them in 2012.

BAIER: Yes, a challenge for incoming Speaker Boehner to figure out how to deal with all these new members?

WILLIAMS: You know, he's done very well so far. I mean, I don't have a crystal ball. But I will say that if I look at how John Boehner has handled the Tea Party so far, notably in keeping Michele Bachmann out of a leadership post, I would say that he's done very well.

It's not that he has totally isolated Tea Party elements, but he has really said, you know what, I'm in control here, we have responsible leaders in Washington. We will hear your voices, but we are not -- and this was a charge made against Mitch McConnell in the Senate by Harry Reid, the Democratic Senate majority leader -- that the Republicans in the Senate on the omnibus had become a total subsidiary of the Tea Party. You can say that about John Boehner. John Boehner looks to be his own man at this moment.

Just quickly let me add -- I think the big drama that I'll be watching closely is what happens to the Democrats in the House. At the moment, they feel like they have been left behind and that the conversation going forward is a conversation between the White House and Republicans when it comes to the House of Representatives.

BAIER: Charles?

KRAUTHAMMER: Democrats in the House are not relevant. I think what is relevant is the Republicans who are going to be in charge. And I think that the big split between the establishment and the new people, the Tea Party folks, is vastly exaggerated.

The agenda for the Republicans in the House is clear, spending cuts.  Every way, every week, propose it. And also, try to repeal, oppose, take away the funding that is behind Obamacare. Those are the major issues, and on that there's unanimity.

I think if Boehner speaks to a fairly narrow agenda, he wins. And I don't think this great split is even going to happen in the Senate agenda either. In the Senate, there are 23, I think, Democrats who are up for reelection, including Webb of Virginia. Joe Manchin, whom we just saw, he only got a two-year term in West Virginia.

BAIER: Claire McCaskill in Missouri.

KRAUTHAMMER: Right. Who are really going to look to the re-election; they are not going to be the lock step Democrat or liberals. So, I think the Republicans actually have a kind of working majority in the Senate and all they have to do is to agree on an agenda. I don't see this great split and the civil war inside the party.

BAIER: Steve?

HAYES: If there are not those splits, it's because the Tea Party has won. The Republican Party as party did not focus on spending in 2006, 2007, 2008 and beyond. If they focus on spending now after these 2010 elections, it's because the Tea Party voice was loud and it was heard and it was triumphant.

KRAUTHAMMER: And it's because their party knows how to read an election and it was a clear message.

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