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

[FloridaGeek]

The SS program is clearly a disgrace, as stated. Its supposed to be a trust fund, but the congress treats it as tax revenue.

Perhaps the reason its "popular" is the misinformation spread by the media, this site included?

[Grunty1]

So, by that logic, wouldn't that make the ones who mismanaged the funds, which includes John Mc'Cain, the disgrace?

[FreedomBeforeDemocracy]

Yes. Unfortunately, it also make Barack Obama a disgrace. Although he's been there a shorter time, he embraces the status quo more than McCain. Most politicians wouldn't have the guts (or stupidity) to take on social security during an election season. You have to admit that McCain takes this maverick thing to the extreme (like telling Iowa that ethanol is a bad idea).

[The Hedonistic Pleasureseeker]

Socialism for the rich indeed. What makes y'all think this wasn't planned ALL ALONG?

These people treat the book Nineteen Eighty Four like an instruction manual, so why wouldn't they also use the "lessons learned" from the S&L and ENRON debacles to screw the pooch AGAIN, possibly on a global scale this time? Each time MOST of the rich guys got away with their ill-gotten gains, leaving you and I, the little guys, holding the bag. It's the ENRONization of the whole world.

It works for them every time. Why should they stop?

It's that "off balance sheet" funny math that dupes investors every time. They sold us pigs in pokes, AGAIN. When WE do it, it's called FRAUD, and IAW contract law any contract WE (you and I) make based upon fraud is NULL AND VOID, meaning, it's as if the transaction never took place. The same contractual standard should be required of these clowns. THE COUNTRY WANTS IT'S MONEY BACK, thank you.

[likeicare]

Prohibit banks and mortgage lenders from advertising on TV. That would end the majority of the abuse.

Everyday, I see tons of TV ads for these slimeballs, all directed at the most vulnerable populations -- the elderly and poor. then, when these people default on their loans, the banks whine about how it's the peoples' fault b/c they let themselves get hustled!

This is obscene.

[recruitgal]

I think that these companies should be allowed to fail. I know that means some pain in the short term, and job losses for individuals that work there, but private companies should not be bailed out by public money.

If we don't hold the people at the top accountable, there is no way of encouraging better corporate citizenship in the longer term. They'll just keep taking unacceptable risks, and then expect the tax payer to bail them out when they get in over their heads.

[Woodn88s]

I agree, let them fail,
Nobody would be running to bail my small companies @ss out if I got in trouble, they'd be auctioning off every last bit of my worth and I'd be homeless..................nobody would give a sh*t

I am becoming one angry american...................damn

[Indubio]

Honesy, letting Fannie Mae and Freddie Mac fail wouldn;t mean pain in the short term. I don't think you understand the size of these two entities. Together, the two companies control more than 50% of total US debt. If you'd like to see economic collpase then let these two operations fail. I'm not suggesting we not hold people accountable but that can be doen without letting these fail. Further, if government fails in its reponsibility to businesses (And people), then government should provide bail outs. Reread Bernstein's blog: What he says is that government had a responsibility to provide oversight and regulatory control but failed to do so. It's hardto know whose at fault in this situation and so rathger than let the two mortgage giants fail there needs to be an investigation and supports to keep them from going bankrupt. Wen government fails to do it's job the taxpayer foots the bill, which is why regulatory control is so critical. Those invested in the two companies will lose everything and in fairness I think those at the top should be compelled to accept the responsibility if indeed they are guilty of poor judgment or malfeasance. The price these people pay should be based on the nature of the guilt.

[ouroborous]

It's not the people at the top who will pay if we bail them out.

It's American taxpayers, to the tune of something like 5 trillion dollars of extra securitized debt.

Some economists I've been reading have said that the Treasury simply couldn't afford this; that it would bankrupt us (either through ruining our credit, inflation due to massive money printing, or both).

I'm no economist, but my belief is that sometimes the best choice is to let a sick institution die.

[leftLibertarian]

Sorry Indubio, nothing should be too big to fail. Let the chips fall as they may.

[Charley2u]

"there needs to be an investigation and supports to keep them from going bankrupt."

Hmmm...and i suppose this investigation will be done by the very same people who won't bring Kucinich's articles of impeachment up for a vote.

Wake up, Washington sees you as an ATM, nothing more - and, both parties are in on it.

http://pogoprinciple.wordpress.com/

[Charley2u]

Can I shake your hand?

At last, someone with sense.

[nyboomer]

After the savings and loan debacle of late 1980s, all my rich friends were looking for profitable deals to pick off as the government sold the properties it had to take in compensation for the $100 billion dollar the taxpayers provided to help those poor bankers and S&L officers out.

The rich borrowed the money and threw it away and then they bought the distressed properties at a steep discount.

By the way, Bush's younger brother's finacial institution was involved in that debacle to the tune of $5 billion loss. How is he doing these days? Is he poor and contrite or rich & laughing all the way to the bank?

[Binea]

... yet they Ignore Ron Paul,who has been right all along .Go to utube and see video of Ron Paul with Bernake and greenspan before him.

Introduction

"America became the greatest, most prosperous nation in human history through low taxes, limited government, personal freedom and a belief in sound money. We need to return to these principles so our economy can thrive again. When enacted, my plan will provide both short-term stimulus and lay the groundwork for long-term prosperity.

Other candidates talk a lot about stimulus packages, but my record stands alone. I have fought for these measures for years as a member of Congress and will make them a top priority as president.

Ron Paul, a 10-term Republican congressman from Texas’s 14th District, is currently the ranking member of the House Financial Services Committee’s Subcommittee on Domestic and International Monetary Policy, Trade, and Technology. He has been named “Taxpayers’ Best Friend” for 10 consecutive years by the National Taxpayers’ Union. Ron Paul is also the author of several books on monetary policy and economics.

The Four-Point Plan


Tax Reform: Reduce the tax burden and eliminate taxes that punish investment and savings, including job-killing corporate taxes.
Spending Reform: Eliminate wasteful spending. Reduce overseas commitments. Freeze all non-defense, non-entitlement spending at current levels.
Monetary Policy Reform: Expand openness with the Federal Reserve and require the Fed to televise its meetings. Return value to our money.

google "Ron Paul four point economic revitalization plan"

[openhand]

thats a really good start, i just dont know why it always makes me think of george and ringo. any space for impeachment or war crimes?

[chombo]

Is it me? I only count three points in that four point plan.

[ubetchaiam]

"including job-killing corporate taxes. "; NO, corporations do NOT pay their fair share; look at the tax code. AND it is the 'privatization' of the 'public commons' that serves as the fuel for corruption.

Better yet ,REDUCE significantly ALL 'defense' spending -that will 'save' close to a TRILLION dollars a year.
"Eliminate wasteful spending"; yup, a single payor healthcare system would do that but we all know that's going nowhere under either McCain or Obama.

I suggest you read here-as well as others- for more insight:
http://www.newsdissector.com/blog/

[ouroborous]

I think a single-payer healthcare system is a good choice, but let's not fool ourselves into believing that it would cut down on (let alone eliminate) spending.

In fact, most estimates are that a nationalized healthcare system would become the #1 burden on the U.S. economy, leading even national defense.

However, the point of single-payer is that it would shift the burden of healthcare away from taxpayers and onto the state, where it arguably belongs ("common weal" and all that).

[Viper]

Most of what Ron Paul was pushing is in fact the Wall street finanical policy. Trickle Down, Laisez fair capitalism, deregulation and that is what you have been living under for the past 7.5 years and hoiw is it working out? . And the sad part is you dont realize that. He is my Congressman. He believes that Government is the problem as does BUSH.. he believes in free/unreglated markets. He loves Larry Kudlow. He does not support Medicare or single payer healthcare....

Regards

[Charley2u]

"Freeze all non-defense, non-entitlement spending at current levels. "

I am not sure the logic of allowing defense and entitlements to rise? They are the fastest growing part of government.

Ron has a few good ideas, but overall he misses the point.

[bgregs]

How about we also GUT the "defense" spending which is going instead to the largest single discretionary item in the budget!

[lionqueen]

Mortgage lenders were put in a position to offer no doc, zero down loans with low initial teaser rates or lose their portfolios through refinancing by those that did. Consumers were quick to jump on the easy qualify bandwagon, as were Wall St. firms who sold payment tranches to little old ladies. Ratings firms gave AAA ratings to these instruments.
This was not caused by mortgage lenders? They saw it coming, as underwriting standards were thrown out the window.
Blame? Moodys and S&P for granting AAA ratings on payment tranches of no doc, zero down, low teaser rate loans secondary investments. Wall St. firms who invented these instruments, doomed to fail in any housing correction.
Beware of asking the Fed to be preemptive in bursting a bubble. Their job is clear - price stability and full employment. Over regulation subsequent to a problem without clearly defining its cause leads to Sarbanes-Oxley and its like.
The fault for this situation falls squarely in the lap of Wall St. and the ratings services, and that is where oversight should be focused.

[sufi66]

Nothing new here: capitalism for the poor, socialism for the rich.

[WIpatriot]

Indeed. Jared makes this sound like this is a new bag of crap we'll be holding, when in fact, it is the same bag that we've been stuffing past capacity for decades.

[Torus34]

Sir;

Your 'takeaway' line in the penultimate paragraph laid a responsibility on the incoming Congress.

I must ask you, Sir, if in your heart of hearts you truly believe that Congress, our polarized, distracted, self-serving Congress, is up to the task? I, for one, have some reservations.

[Gasparilla]

The Republicans always seem to be in office when these meltdowns happen.

[bgregs]

Either that or they've been in power recently. In the last time this happened, it was partly on daddy bush's watch, and partly on Clinton's. The time before that the troubles were created under Nixon, and continued under Ford, but the troubles only came to light under Carter!

[jplraider]

??

Last meltdown occurred in 2000. Nasdaq lost almost 50% of its value.

[chombo]

Republicans had controlled the House and Senate for six years by 2000. They also had Bill Clinton - the greatest Republican President of the 20th centruy - to work with. The 2000 "meltdown" didn't result from unregulated banks but from over-valued tech stocks.

[Grunty1]

I can only assume Gasparilla means 1929 as the "last time"

[unionave]

Where does our government get all the money to bail out so many badly managed big corporations ? Have we paid back the money McCain and his gang of 5 pilfered from the insured S&L companies ? Since we bailed out the badly managed airline companies some of them filed for chapter 11 . Are we paying for them also ? After pondering the above mess I found out about a new movie called "The Reflecting Pool" which is on DVD and at the movies . I suppose this movie will increase my head ache from a two pill pain to a four pill pain .

[ccpostman]

We get the money from China.

[fpal]

No, we get the money from future generations. It's also called inflation.

[researcher]

oh the fruits of capitalism

we borrow from communists, socialists, and kings to keep our capitalism afloat

and americans love capitalism best in the world to them

paradigm paralysis at its best

it is doing what it does best creating a society of haves and have nots

while americans blame politicans ie play the blame game

must look at the system creating the haves and have nots

[Viper]

Communism , socialism and kings also create the haves and have nots.

Laisez faire capitalism does to....

What we have now is unregulated greed. And I'm not sure given the willingness to let governments buy Companies (Sovereign funds... thats socialism); OR the giving of half your company to the government in Communist China or Dubai, that what we are seeing are true capitalist... just greedy pigs at work w/o any economic or moral compass.


Regards

[marinara]

excellent post. Very good post byJ.Bernstein

[samuelpablo]

Thank you sir, may I have another?

[ubetchaiam]

"Maybe it's me, but I don't think the McCain/Gramm team is up to the challenge."; granted but what makes you think the Obama 'team' is?
http://www.nytimes.com/2008/07/14/us/politics/14convention.html?partner=rssnyt&emc=rss

"exactly the type of special influence that Mr. Obama had pledged to expunge from politics when he said he would not accept donations from lobbyists.-"--but another reason this independent voter will not be voting for Obama.

"AT&T, Comcast"----viola, the answer to Obama's supporting the FISA bill.

And for a few facts re 'the middle class'(wish the mass media and Congress critters would admit to this data when talking about the 'middle class'):
As of 2006
42.7% of the U.S. population earned less than 25K per year, and

71% earned less than 50K per year.

(A condensed table of the poorly organized U.S. Census bureau figures is available at wikipedia.)

[Viper]

So we know the past 8 years of policies suck. That since 1980 we have been going down hill or slightly longer than that with a free trade, gutting of our MFG base, healthcare cost more than twice the rest of the world (drug price 5 times as high) and only cover 75% of the people... From largest Creditor nation to largest debtor nation. From trade surpluses to huge trade deficts. Now the outsourcing of High tech and finance .

There is no differene between McCain economically than Bush. McCain tax cuts give him 400Kmore; the average guy about 900 bucks again.

You have two choices and you picked More of the Same... When my country is going to hell in a hand basket, I'll gamble on the possiblity of something new instead of a known policy of failure and a man who at 72 is showing real memory problems... He has forgot in just 2 weeks he was not even in Washington to vote on the GI bill or the FISA bill.

I had to hear that Obama in the State legislature never voted... turned out he missed LT 100 votes out of 4,000 in a part time job. He voted over 98% of the time!

McCain has doidged every important vote in the past six months and even claimed he supported the GI bill he did not vote for and spoke out against.

McCain has missed more votes than anyone in Congress since 2000.

Regards

[scooperss]

mccain didn't forget that he didn't vote on those bills. mccain didn't forget about how he voted on the GI bill either. mccain knows what he's doing, he's hoping voter are stupid.

[ubetchaiam]

NO, I have -and so do you- more than two choices. I've been voting for 40+ years and am sick and tired of 'choosing between two evils'. Voting is NOT about choosing who one wants to 'win' -and after all, one is not voting for a person but a slate of electors- but who one thinks best reflects one's values. It is THAT misconception that allows the corrupt two party system to continue to eviscerate the Constitution and bankrupt this nation.

I will not be voting for McCain nor for Obama because I DO have more than two choices.

And ,please, do not trot out the SCOTUS argument because it is the Senate who approves nominees; that is where -as well as in the House and State governments- 'change' needs to occur. The U.S. does not need an executive branch that acts like a benevolent king.