TERRY MORAN, ABC ANCHOR: Good morning. It's a brand-new ballgame here in Washington, as the president heads to Capitol Hill this week to deliver the State of the Union address. He's dealing now with a Congress that's been dramatically altered by the stunning victory in Massachusetts. The Republican, Scott Brown, to fill the Senate seat head for 46 years by Ted Kennedy.

Health care reform is now in deep trouble, as is much of the president's agenda and the Democrats' political fortunes this election year.

And this morning, a reminder that this all takes place in a still-dangerous world. There's a new audiotape believed to be from Osama bin Laden, in which the Al Qaida leader specifically mentions the failed Christmas Day terror attack onboard Northwest Flight 253.

So joining us this morning to talk about all of this, David Axelrod, the president's top political adviser.

Thanks for being with us this morning.

DAVID AXELROD, WHITE HOUSE SENIOR ADVISER: Good to be with you, Terry.

MORAN: Well, that was the week that was, wasn't it? After the Massachusetts upset, the Republicans are stoked -- yes, why are we going to stop?

(BREAK)

TERRY MORAN, ABC ANCHOR: Good morning. It's a brand-new ballgame here in Washington, as the president heads to Capitol Hill this Wednesday to deliver the State of the Union address. He's dealing now with a Congress that's been dramatically altered by the stunning victory in Massachusetts, a Republican, Scott Brown, to fill the Senate seat head for 46 years by Ted Kennedy.

Health care reform is now in deep trouble, as is much of the president's agenda and the Democrats' political fortunes this election year.

And this morning, a reminder that this all takes place in a still-dangerous world. A new audiotape believed to be from Osama bin Laden, in which the Al Qaida leader specifically mentions the failed Christmas Day terror attack onboard Northwest Flight 253.

So joining us this morning to talk about all of this, David Axelrod, the president's top political adviser.

David, thanks for being with us.

DAVID AXELROD, WHITE HOUSE SENIOR ADVISER: Good morning, Terry.

MORAN: That was the week that was. The upset in Massachusetts has Republicans stoked, Democrats shocked and in near panic mode. And polls in general are showing that the public is rapidly losing confidence in the president's policies and his leadership. Just by way of illustration, Time and Newsweek this week, their covers, Newsweek, "The Inspiration Gap." It says, "How the trailblazer of 2008 became the stymied president of 2010." Time, "Now What? Obama Starts Over."

So is it that the president failed to connect with ordinary Americans? Or is this all a sign that the country's rejecting his approach in his first year?

AXELROD: Well, first of all, let's understand that we are governing in the worst economy since the Great Depression. When the president walked in the door, he was handed the worst economic downturn since the Great Depression, a financial crisis that held out the prospect of the collapse of the financial system and a fiscal crisis. President Clinton left a $237 billion surplus; President Obama received a $1.3 trillion deficit.

And these are the problems that he was asked to deal with when he took office, and he readily accepted that. But I said to him a year ago, "Mr. President, your numbers are going to be considerably worse a year from now than they are today, because you can't govern in an economy like this without great disaffection," and that's -- and that's what's happened.

People are working harder. If they have a job, they're working harder for less. They're falling behind. That's been true for a decade. They look -- and they look at a wave of irresponsibility from Wall Street to Washington that led to that. And the -- and those were the frustrations that got the president elected in the first place, and they were reflected again on Tuesday.

MORAN: But it is not just the situation, is it, David? I wonder if it's also -- and this is what I'm asking -- the policies and the approach of the president. If you had the last few months leading up to this political moment to do over, what would you do over? What have you learned?

AXELROD: Well, look, first of all, some of those policies were ones that no one wanted to undertake but were absolutely essential. Nobody wanted to have to throw a lifeline to the financial sector. Nobody wanted to shore up the auto industry. Nobody wanted a $787 billion emergency Recovery Act as our first initiative as president.

But the -- but our responsibility was to make sure that the economy didn't tip into a second Great Depression, which was a real possibility. But those were not popular things to do.

I have no regrets about that. I think history will look back and say the president of the United States met his responsibility.

MORAN: You wouldn't do anything differently?

AXELROD: In terms of health care, one of the -- one of the -- one of the great burdens, one of the great burdens on middle-class families across the country, whether they have insurance or not, on small businesses, on government generally is the cost of health care. And what the president tried -- has tried to do and it continues to try to do is deal with that, so people don't have to -- don't have to face bankruptcy if they get sick, so that if you have a pre-existing condition, you can get covered, if you're a small business, you can afford health care. This is all part of bringing economic security to the American people

But process, eight months of debate, were less than satisfying. And that was clear. And if you look at the polls out of Massachusetts, people reacted as much to the process as anything else. Were there things we could have done there? Perhaps. We have to think that through.

But this president's never going to stop fighting to create jobs, to raise incomes, and to push back on the special interests' dominance in Washington and this withering partisanship that keeps us from solving problems.

MORAN: So no do-overs. But now David Plouffe is back, the president's campaign manager in 2008, the architect going over to the Democratic National Committee to help oversee House, Senate and gubernatorial races. It seems that this whole political moment caught you off-guard a little bit, at least in Massachusetts. Is the return of David Plouffe to a position of prominence here essentially an admission that the White House political operation failed the president and the party?

AXELROD: Well, look, first of all, I think that there was -- the entire political community was caught a little bit unawares on that one, but -- so we have a -- we have a very strong political operation. What it's a reflection of is that David was working on his book for the last year. He's done with that now. He's enormously talented, as everyone knows, and he brings value added to our operation as we look forward, in terms of strategy and tactics, and he'll be consulting with us on that, and we'll be stronger for it.

I think that the reaction to it has been overblown, but I know that Washington loves a great -- Washington loves the shake-up story, Washington loves the "When are we going to throw a body out?" story. That's not how we roll.

MORAN: Fair enough. Let's get to specifics now, the impact of all this on the president's agenda. Health care, the day after Scott Brown's victory in Massachusetts, the president gave a remarkable interview to George Stephanopoulos in which he seemed to dramatically scale back his ambitions for health care reform. Here's what he had to say.

(BEGIN VIDEO CLIP)

BARACK OBAMA, PRESIDENT OF THE UNITED STATES: I would advise that we try to move quickly to coalesce around those elements of the package that people agree on, that we know that we need insurance reform, that health insurance companies are taking advantage of people.

(END VIDEO CLIP)

MORAN: So according to the president, then, David, health care reform as we know it, that huge bill that Congress labored on for months, is dead, right?

AXELROD: No, that's not true at all, Terry. I think what he's saying is let's take a look at this. There are so many elements of this -- tax breaks for small business, extending the life of Medicare, more assistance for seniors with their prescription drugs, a cap on out-of-pocket expenses, help for people with pre-existing conditions -- that are too important to walk away from. What he's saying is, let's get back to it.

Now, I will -- I must tell you that, if you look at the polling in the Washington Post yesterday on the Massachusetts race, it's very clear, people don't want us to walk away from health care. They want us to address their concerns with the program, and they want Brown to come and work with us and not be obstructionist. That was very clear in the polling.

And I suggest that the Republican Party look at that poll, as well. Their policies were viewed more dimly than -- than Democratic policies. And people were crying out for cooperation instead of obstructionism.

So we're looking forward to working together to pass this on behalf of the American people, who are going to feel greater and greater burden from this -- these health care costs if we don't step up and deal with it.

MORAN: You're looking forward to pass this. Now, this -- the president sounded like he was reducing the scale, let's coalesce around some core elements, insurance reform, cost containment. And -- and are you talking -- what do you think of the idea that is being...

AXELROD: Well, I think what the president...

MORAN: I do have a question here. What do you think of the idea that Speaker Pelosi and Majority Leader Reid are cooking up that you could essentially strip the Senate bill of a few provisions on a parliamentary maneuver requiring only 51 votes and then getting the bill through the House? Do you, A, think that's possible? And, B, getting the original $800 billion bill that the voters of Massachusetts soundly rejected, do you think that's a good idea?

AXELROD: Terry, again, I think you're misreading the Massachusetts poll. I think people want action on health care. In fact, the bill that the House and the Senate passed, which are largely the same in the main, were patterned in many ways on the Massachusetts health care plan, which is a unique plan in that state. And 68 percent of the people who voted last week said they liked the Massachusetts plan. Senator Brown said he wouldn't change it.

So I think you're misreading the results out of Massachusetts. The president will not walk away from the American people, will not hand them over to the tender mercies of health insurance companies who -- who take advantage. He will not walk away from people with pre-existing conditions. He will not walk away from senior citizens in Medicare. He's just not going to do that.

And let me tell you, as a political matter, the foolish thing to do would be for anybody else who supported this to walk away from it, because what's happened is, this thing's been defined by insurance company -- insurance industry propaganda, the propaganda of the opponents, and an admittedly messy process leading up to it.

But the underlying elements of it are popular and important. And people will never know what's in that bill until we pass it, the president signs it, and they have a whole range of new protections they never had before.

MORAN: All right. And the president and you sounding a lot more populist these days. The president on Friday in Ohio using the word "fight," fight for Americans more than 20 times. And the State of the Union address coming up this Wednesday. Is this really what we're going to see on Wednesday, what some are calling Barack Obama 2.0, the populist crusader?

AXELROD: You know something, Terry? I -- I would be happy to sit down or you or anyone -- I traveled with the president across this country for two years. I heard all of his speeches. And the -- what he -- what he said in Ohio on Friday is completely consistent with what he's been saying for two years. We have to make this economy work for all Americans and not just for a fortunate few. We've got to make sure that work pays, that people who work hard and meet their responsibilities get ahead, and we have to insist on responsibility from our institutions, whether it's on Wall Street or in Washington.

And we have to push back on special interests. We have to push back on partisanship and meet the problems that are important in people's lives. And that has been what he's been saying, really, since the -- 2004, when he spoke at the national convention.

I think that, you know, in Washington, people look for signs, cues for their script to say, oh, you know, here's Obama 2.0. This is Obama -- this is the Obama who ran for president.

And the themes that he talked about in that campaign were very much echoed by Senator Brown in his campaign, which tells you that the hunger for that kind of leadership is still very strong.

MORAN: All right. So we'll hear from the president on Wednesday night, the bully pulpit at the State of the Union. David Axelrod, thanks very much for joining us.

AXELROD: Terry, thanks for having me. Appreciate it.

MORE

MORAN: And to talk about the political road ahead, I'm joined now by Senator Robert Menendez, who's -- of New Jersey, who's the head of the Democratic Senatorial Campaign Committee, and from Greenville, South Carolina, Republican Senator Jim DeMint, one of the conservative leaders in the Senate.

And, Senator Menendez, let me begin with you, and let's start with Massachusetts. Your job is to get Democrats elected, and I guess that didn't go so well last week. Are -- are you willing to accept -- especially in light of the reports from Massachusetts that there was unhappiness -- with how nimble the Democrats were, that there wasn't enough support gotten quickly enough to the Coakley campaign? Do you think you bear some of the responsibility for what went down up there?

SEN. ROBERT MENENDEZ (D), NEW JERSEY: Well, look, there are lessons to be learned from Massachusetts, and we certainly did everything that we could in resources, in personnel to help Martha Coakley win that election.

I think the biggest takeaway from Massachusetts, however, is that there is enormous economic angst in the country, there are people who have lost their jobs, they have a family member who's lost their jobs, their house is worth less than what their mortgage is, and that was, I believe, a driving force of the voters in that state, and it exists across the country.

And that's why I believe that the president in the State of the Union speech will address those concerns head on, and Democrats in the Congress, hopefully joined by Republicans, as well, will address it as we move legislatively to help small businesses have the resources they need to continue to exist and to grow and to hire people to be able to create opportunities and infrastructure work across the country, to help states and localities be able to retain critical personnel that is necessary and keep those people employed, but deliver services.

So I think that these are the elements of what you'll see a very focused jobs package, on an economic package, and also making sure that middle-class families have tax relief, as well. Those are all the elements of what we'll go to work on and a lot of what I clearly heard from Massachusetts.

MORAN: Yes, the Massachusetts message heard loud and clear. And, Senator DeMint, I want to ask you about something you said last summer about the health care reform fight as it was beginning. Listen to this.

(BEGIN VIDEO CLIP)

SEN. JIM DEMINT (R), SOUTH CAROLINA: If we're able to stop Obama on this, it will be his Waterloo. It will break him.

(END VIDEO CLIP)

MORAN: So did you break him? And is that really how Americans want you to behave here in Washington, break the president?

DEMINT: Terry, good morning.

And, Bob, good morning to you.

MENENDEZ: Good morning, Jim.

DEMINT: I did not want this -- this to be the president's Waterloo, but pushing through a massive government takeover of our health care system was certainly not a good idea. And what happened in Massachusetts is just part of an American awakening. We saw it in Virginia and New Jersey. We see it all over the country in tea parties and town halls. People are alarmed and angry about the spending, the debt, the government takeovers.

And I've been amazed to hear Mr. Axelrod and what the president said this week. After three years of controlling both houses of Congress, they're still trying to blame someone else.

The -- Massachusetts was a rejection of the president's massive policies of -- of spending and debt. And we -- if we're going to work together, we've got to do it in a step-by-step, reasonable approach.

We've been as Republicans pushing health care reform for years. Unfortunately, the president, when he was in the Senate, he voted against interstate competition, he voted against fair tax treatment for people who don't get their health insurance at work, he voted against changing the abusive lawsuit system that adds so much to the cost.

So it's hard for us to take seriously that the president really wants health care reform. He seems to want more of a Franklin Roosevelt massive government program. I think the American people want us to work together to -- to just step by step improve the best system in the world.

MORAN: Well, there's no question that you both agree on the amount of anger that's in the electorate, but, you know, Senator DeMint, the polls show that while the voters in Massachusetts did reject the Democratic approach, they have not embraced what the Republicans are talking about. They can't really figure it out much.

There was one liberal wag (ph) who said Obama campaigned on hope, Scott Brown campaigned on nope. There are a lot of people out there who see the Republican Party as -- as the party of no right now.

DEMINT: Well, clearly on health care reform, if you look at the record, we -- we have been pushing reform for years, but the rejection of the Democrat agenda in Massachusetts was not necessarily acceptance of Republicans. We've got to earn the right -- we've got to re-earn the trust of the American people.

So it's incumbent on us over the next several months to show the American people how we can not only improve health care, but focus on the real priority of jobs.

The president's stimulus has been a massive failure. When the Democrats came into power three years ago, unemployment was half what it is today. We've seen in the past, from John Kennedy all the way to the present, that broad-based tax cuts for small businesses, as well as individuals, is the best way to get the economy turning again.

This massive government spending program is not working, and we've got to recognize that quickly. Otherwise, people are going to continue to lose their jobs.

MENENDEZ: Well, Terry, you know, my dear friend, Jim DeMint, did want to break Barack Obama. And the Republican whole political strategy is for this president and this Congress to fail. The sad thing about that, it's not about Barack Obama failing or Democrats in Congress failing. It's about the country failing at one of the most critical challenges the country has had.

And, you know, I love my dear friend talking about, you know, fiscal responsibility, but when George Bush came to office, he had a $236 billion surplus. Barack Obama was handed a $1.3 trillion deficit. He was handed an economy that was almost on the verge of depression. He was handed financial institutions that went wild during the eight years that Republicans controlled and ultimately were on the verge of collapse and would have created a major calamity for people across this country.

So the bottom line is -- and since the president came, after having inherited all of those realties and trying to meet those challenges head on and having to spend so that we could stop the economy from going into depression, be able to start moving the economy in the right direction, meet the challenges of the abyss that we were almost in, all our Republican colleagues have said is no.

They have used the filibuster, a procedure in the Senate, to stop progress 101 times, unprecedented in the history of the United States Senate. So I hope that they understand that they have as much responsibility to help us govern and move forward. "No" doesn't create a job. "No" doesn't create health care insurance for anyone or, for that fact, stop the abuses of the insurance company. "No" doesn't help a senior citizen with their prescription drug coverage. It's time to begin to say "yes" to move the country forward.

MORAN: OK, let me just follow up. You gave a very eloquent description of the situation when Barack Obama became president and the anxiety in the country, but what did he choose to do? He spent eight months on health care, which people ended up not understanding and certainly not approving.

MENENDEZ: Well, no...

(CROSSTALK)

MORAN: Was that a mistake? Let me just ask you, yes or no, was it a mistake for the president to do that?

MENENDEZ: First of all, let's look at what happened last year. People forget. It's amazing how quickly -- just as people forget what Barack Obama inherited and the enormous economic consequences and spending on the Republicans, two wars totally unpaid for, credit card mentality, putting it on our kids' future, a Medicare Part D program totally unpaid for, tax cuts for the wealthy, totally unpaid for.

But, you know, the bottom line is, he passed a stimulus package to stop the nation from going into a deep depression. He succeeded at that. An omnibus bill to create new, high-energy jobs that we are moving towards...

(CROSSTALK)

MORAN: All right. So health care was the right thing to do, in your judgment?

MENENDEZ: No, and health care is an economic issue, as well.

MORAN: All right. All right. Fair enough.

MENENDEZ: If you're a family without health insurance and you get sick, you can be in bankruptcy. If you're a family with health insurance and you see the skyrocketing costs that Republicans have permitted over their years of double-digit premium increases, you can't afford it. And if you're a senior who is trying to be able to do what your prescription drug coverage and have that gap that they created, then you need to fill it. So this is what we're trying to meet.

MORAN: OK. Senator DeMint, that was quite an indictment. I've got to tell you, I don't hear much bipartisanship here, but fire away.

DEMINT: Well, we're not going to have bipartisanship as long as the Democrats are moving towards just more spending and debt. Listen, when the president came into office, the Democrats had controlled Congress for two years. Presidents don't write policy and spend money. The Congress does.

The Democrat Congress had taken us in the wrong direction. And the first year of the Obama's presidency, he created more debt than George Bush did in eight years.

So we've got to get rid of this inheritance idea. The president and the Democrats need to take some responsibility.

The Republicans want to work with the Democrats on improving health care, focusing on jobs. There are a number of other priorities. But for this first year, the president really believed that he could steamroll the Republicans, not even have us in the same room, and in the process, he was steamrolling the American people, not listening to what they were saying.

That's where the anger comes from. People feel like the president, the Democrats, and even some Republicans have not been listening to him.

People are sick of politics. They're sick of both parties in a lot of ways. I've been proud that the Republicans have been coming together to try to stop the spending and debt. And now what we need to do is work together.

And hopefully, the president will stop this effort to take over our health care system, refocus on jobs, and look at ways to get the economy going, rather than just expand the government.

MORAN: All right. You're all in the same room now, not literally, but in the Senate, but with the 41 Republican votes. But let me -- let me shift gears. I want to ask you about this landmark Supreme Court decision that came down this week, the Supreme Court this week saying that the campaign finance reform ban on corporations and unions spending their general funds to advertise directly in favor or against individual candidates, that's a violation of free speech. That's going to help Republicans. What -- what do you think?

MENENDEZ: Well, the big losers are the average American citizen. This is going to put enormous amounts of money and influence on behalf of big oil, health insurance companies, big banks, that are going to obviously support candidates who support their point of views.

That means, will Republicans join us on regulatory reform so we don't have the excesses of Wall Street that they permitted? Are they going to join us to make sure that health insurance companies don't arbitrarily and capriciously deny people their health insurance that they have, even when they need it the most?

So this is a David and Goliath situation. And the reality is that the average citizen is going to get steamrolled, and that's why we're going to seek to legislatively respond to it.

MORAN: You're going to try and reform this through legislation?

MENENDEZ: We are going to try to make sure...

MORAN: It's a First Amendment decision. It's going to be hard to do.

MENENDEZ: Well, it's a First Amendment decision, but there are a lot of elements on disclosure and otherwise that can, I think, curtail this. And I hope that the Republicans -- this was a reform effort 20 years ago when it was instituted. John McCain, McCain-Feingold a big part of this. I hope that Republicans are going to join us hand in hand to make sure that the special interests don't roll over the little guy.

MORAN: All right, Senator DeMint, quickly, are you on board for trying to limit the impact of this Supreme Court decision?

DEMINT: We can't promote freedom and democracy by repressing free speech. That's not the way to do it. I think people should be able to come together in associations and organizations and spend money to get their message out. I think that's going to promote the democratic process, instead of really what we've got now, is where you essentially give the labor unions carte blanche over our system, grassroots as well as spending.

I think this will give businesses a chance to participate in the process as well as associations.

MORAN: OK.

DEMINT: So I think free speech needs to come first.

MORAN: OK. And, finally, are you in favor of foreign corporations being able to participate in American elections through this decision?

DEMINT: I don't believe that -- right now, foreigners cannot give to the political process. And I hope, as this thing is sorted out, that we'll make sure that this is an American focus, so we'll have to sort all that out. I hadn't read all the details of the court's decision.

MENENDEZ: The problem is, a corporation is a corporation is a corporation. And a foreign corporation is going to be able to spend their monies in determining who is elected to the United States Congress. That's not good for the average citizen.

MORAN: It -- it is a tough problem going ahead. Senator Robert Menendez of New Jersey, Senator Jim DeMint of South Carolina, thanks very much for joining us this morning.

MENENDEZ: Thank you.

DEMINT: Thank you, Terry.