The Political Economy of Last Week

It's been an intense week for political economics. Here's a rundown and one beltway denizen's view of what it all means.

McCain's Pain, Gramm version: Phil Gramm's economic policies from his days in the Senate are making life hard for millions of people right now. But it was his gum-flapping last week that was particularly tough for McCain. Gramm is McCain's top economic advisor, so when he described the current economic downturn as existing in people's heads ("a mental recession") and called us a "nation of whiners" -- well, I guess he gets points for calling it like he sees it. From McCain's perspective though, he's a bit off message.

One policy note caught my eye re Gramm's role in the current meltdown in financial markets, especially in a week where the problems at Fannie and Freddie came into light (more on that later). As I discuss in the link above, many believe that a bill Gramm championed -- Gramm-Leach-Bliley, which open up investment banks and insurers to commercial lending, but without the oversight of commercial banks--helped pave the way to the housing bubble, the credit crunch, and the current downturn.

But check out Dr. Phil's response from this obsequious interview with Gramm by Steve Moore of the Wall St. Journal's editorial page, itself a cauldron of crazed economics. When Moore "delicately" broaches the subject of Gramm's bill in today's crisis, he responds, "There's every evidence that the markets were made more stable by the diversification. J.P. Morgan could not have bought Bear Stearns and prevented a meltdown without Gramm-Leach-Bliley."

Markets more stable!? If they were any less stable, Wall St. would fall into the Hudson Bay. And how about the comment re Morgan buying Bear? It's like saying, "don't you get it? If I hadn't gotten rid of the cops, then one street gang couldn't have beat up the other street gang." The fact that Morgan had to bail out Bear is a bad thing, Phil. Shareholders and employees lost millions in equity and the deal has exposed the taxpayer to huge potential liabilities.

What kind of person thinks like that? Or perhaps the better question is: what kind of person hires that kind of person to be their top economic advisor?

McCain's Pain, self-inflicted version: McCain also hit us with some straight talk re Social Security this week, calling the program a disgrace. What he specifically found disgraceful was the fact that today's young workers sacrifice a portion of their paychecks to finance the guaranteed pensions of today's retirees. But that's the program.

To me, the quote sounded like he just discovered that this is how it works. But Social Security is the biggest single program we fund; at $600 billion, it's one-fifth of the damn budget. And he's been up there for almost 30 years. I'm not saying I want a policy wonk for president. But this betrays a scary lack of understanding of basic government functioning.

It also betrays something deeper. The intergenerational dimension of Social Security is one the wonderful things about it...sorry if I sound sentimental, but this part just always chokes me up. When they were younger, today's retirees worked to create the economy we have today. They produced the capital, the infrastructure, they taught us in our schools, and treated us in our hospitals. We've inherited these goods, public and private, and we're using them to create the growth that our families enjoy today. Under Social Security, we shave off a portion of that growth to help provide for those who came before us, while creating a new economy for our progeny, who will do the same for us ("Circle of Life" music swells up here...).

To the extent that McCain's thinks about stuff like this, he's a YOYO economist (you're on your own), which is why he wants to drain the risk pool that makes Social Security work, and introduce private accounts. Further evidence that the YOYOs are congenitally unable to appreciate anything that smacks of WITT (we're in this together).

The Ballad of Fannie and Freddie: The nation's largest secondary mortgage insurers are on the ropes. Fannie Mae and Freddie Mac are government sponsored institutions -- the feds created them, but they operate in the private market and the government does not guarantee their investments -- that buy mortgages from primary lenders (the people who lend them to you and me). This makes for a more liquid system of lending for home buyers--banks that make the loans are quickly recapitalized when they sell those loans to Fannie or Freddie.

But like so many of the institutions out there right now, the bursting housing bubble is wreaking havoc on the solvency of these two companies, as some of the debt they're holding starts to go bad. They're even less capitalized than Bear Stearns was -- they borrow a lot, take on lots of debt, and don't keep a lot of money lying around -- in part because they've always been able to borrow freely at very favorable rates. And the reason for this is that most lenders assume the government will backstop them.

And most lenders are almost certainly right. Treasury Sec'y Hank Paulson stresses that the feds are not planning a bailout, by which I suspect he means the feds are planning a bailout. Because if anybody's TBTF (too big to fail), it's this guy and gal (Fred and Fan).

Yes, once again, Mr. and Ms. Taxpayer, you may well be about to hold the bag for a failing financial institution, infusing these firms with the money they need to keep buying and selling mortgage debt, while any sorry souls with stock in the companies will find themselves facing an "equity wipe," as they quaintly call it on the street.

So what can we learn from this, Dorothy? Here are a few random observations, all of which have bearing on the actions of the next administration.

-- Bubbles are much worse than we like to think, and we should work much harder to identify and prevent them. By "we" I mean, among others, the Federal Reserve, who, under Greenspan, had a fairly explicitly stated policy of waiting by the sidelines as the bubbles inflated, mops at the ready.

-- Overleveraging means undercapitalizing. See Fannie/Freddie/Bear Stearns and pretty much every hedge fund and investment bank that borrows short and lends long. It's one thing if big banks want to play with fire. It's quite another if I'm going to be called upon to put the fire out. If you're TBTF, then we must provide you with the necessary oversight to avoid charging a costly bailout to US taxpayers.

-- When derivatives are worth multiples more than the underlying value of the equity or bond from which their value is derived, that's not a hedge. It's a big, speculative bet and a recipe for greater volatility and risk ... risk which will typically be under-priced.

-- Speaking of pricing risk, yes, moral hazard is a big problem that contributes to the underpricing of risk (which, at some level, is the main factor behind all the bad stuff that's happening now). But the time to worry about moral hazard is not the weekend when the big bank is failing. It's years before, when you're setting up the regulations under which the financial system can flourish without going off the rails.

These are tough challenges, and deep-pocketed, powerful forces will fight reform every step of the way. It's going to take equally tough, persistent focus by the next administration and Congress to craft the regulations that truly promote greater stability in the financial system. Enough already with the shampoo approach to economic growth: bubble, bust, repeat.

Maybe it's me, but I don't think the McCain/Gramm team is up to the challenge.

Comments

[NicoleW]

In 2000' our politicians lifted many bank regulations. Now the public has to pay the price. However, this is never mentioned. The same with the oil regulations that were lifted in the 80's by Reagen, and oil is where it is today, everyone keeps ignoring these facts.

[Charley2u]

"Yes, once again, Mr. and Ms. Taxpayer, you may well be about to hold the bag for a failing financial institution, infusing these firms with the money they need to keep buying and selling mortgage debt, while any sorry souls with stock in the companies will find themselves facing an "equity wipe," as they quaintly call it on the street."

So, why doesn't your candidate just put his foot down and say, "Not this time."

You seem to want to have your cake and eat it too, Jared. Whine about poor regulation, but, continually step in to bail out the Republican mismanagers.

Every time they screw the country, you can bet the Democrats will be there to telling us to lay back and enjoy it for the good of the economy.

[leftLibertarian]

Let's see: The US Government borrows money from totalitarian China to bring democracy to Iraq.

And now it must borrow more money from socialistic China to help the 'free market' in the US.

Every time I hear the phrase: the 'Bush Plan' I know it will fail.

[ilovemydoggy]

We trusted these fools in Washington DC. They were asleep "at the helm" and so were we! Trouble is I never understand economics, but that's no excuse -- some things were obvious. Hurricane Katrina should have taught me "We're on our own" -- the 'government' cannot help us.

Regarding bank foreclosures: you can get a list to bank databases of foreclosure properties here:
http://www.nancys-kids.com/reo.htm

[musselmanm]

I forgot! Our home here is paid for in full.

[Viper]

But never the less likely worth less. And if your neighbors house is foreclosed and sits there empty with a brown weedy lawn... your quality of life along with its value will tumble. Imagine several on your street. And the city having less taxes for schools and road work.... And imagine tenants moving in all aropund you at very low rates and the landlords not able to maintain the property.... But you house is paid for... if you still want to live there.

And this can spill over such that you lose your job.. the house may be paid for, but you still have property taxes each year, electrical bills and maintenace.

regards

[musselmanm]

Thank you for the housing bubble! My wife and I sold in the Sacramento area just before the bubble began to deflate. We sold our home within 25,000 dollars of the top price the same model ever got in that area.
We moved here to North Carolina and now have an acre of land and a home built in 1998.
My son and his wife just bought their first home due to the deflation in housing prices in the same city.
We have been bucking the market with oil stocks and green energy stocks, backed up by commodeties and gold etf's
We have always been middle class and have never been in favor of all of the deregulation of all of the things which have screwed up in the last few years. In fact I am a liberal Democrat!
Thanks again to all of you that fell for the Republican talking points. I bet I am one of the few working poor that made money on all of the phony deals perpetrated on America by the Military, Industrial, Corporate Pirates represented by BOOOSH! And next, McBOOOSH!

[BlackbirdHighway]

These companies are just a bunch of whiners, the problems are all in their heads.

[MrJoyboy]

It's amazing how much the U.S. can borrow from China. Enough to fund a trillion dollar war in Iraq, a multibillion dollar war in Afghanistan, and plenty more billions to bail out failing companies. At least we're saving by not wasting money to educate our children. I hear Chinese is a difficult language to learn.

[zippywpinhead]

Real men don't speak a second language. Only elitist, sissy libruls are multilingual, as it is nothing more than a plot to turn us all into Marxist, socialist, turrist loving, America hating radicals. if you can't even speak English properly, so much the better...

[beaupritchard]

What I'd like is a list of what banks are on the verge of collapse ... anyone with a url

[The Hedonistic Pleasureseeker]

http://www.bankimplode.com

Also Google Richard Bove at Ladenburg Thalmann: He has run a few screens on bank stocks to see who elese may be in danger of failing.

[Viper]

Whats happening. Cape Coral Floirda 2300 new Foreclousres per month. As many as 20K people with no work have left town of 170K. This is common all over Florida and may come to a home near you. Over 3 million foreclousres expected in the U.S. this year

Foreclosed Condos with 175k mortgage being sold by bank for just $35K. Now thats the comparable for the other units around it. Do those owners walk or make 1500 payment ona 35K condo you can rent for $500?... In some complexes half the units are in foreclosure so those trying to stay are paying double the Condo Assoc. dues. For how long? With the drops in value, there is no way to refinance and get lower monthly payments, even if interest rates were down.

This wholesale devaluation will cut City tax revenue in Half.. City employees will/are being let go. Road work and city improvements on hold... so subcontractors losing work.

Abandoned property being gutted even in neighborhoods of 1 million dollar homes.

As gas/diesel prices surge, owners are walking away from their boats; defaulting...The same for RVs/ cars.. This will result in a huge number of bank failures and more lost jobs. Finance is 30% of the GDP and the largest employer oustide of retail.

Tourist locations hurting. More lost jobs. Airlines laying off.

If the oil bubble is not busted, this will be a depression. The snow ball is rolling down the hill.

,

[johnmorgan]

They've timed it just perfectly to coincide with a Democrat becoming president....Guess who the mainstream media will blame for the debacle, Bush....or the new Democratic president?

One guess!

[bgregs]

Unfortunately! I think that they learned their lesson from the depression!

[MyOwnPerson]

Viper, you forgot the greed factor. The real estate industry has inflated the prices of houses and land to a ridiculous point. I don't think there's such thing as reasonable real estate prices any more. I have very little sympathy for the banks that sold properties at overinflated prices and interest rates, and are left holding the bag for their own greed. I know everyone want to make a buck, but come on...let's be reasonable too!

[bgregs]

Yeah, there's a reasonable price. You look at what it was before the surge in prices really started (around 95 for most locations, around 90 for CA)and then you figure the AVERAGE annual increase over the course of US history (which is an amazingly steady percentage, until the surge in prices started with this bubble) and then figure out how much they would be worth....

[Viper]

Prices are pushed up from the bottom. When a person gets a loan for more than he should... then the next buyer pays more because of the comparables and some one else had out bidded on the last house.

The person who made more on the house than he should can next out bid some one else. The money was easy to get and by the way people who waited for a year for prices to come down in 2000 and 2001 and 2003, all paid more in the end.... Momentum, just like with oil speculation now.

In other parts of the country like florida, the Cheapo dollar meant U.S. buyers were competing with foreign buyers.

Pls note given the devaluation of the dollar (and this is a direct result of BUsh tax Policies/wars) and rise of comodoties, houses are selling at below replacement cost in many cases. The cost of reroofing has doubled in the past 5 years.

Regards


Regards

[keriheb]

I nominate Viper to be the head of the Treasury Department or possibly the head of the Federal Reserve.

Maybe just maybe Viper should be the republican candidate for president, the bone head they have running does not have a clue.

Consider this, if Bush-wack and company had been allowed to privatize social security, it would have been totally bankrupted by the financial mayhem we are now witnessing. And think of all of the yahoos, such as Limbaugh, who were trumpeting this idea as divine wisdom.

It is sad to say but so many of the democrats have been a part of this meltdown we are now witnessing. Didn't Clinton stop welfare for mothers? Okay, this is an equal opportunity nation, lets stop welfare for corporations!

[JAMES GORMAN]

MCAIN'S STAFF is not the problem--the problem is,gosh,McCain. Something like the Financial
Fatso that is Gramm is typical. Gramm has been ripping off the upper=levels of fat for 25 yrs with huge
companies in Europe--and was almost nominated for President by McCcain.
McCain cannot escape who he really is--a soldier who nearly died in a forgotten and tragic war--
he has no military vision or strategy, and is hopeless in economics. Moreoever, he has Lieberman at his
side pressing the cause of the Israeli lobbies--bomb Iran.
It is classic pre-destruct to predict destruction--of course there will be an attack in the first months of
McCain's presidency--because McCain has campaigned on anti-Iran atttacks. Terrorists will do to
him what they did to Bussh in 9/11===Osama said so--when Bush left Israel roam at will all over Gaza
and Lebanan, and to bomb as suitable, Osama said would happen==and we're in for a re-run.
That presumes McCain wins---and the powerful lobbies plus corporate failures will see to it that
he does win--fair means, fews as they be, and foul--as in as many are for sale. J Gorman

[prochange]

If only people would wake up and stop consuming like crazy. Stop buying cars, use public transportation, bicycles, share rides, walk. Buy at 99 cent stores, thrift stores, garage sales, etc/ do not buy the latest gimmick, the latest fashion , the bigger house, the newest car. Do not use banks who charge fees, throw away your credit cards, stop swallowing every stupid pill advertised on TV.
Stop buying all this fattening manufactured food. Try to buy nothing processed.
Join unions. Refuse to work without benefits. If everybody does it, things will change.

I know, I am dreaming. This society is so sleepschooled to do everything they are told to do by the big corporations, that they actually think life is not worth living without all the gimmicks, the fast food, the sodas, the stupid entertainment etc.

[Viper]

And not realistic. We are a consumer economy that makes nothing. 70% of our economy is now sadly consumer spending, not producing...

In fact as consummers stop spending, which they are doing.... the problems will get worse....

Regards

[prochange]

One of the remarks which pxxxxd me off the most was Bush after 9/11: Keep shopping.

Everybody has been trained to think that the solution is shopping. But we are shopping for products which are manufactured in other countries.

If people stop buying they are forced to lower prices and to rethink their policies of penalities and high interest rates. We have been lulled into thinking that we all have credit to buy anything we want. Now with all the foreclosures and repos they are forced to think about other solutions. Hundred thousand of unsold houses and unsold cars are just the tip of the iceberg. Fifty million without health insurance is the much bigger problem and a problem which will get even bigger. This is supposed to be the greatest country on earth? Well, keep dreaming. Only because people cannot afford to travel anymore, they have no idea how much better people live in other countries.

Doctores without borders now have to work in this country. No need to go into third world countries. Third world is right here.

The gas price is never going to go down again and the U.S. lacks public transportation in huge parts of the country. Keep pushing for railroads being built and solar power stations while you ride your bike or walk.

[musselmanm]

People can be forced to conserve. This can be done with toll roads for private vehicles and a nice gas tax on private vehicles. People that buy long term tickets on public transportation will be given tax write offs. Intallation of green energy products and systems in private home will also get a tax write off.
I would bet everything that none of our political leaders have the cajones to propose any of this.

[leftLibertarian]

Sadly most people live in the sub-ex burbs where there is no public transportation and riding a bike is very dangerous.

[prochange]

I have been riding my bike now for five years and use public transportation. I have to admit that the biggest danger on the road are SUV-drivers on their cell-phones and in the other hand a super-sized soda. But so far I survived. I need no health club as I get enough exercise and I save a lot of money for things I like to do.

[Charley2u]

You are targeting the wrong people.

It is not people who consume too much, it is government that wastes too much at the expense of consumption.

I can understand you problem with consumerism, but it is the spending that occurs at the expense of our living standard - military, for example - that is the root cause of the problem.

Neither you, nor I can print money at will.

[prochange]

This is supposed to be a democracy. If people would care to vote and be interested in the political process we would not be run by big corporations who make a killing on wars.

If the money which is spent on the armament industry would be spent on education, we could be the leading country in research. But the only thing we are leading in is military spending. And maybe entertainment but I am sure that the Indians will catch up very quickly in the entertainment sector.
We went to war. What for? Oil? With India and China growing so rapidly the whole world will have to find other solutions to run things but oil. If a country like Germany is leading in solar power (they do not get much sun over there) I am asking myself why installing solar power in my home is so extremely expensive here? I live in Nevada !!!!!!! Every hosue here should be run on solar power. And in Arizona and California too.

[eomonroe00]

this stuff is so corrupt and so in the open, if we rob a store we go to jail, if investers and banks do the same but all fancy like, they get back the money the lost-why dont we get bailed out when our investments fail?

bush should be in jail and is assistants for giving the order to not regulate, to not follow the law of the land-

everyone at S&p and others giving top ratings should be in jail, everyone who began and sold these slippery shady mortgages should be in jail,

why dont we know there names, im sure everyone in the industry knows these shady guys who are involved in all these busts, the enron, the housing bubble, the internet bubble, the savings and loans, its the same people, cant we isolate these people, make their names public,

anyone involved on with these shady illegal, heartless activity should be

[eomonroe00]

this stuff is so corrupt and so in the open, if we rob a store we go to jail, if investers and banks do the same but all fancy like, they get back the money the lost-why dont we get bailed out when our investments fail?

bush should be in jail and is assistants for giving the order to not regulate, to not follow the law of the land-

everyone at S&p and others giving top ratings should be in jail, everyone who began and sold these slippery shady mortgages should be in jail,

why dont we know there names, im sure everyone in the industry knows these shady guys who are involved in all these busts, the enron, the housing bubble, the internet bubble, the savings and loans, its the same people, cant we isolate these people, make their names public,

anyone involved on with these shady illegal, heartless activity should be blacklisted from the industry,

[sowhatdemos]

Trouble is the entire industry is corrupt just like this entire administration is corruption squared. The rich are laughing at us stupid taxpayers who have to give up for of our hard earned tax dollars to bail them out. Reminds me of Neil Bush and the S&L fiasco. These people have no scruples, they will steal every dime they can suck out of this country. Bastards, the lot. Let's kick them out!
Obama '08!

[LeonBNJ]

It's too bad we can't get some of the billions lost from those that profitied from these finanical scams, like Wall Street bankers getting $1 Mil bonuses or those who made huge profits 'flipping' residential property. They shared in the wealth - they should have to share the pain.

[ouroborous]

This is actually the proposal of those like Obama. They propose to shift the tax burden towards the rich.

While this wouldn't be entirely fair (some people made their money the old fashioned way... they earrrrrned it), it would certainly be a way for the country to ask those who grow obscenely rich due to the extremely lax and friendly-to-the-rich legal system we have, to contribute back to the workings of society.

Of course, McCain and all other fiscal conservatives consider taxation to be heresy and asking the rich to pay their fair share of taxes to be "socialism." This is a crock. Warren Buffett himself has wondered why his secretary, who makes about 60 grand a year, pays almost 30% in taxes, while he pays about 17%.

Seem fair to you?