This is a rush transcript from "The Journal Editorial Report," January 2, 2010. This copy may not be in its final form and may be updated.

PAUL GIGOT, FOX HOST: This week on the "Journal Editorial Report," a new year and a new set of challenges for the country and for President Obama. Amid high unemployment, will the economic recovery continue?

And with Obama's declining approval ratings, will the GOP make big gains in the midterm elections?

And with trouble spots all across the globe, will the president's policy of engagement finally show results?

All that, and our panel's predictions for 2010.

Welcome to the "Journal Editorial Report," I'm Paul Gigot.

Well, with the New Year comes a new set of challenges for President Obama and his party, not the least of which are the 2010 midterm elections. With the president's job approval below 50 percent and a potential health care backlash brewing, can Republicans make some big electoral gains this November.

Joining the panel this week, Wall Street Journal columnist and deputy editor, Dan Henninger; editorial board members, Dorothy Rabinowitz and Jason Riley; columnist Mary Anastasia O'Grady; and in Washington, senior economics writer Steve Moore.

Steve, starting with you, the president's approval rating has fallen faster and farther than any recent modern president. How much trouble are the Democrats in?

STEVE MOORE, SENIOR ECONOMICS WRITER: They're certainly lucky that the midterm elections aren't tomorrow. Right now, they're looking in really deep, deep water. A lot can change in the last year. But I do think there are amazing parallels between the situation the Democrats are in today versus they were — remember, Paul, back in 1993, after Bill Clinton's first year in office and anybody with a D next to their name lost elections in that following year. So I think that Democrats are facing a big problem. The one thing that could bail them out would be an economic recovery.

GIGOT: Well, but there's one difference between now and 1994, Jason, and that is that it looks like they're going to pass health care this time around. And they failed in 1994. And Rahm Emanuel's argument, the White House chief of staff's argument, if you pass this, that won't happen to you. If you don't pass it, you'll lose just like then.

JASON RILEY, EDITORIAL BOARD MEMBER: Well, it's a double-edged sword of having the majority in both the White House — having the White House and a majority of the Congress, is that you get to push through legislation on a partisan basis, but then you own it. Your party owns it. And so this passing health care could be what does them in, in the midterm elections.

GIGOT: Now, passing health care could do that?



RILEY: The backlash.

GIGOT: Backlash, but it's a great triumph. Why would there be a backlash? What backlash are you talking about?


RILEY: In midterm elections, the president's party traditionally loses seats in Congress.

GIGOT: Sure.

RILEY: Already, you have some skittish Democrats deciding not to run.

GIGOT: But what is it about health care in particular that is going to be troubling for them?

RILEY: Well, you have taxes going up to pay for health care now, benefits not kicking in until years down the road.

GIGOT: I see. So nobody will see their benefits. Meanwhile, the regulations and the taxes hit right away.

And, Mary, maybe, maybe insurance prices go up?

MARY ANASTASIA O'GRADY, COLUMNIST: You know, all of those things may happen, Paul, but I think the Republicans would make a big mistake to be too over confident this year. One of their problems is going to be the sort of tea party-thing brewing over in the corner, which is the possibility that people will — you know, they'll be independent candidates. I don't think the Republicans have shown a cohesive, unified, clear message. And I think that people will be asking themselves, in 2010, am I better off than I was in 2008? A lot of people feel like they're not, so they'll be dissatisfied, but I don't think that necessarily means a big sweep for the Republicans.

DAN HENNIGER, COLUMNIST & DEPUTY EDITOR: Can I pick up on Mary's point? I know the Democratic reelection leadership has said explicitly they do not expect the Republicans to pose much of a substantive challenge. They haven't said much of Obama's first year. You can't beat something with nothing on policy. Now, that's...

GIGOT: But, Dan, you can. The Democrats beat something with nothing in 2006. They offered nothing except we're not George Bush and we don't like Iraq.

HENNINGER: Well, I don't think Republicans — some Republicans don't want to run that way. There's something very interesting going on in the Senate, which is that Senator Jim DeMint, who is the head of the Senate Steering Committee is posing his own...

GIGOT: South Carolina.

HENNINGER: ... his own candidate in opposition to Senator John Cornyn's traditional candidates. For instance, in California, he's come up with a candidate, a conservative businessman named Chuck DeVore, who DeMint is running against Republican Carly Fiorina, who is Cornyn's candidate. This is happening in three or four other states. In Florida, you've got Marco Rubio, the conservative, being pushed against Cornyn's candidate, Charlie Crist.

The Democrats will say this means that the Republican Party is once again tearing each other up. I think it's good competition, if at the end of the day, the winners of those primaries are supported by the Republican voters.

RILEY: And we've had some interesting trends starting in late '09. You have the two governorships in Virginia and New Jersey going Republican.

GIGOT: Right.

RILEY: And you had some Democrats in vulnerable districts announcing they're not going to run. You had a party switch, a conservative Democrat switching to the Republican Party. So it will be interesting to see if the Republican can continue this momentum going forward in the midterms.

MOORE: You know, Paul...

GIGOT: I think — go ahead, Steve.

MOORE: Could I raise a point about so what do Democrats do now, assuming they have got their health care bill pretty much passed? Now the Democrats that I talked to say we have to pivot back to the middle, get back to the center where the American electorate is. And then you ask the question, how do they do that, on what issues are they going to do that. Clearly, the president is going to sound, next year, like a big Ronald Reagan fiscal conservative, a deficit hawk. I don't think he can pull that off after the $2 trillion of debt this year.

And the other issue to look out for in 2010, in my opinion, Paul, the national sales tax, or VAT. Democrats now have to pay for the spending they've done.

GIGOT: I agree with you that taxes are going to be a big issue. And now they have to pay for it. But I think you're going to see that tax issue, sales tax be put off after 2010, 2011.

MOORE: You may be right.

GIGOT: So Republicans are going to have to bring it up.

All right, that's it for this segment.

When we come back, all eyes are on the economy. As the New Year begins, the worst may be behind us, but what kind of recovery lies ahead? And will you be paying more taxes in 2010?


GIGOT: With the New Year come new hopes for an economic turn around. And stocks at least seem to be headed in the right direction. The Dow Jones Industrial Average ended the year back above the 10,000 mark after a disastrous winter. But the unemployment rate is still hovering around 10 percent, leading many to wonder if we're in for a jobless recovery.

Mary, I think we're in a recovery. And I think it seems to be gaining speed. But how strong will it stay in 2010?

O'GRADY: Well, I think you have to remember how far it fell because that's going to tell you a little about how much it's coming back.

GIGOT: And that was really far.

O'GRADY: It was a big decline. And now you're seeing first-time jobless claims are going down. You're seeing corporate earnings improving. You're seeing inventory push, temporary health jobs, incomes are responding to more hours worked. So, you know, you're seeing things start to be more positive. Also, commercial real estate that a lot of people are worried about is a lagging indicator. And, you know, you have — not to use too much technical jargon — but you have a steep yield curve, which generally predicts a recovery.

GIGOT: And that means banks can borrow cheaply money near zero interest rates, but can lend longer at 3 or 4 percent interest rates.

O'GRADY: Right, and that's one of the things the fed is doing to help the banks repair their balance sheets. Those are all positives.

One thing I'll say, when the economy starts to look healthy, that's going to be the time when the stock market starts to slow down a little bit, because that's when people are going to be expecting the fed to raise rates.

GIGOT: The Federal Reserve will raise interest rates. I think it will happen sooner than the consensus expects.

Dorothy, unless people feel like this recovery is real, and that really means unless they see their neighbors getting hired, themselves getting raises, they're not going to feel like they're in a recovery.

DOROTHY RABINOWITZ, EDITORIAL BOARD MEMBER: That's right, they don't now. And they don't now. The entire fantasy push about this great, extraordinary emergency, about the need to reform health care, of course, pushed aside the central concern in people's lives. They're living on part-time jobs. Huge. The new jobs are all part-time jobs, and dimmer and dimmer is the prospect of long-term employment.

Now, this is the real issue. And I have to say that normal American citizens, in the aftermath of this health care passage bill, do not walk around saying, my life is better because the Democrats have won a legislative immense historic passage.


GIGOT: You're really disappointing Rahm Emanuel with that, Dorothy.


RILEY: I also think that housing will continue to be a drag on this economy this year. You have one in four homeowners underwater, meaning they owe more than their homes are worth. You have more than seven million people...

GIGOT: Jason, we've been pouring hundreds of billion dollars worth of mitigation. Where has it gone?

RILEY: More than seven million households are either behind in their payments or in foreclosure. This is going to continue to put downward pressure on housing prices in 2010.

HENNINGER: Here is one big problem. There have been three unemployment peaks in the post-war period, during the Kennedy administration, in 1964; Nixon, 1975; and Reagan, who was at 10 percent unemployment in 1983. What they did in all three instances was essentially reduce the tax burden, right? Unfortunately, Obama is looking back to FDR, which is a public-sector led recovery. That's the only time we had 10 percent unemployment for ten straight years. That, of course, was the Depression.

GIGOT: 1930s.

HENNINGER: That's right. Now I'm looking at unemployment coming down, at best, to 8.5 percent, if it stayed at 10 or even rose. Because they're raising the tax burden, I'm not going to be shocked.

GIGOT: Steve, Christina Romer, the White House economic advisor, said, if you pass the stimulus, the jobless rate won't be above 8 percent. Now it's 10. And now she says, probably it will not go down to 9.5 percent, much below that by next November. Are you more optimistic than that?

MOORE: You know, what's keeping the folks at the White House up at night is that unemployment number and the fact that we have 15 million unemployed. And I think that Dorothy is right, no matter how many times the White House talks about how wonderful things are in this expansion, if we don't see a resumption of jobs, the Democrats are in trouble.

And the president keeps saying that he's averted us from a 1930s style depression. And that might be the case. But what I'm seeing — and I agree with Dan. I'm seeing the policies of the 1970s, which was the second-worst decade of the last hundred years, when you had high inflation, high unemployment, stagflation. Nothing we're doing in Washington right now is promoting growth. And certainly when you raise tax rates on businesses that don't get employers to hire workers.

GIGOT: What could be big negative surprises in 2010 economically? What are you worried about?

O'GRADY: What worries me is that we're creating a bubble in the stock market and that people are putting money in the stock market because of the very low interest rates. I mean you're getting like .0 percent on your savings.

GIGOT: On your savings account.

O'GRADY: Yes. So this is putting a lot people into the market, but I think it's an artificial move in many ways.

GIGOT: A correction coming then, you say. Could this be the peak?

O'GRADY: I think it could happen — no, I don't think this is the peak. But I think in this year, in 2010, that the stock market will, you know — the bubble will grow bigger and then, pop.


All right, when we come back, from Obama's Afghan surge to Iran's troubled regime, a look at stories sure to make headlines across the globe in the year ahead.


GIGOT: From the left's opposition to the Afghan surge to Iran's continued nuclear defiance, a world of troubles awaits the administration as the New Year begins.

And, Jason, particularly Iran, where the democratic protests are continuing below the surface, but clearly very powerful, at the same time that Iran continues to defy world opinion and push ahead with its nuclear program. Are we looking this year at a showdown between President Obama and Iran?

RILEY: We could be. I think the more interesting showdown though might be between Iran and Israel, who I think has less patience than Obama might have here. So that will be interesting. And also, as you mentioned, those protests...

GIGOT: You mean a possible military attack?

RILEY: Yes, yes, exactly.

GIGOT: Israel?

RILEY: I would not be surprised if Israel acts before America does, militarily.

GIGOT: But Israel does not want to do that if it doesn't have to, we know that, because the consequences would be severe, not just in the return fire on Israel, but also the opprobrium of much of Europe and also in the world community. So President Obama wants to forestall that, but is he going to act in time? Can he rally the world opinion to forestall that?

RILEY: No, I don't believe he can.

GIGOT: You don't believe he can?

RILEY: I do believe he thinks he can.


GIGOT: Because he thinks he can get U.N. sanctions together. Well, China is already saying, no dice, we don't want to do it.

HENNINGER: Well, you know, this raises my biggest concern about this coming year, Paul, which is this is going to be the beginning of the surge in Afghanistan, big commitment. It's complicated by the behavior of the Pakistanis as well. This is a really big thing for Barack Obama.

I think my question is, can he handle two big crises and something like Iraq would be — or Iran...

GIGOT: Iran.

HENNINGER: Iran — would be that. And it's not clear to me that this White House has the will to take on two or three big things. And, you know, the world being what it is, there is inevitably going to be something else other than Afghanistan to hit this White House.

GIGOT: On that point, Dorothy, it sounds to me as if everything you hear from the administration, they want to have his Afghanistan be a nice discrete political problem that the military handles, that Robert Gates, the defense secretary, handles. The president doesn't mess his own hands up while he's trying to do great domestic reforms. Can he pull that off this year?

RABINOWITZ: I don't think he can. And I don't know what he will do when he decides, when he sees that this is a muddle that's going to take much longer than possible.

GIGOT: And his own political capital to succeed?

RABINOWITZ: Indeed, and this is true. But that back to Iran as well, there's a real possibility that the government control in Iran, there's a real possibility is that not just a quiet revolution and I...

GIGOT: That would be fabulous.

RABINOWITZ: Yes, it would. But I'm not sure that the administration is prepared for this. And this is one of the things that, to think about.

GIGOT: What do you mean prepared for it? You mean they're not pushing hard enough for it.

RABINOWITZ: They're not pushing hard enough and not pushing to see — what will they do in the event that this — that this event takes place, which is very promising. They're increasing rebellions in Iran now.

GIGOT: And not doing much to promote it because...

RABINOWITZ: They're not doing anything to promote it.

GIGOT: ... they're split. They probably would rejoice if the regime did fall.

RABINOWITZ: Absolutely.

GIGOT: On the other hand, they don't — they want to engage this regime at the same time, which means legitimizing in the eyes of world opinions.

RABINOWITZ: They keep engaging and engaging, and they keep being pushed back and refused.


Changing subjects to Guantanamo. The president's promised a January 22nd deadline for closing it.

I don't think he's going to make it, Mary?

O'GRADY: No, I don't think he's going to make it. He's really opened a big can of worms with this, not only because of his promises to close Gitmo, but also because of his proposals to move it to southern Illinois, which will be not only, you know, uncomfortable for the people of Illinois, but also, extremely expensive. And there's some question now about how they can actually secure that location.

GIGOT: I think they can secure it if they have enough money. I don't know that they're going to get the money from Congress to do this.

O'GRADY: That's right.

GIGOT: Congress, these Democrats, don't want to take a vote saying, yes, we voted to bring terrorists from Gitmo, off shore, into Illinois. How do you feel about that, American voters? They don't want to make that vote.

HENNINGER: It's like the commitment that Obama made in Copenhagen that we're going to spend hundreds of millions of dollars to help the developing world reduce their carbon. The Democrats want to spend the money in the old U.S. of A. They're spending money there. And stuff like this is going to be marginal for congressional Democrats.

RILEY: And it's all a piece with the decision to try the 9/11 terrorists in New York. These are political decisions that Obama's making to throw bones to his left wing.

GIGOT: And a big wild card this year, the special counsel that Attorney General Eric Holder appoint to look into whether the CIA and Bush administration officials should be indicted for their anti-terror policies. If he indicts — recommending indicting some of those, you're going to see a firestorm.

RABINOWITZ: There's a good chance he'll make that recommendation.

GIGOT: All right, Dorothy.

We have to take one more break. And when we come back, the big events that will shape 2010 and beyond. Our panel's predictions are next.


GIGOT: Time now for our new year's predictions. And it's on tape, so we're going to hold you to them, all right? Play them next year.

All right, Dan?

HENNINGER: Well, Paul, my prediction flows out of all the anxiety we've been pumping out on this program tonight.


I'm predicting there is the possibility of an Independent or third party movement emerging in the United States. I know they're usually hopeless, but look what's been going on, not just in Congress, but the legislatures in California, New York, New Jersey, are in a state of crisis. And I think there is a crisis of governance emerging in the United States, and that the American people are upset not just at the Democrats, but at the Republicans. So if some billionaire steps forward to run, I'm not going to be shocked.

GIGOT: Dorothy?

RABINOWITZ: Well, as we were speaking earlier, there is the plan afoot to move 112 prisoners from Guantanamo Bay, the closing of which is the signature moral issue of the Obama administration, to a little rural place in Illinois, Chicago, Thompsonville. My prediction is, if this will happen, there will be an instant of riotous outbreaks from the left and anti-war demonstrators in the streets. The prisoners themselves will be complaining bitterly about...

GIGOT: In the streets of Thompsonville?

RABINOWITZ: In the streets of Thompsonville, about their diet, lack of facilities for religious observance. And the ACLU will be taking their cases. And in the midst of this turmoil, we will see President Obama and Eric Holder declaring this is a victory for American values.


GIGOT: We can't wait for that.


RILEY: My prediction is that President Obama will get another Supreme Court pick this year when Justice Ginsburg retires. She will be replaced by Justice Diane Wood, Judge Diane Wood, of the 7th Circuit Court of Appeals. And Justice Wood will be an improvement.

GIGOT: An election year Supreme Court fight, wow, OK.


O'GRADY: My prediction is that the chairman of the Senate banking committee, Senator Chris Dodd, from Connecticut, will not run for reelection in November. Mr. Dodd, who's been in Congress for 39 years, is running into terrible political problems. He's now polling around 40 percent approval in Connecticut. And put up against the three most possible Republican candidates, he's not showing that he could beat any one of them. So I think that his friends in the Senate will say, listen, we need this seat, and I think you should spend more time with your family.

GIGOT: We have an offer you can't refuse.


All right, Steve?

MOORE: The Cubs are going to the World Series in 2010. I know I've made that prediction the last five years, but this time I feel confident.

GIGOT: I think the last 40 years, Steve.


MOORE: Unfortunately, they're going to lose to the Yankees.

Second, I think we're going to see movement towards a college football playoff system.

And most importantly, Tiger Woods will make a triumphant return and he will win the U.S. Open at Pebble Beach, and America will have forgiven him.

GIGOT: Yes, Steve, this is your — sounds like about a 50-year wish list and predictions.


All right.

My prediction is that the U.S. Supreme Court will overturn at least most of the conviction of Conrad Black, the imprisoned former newspaper publisher. And in doing so, they'll issue a landmark ruling on the Honest Services Statute, which has been used by prosecutors — overused by prosecutors to throw in business people, accuse them of white collar crimes that may or may not be crimes. That would be a landmark event for justice if it happens.

All right, that's it for this week's edition of the "Journal Editorial Report." Thanks to my panel and to all of you for watching.

I'm Paul Gigot. Happy New Year to all of you. We hope to see you right here next week.

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