Turmoil in the Markets

In college football, there is a Game of the Century just about every year. Similarly, the Worst Economic Crisis Since the Great Depression is roughly a biennial event, occurring most often during election years.

The current crisis, in its various manifestations, can be traced to the subprime mortgage market. A casual observer might wonder why there is such a thing as a subprime mortgage market, since a subprime loan is one that a lender would normally prefer not to make.

There are two answers to that question. The first is that various levels of national and local government pressured mortgage lenders to make risky loans so that they would be classified for regulatory purposes as good corporate citizens, and would be immune from charges of racism. So, like many market failures, this one has its roots in government policy. The second reason for the expansion of the subprime market is that mortgage lenders figured out that they didn’t have to take the risks associated with bad loans. They were able to package mortgages together as components of fancy securities that, it turns out, virtually no one fully understood.

All of this worked until borrowers started defaulting and, partly in consequence of those defaults, home prices fell. All markets tend toward bubbles, and home prices could no more continue rising indefinitely than could tech stocks in the 1990s or tulips in 17th century Holland. Literally no one foresaw the consequences, which now include the demise of Bear Stearns and Lehman Brothers. Of course, the fact that politicians and pundits didn’t see the problem coming doesn’t prevent them from assuming they can come up with a solution.

The financial “crisis” is relatively manageable so far. While it has been disastrous for a few entities like Bear Stearns, Lehman Brothers and possibly AIG, the broader market has been impacted only slightly; nothing like the crash of 1987, when the Dow fell more than 22 percent in a single day, or the protracted collapse of the dot-com bubble between 2000 and 2002. For most people, the biggest financial impact will be the cost of federal bailouts of Fannie Mae, Freddy Mac and possibly other entities.

Predictably, the market turmoil has been fodder for politicians. CNN reports that the Obama campaign was delighted at the bad economic news and hoped for scary headlines. Obama thinks the solution lies in more regulation of financial markets. Here’s the problem: anyone can diagnose the last financial crisis (or, as it may be, speed bump), but no one–certainly no government agency–has a decent track record of predicting the next one. The people who ran Lehman Brothers were among the world’s richest and smartest people. They didn’t intend to go broke. If they couldn’t foresee what happened to their company, why would a government bureaucrat?

The one thing that was foreseeable was that home prices couldn’t continue rising forever, just as tech stocks couldn’t boom indefinitely. But what could a government agency have done about it? Tell a homeowner that he has to accept a lower offer for his house because home prices are getting too high?

The one thing we know for sure is that increased regulation of financial markets will increase the cost of capital, a drag on the economy that would continue long after the market turmoil that led to the regulation has been forgotten.

While I’m pretty sure that as President John McCain would do less damage to the economy than Obama, his response to the current crisis hasn’t been inspiring, either. McCain sees the downfall of Lehman Brothers as a morality play:

In short order, we are going put an end to the reckless conduct, corruption, and unbridled greed that have caused a crisis on Wall Street.

… This foundation of our economy, the American worker, is strong but it has been put at risk by the greed and mismanagement of Wall Street and Washington. The top of our economy is broken. We have seen self interest, greed, irresponsibility and corruption undermine the hard work of the American people.

When McCain is done eradicating greed, he’s going to take on lust and gluttony.

McCain’s actual policy proposals, as far as I’ve studied them, don’t seem too bad. But is it too much to expect a Republican Presidential nominee to forgo demagoguery on the economy?

Where McCain does have a strong argument is the political money-tree that Fannie Mae and Freddy Mac became. Today, McCain said:

He talks a tough game on the financial crisis, but the facts tell a different story. Senator Obama took more money from Fannie Mae and Freddy Mac than anyone but the chairman of the committee they answer to, and he put Fannie Mae’s CEO, who helped create this problem, in charge of finding his Vice President. That’s not change, that’s what’s broken in Washington.

McCain is right about that, and it only scratches the surface of the Democratic Party’s corrupt relationship with the two mortgage entities. Fox News’s John Gibson reported today:

Lehman Brothers’ collapse is traced back to Fannie Mae and Freddie Mac, the two big mortgage banks that got a federal bailout a few weeks ago. Freddie and Fannie used huge lobbying budgets and political contributions to keep regulators off their backs.

A group called the Center for Responsive Politics keeps track of which politicians got Fannie and Freddie political contributions. The top three U.S. Senators getting big Fannie and Freddie political bucks were Democrats, and number two is Senator Barack Obama. Now, remember, he has only been in the Senate four years but still managed to grab the number two spot ahead of John Kerry, decades in the senate, and Chris Dodd, who is chairman of the Senate Banking Committee.

Fannie and Freddie have been creations of the Congressional Democrats and the Clinton White House, designed to make mortgages available to more people, and as it turned out, some people who couldn’t afford them. Fannie and Freddie have also been places for big Washington Democrats to go to work in the semi-private sector and pocket millions. The Clinton administration’s White House budget director Franklin Raines ran Fannie and collected $50 million. Jamie Gorelick, Clinton Justice Department official, worked for Fannie and took home $26 million. Big Democrat Jim Johnson, recently on Obama’s VP search committee, has hauled in millions from his Fannie Mae C.E.O. job.

Now remember, Obama’s ads and stump speeches attack McCain and Republican policies for the current financial turmoil. It is demonstrably not Republican policy and worse, it appears the man attacking McCain, Senator Obama, was at the head of the line when the piggies lined up at the Fannie and Freddie trough for campaign bucks. Senator Barack Obama, number two on the Fannie/Freddie list of favored politicians after just four short years in the Senate. Next time you see that ad, you might notice he fails to mention that part of the Fannie and Freddie problem.

As for John McCain, he got peanuts from Freddy and Fannie. Not only is he a Republican, he’s actually a reformer. That being the case, McCain could afford to tone down the populism a bit.

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