Tuesday, April 1, 2008

Candidates Speak on the Housing Crisis

The three major presidential contenders gave speeches on the economy between March 25-27, 2008. Transcripts are at http://www.pbs.org/newshour/vote2008/ and on the candidates’ web sites.

Comparison of the three speeches illuminates the candidates, their similarities and differences.

Clinton’s View:

Clinton’s speech was all about helping families that face foreclosure on their homes because they can’t make the payments. She endorses Barney Frank’s and Chris Dodd’s proposed legislation that would have the federal government guarantee those loans. That would make the financial markets that deal in mortgage-backed securities liquid once again, putting an end to the housing-based credit crunch.

Clinton asserts (as does Frank) that the plan is self-financing, which means it would cost no taxpayer money. That’s probably a pipe dream. It assumes that most, or at least some of the homeowners would not default, so the government would not have to cover those mortgages. Of those that did default, the government would own those mortgages, but the thought is that over time the housing market would recover and the government could sell them at par, if not a profit (ignoring the time value of money).

It is a lovely fairy tale. It could happen. More likely though, most of the homeowners would default because the bottom line is, they simply cannot make the payments. That is the fundamental problem. Why would that change? Where are these families going to get the money to meet their balloons? So the government guarantee amounts essentially to a bail-out of the banks who made the loans and have to make good on the packages of them that they sold on to the financial markets.

Does it help families keep their homes? Sure it does. The government just bought their homes for them. What a deal. Lesson learned: home ownership is sacred in America. Buy a home even if you can’t afford it because the government will make the payments for you!

The Frank legislation is ultimately a giant bluff. If the financial markets believe the mortgage-backed securities are “good” again (because of the government guarantee), then the derivatives based on them are also good, so they can be valued at face and traded normally again and the credit markets can recover. Nobody loses money if everybody pretends there is no money lost!

I don’t think it will work like that and besides, it is probably too late. UBS Bank, for example, one of the firms most-exposed to these securities, has taken $40 billion in writedowns, so those mortgage backed securities, most of them derivatives, are now worthless. It would be impossible to re-value them at anything other than zero just because the government guarantees the original mortgages, because there is no audit trail from the derivatives back to the primary mortgage. So this plan will bail out the local mortgage originators but will probably not alleviate the system-wide credit crunch.

Clinton also proposes an “Emergency Working Group” to determine if this plan would even work or if some other, additional steps would be needed. It could be headed, she suggests, by Alan Greenspan, for example. Excuse me? The Alan Greenspan who as Fed Chairman presided over two massive financial bubbles and their catastrophic collapses? There must be something funny in Clinton’s Kool-Aid.

Clinton also suggests (but has not yet proposed) legislation to protect the mortgage-originating banks from lawsuits if they renegotiate the terms of mortgages they have already made. Who might sue them? The financial markets that hold the old (now worthless) versions of the mortgages. They want their money. But Clinton would allow the local banks to redo the mortgages to cut their losses. Let the Wall Street traders in mortgage backed securities suffer! (Anyway, nearly 2/3 of the subprime mortgages were not made by banks.)

Finally, for good measure, Clinton would just donate $30 billion of taxpayer money to cities and towns to do with whatever they like, from buying foreclosed housing, to building new roads, to hiring more police. That nonsequitur just looks like cynical election year vote-buying, to me.

Obama’s View:

Obama gave his speech in New York City to a room full of financial types, and was introduced by Mayor Michael Bloomberg. Contrast that to Clinton, who gave her speech to an audience at the University of Pennsylvania (the state where the next important primary elections are to be held). Clinton is politicking for votes. Obama is trying to address the fundamental issues. I think that difference in choice of venue alone tells us a lot about these two candidates.

No one takes the high ground like Obama. Whereas Clinton starts out with effusive praise for the Governor of Pennsylvania (who recently endorsed her) and then jumps right in to her theme song, “We’ve got trouble right here in River City!” Obama begins by considering the argument between Alexander Hamilton and Thomas Jefferson over the proper nature of a free market economy. Hamilton favored government intervention from time to time, as when he nationalized the debt of the Revolutionary War.

And that is the main theme of Obama’s speech. He sees the origins of the current financial crisis in the 1999 repeal of the Glass-Steagall Act which deregulated the banking industry and which allowed untrammeled greed to get us to where we are today. He comes within a hair’s breadth of accusing the government of abject corruption in repealing that act (and other similar actions, such as the deregulation of the telecommunications and energy industries that led to the Worldcom and Enron fiascos). I think he is absolutely right to focus on the root cause the those crises, and of this current credit crisis: rampant government corruption.

“…we've lost that sense of shared prosperity. … It's because of decisions made in boardrooms, on trading floors and in Washington. Under Republican and Democratic Administrations, we failed to guard against practices that all too often rewarded financial manipulation instead of productivity and sound business practices. We let the special interests put their thumbs on the economic scales. The result has been a distorted market that creates bubbles instead of steady, sustainable growth; a market that favors Wall Street over Main Street, but ends up hurting both.”

“… instead of establishing a 21st century regulatory framework, we simply dismantled the old one - aided by a legal but corrupt bargain in which campaign money all too often shaped policy and watered down oversight. In doing so, we encouraged a winner take all, anything goes environment that helped foster devastating dislocations in our economy.”

This kind of talk may not resonate with mythical Joe Sixpack, who probably would not understand a word of it, but the bottom line is that Joe Sixpack does not vote. Polls show that only 50% of Americans are paying any attention at all to the primary race. Government data show that only 50% of eligible voters even bother to vote in a presidential election. That means every educated vote counts double what it should, so it makes sense for Obama to speak to the people who are actually listening.

But what about a specific fix for the problem of Joe Sixpack losing his house? Obama, like Clinton, endorses the Dodd-Frank proposal to have the government guarantee the subprime mortgages that are the proximal stimulus for the credit crunch. As I noted above, it is not a bad idea in principle, but I am quite skeptical that it would actually solve the problem. Clinton’s ideas are more concrete, such as indemnification of mortgage originators who choose to renegotiate their loans. But I have to say, Obama understands the root causes, whereas Clinton gives no indication that she does.

Obama has some concrete, targeted proposals of his own though, and they tend to focus on causes. He looks upstream of the crisis. He is not about throwing money for the sake of throwing money.

For example, he would impose penalties on fraudulent lenders. He would allow a 10% tax credit on mortgage interest, which would proportionately reduce the mortgage burden more for those facing huge interest balloon payments. That’s minimally intrusive, yet elegantly precise. But first and foremost, he would revamp the regulatory framework dealing with financial markets. He gives five specific proposals for that revamp, all of them imminently sensible anti-corruption measures.

Obama ends by reminding listeners that he is still connected to the average person. He would “provide an income tax cut of up to $1000 for a working family, and eliminate income taxes altogether for any retiree making less than $50,000 per year. To make health care affordable for all Americans, we'll cut costs and provide coverage to all who need it. To put more Americans to work, we'll create millions of new Green Jobs and invest in rebuilding our nation's infrastructure. To extend opportunity, we'll invest in our schools and our teachers, and make college affordable for every American.”

The weak spot in this generally fabulous speech is that it is not at all clear how the President of the United States could clean up corruption in congress, which is where all this crooked legislation is made. The bully pulpit is a useful device, but I am doubtful that it is stronger than the lure of money and power. Still, we are voting for president here, not congress, so at least having a president who knows what he’s talking about would seem to be a plus.

McCain’s View:

McCain’s admirably short speech is simple, and simple-minded. There was a housing bubble, it burst. Tough luck, take your lumps.

Why was there a bubble? “A bubble occurs when prices are driven up too quickly, speculators move into markets, and these players begin to suspend the normal rules of risk and assume that prices can only move up.”

That’s not wrong, but it overlooks the original question: Why was there a bubble?In my opinion, there was a bubble because of unregulated, greedy, socially irresponsible financial practices, from the predatory mortgage originators right up through the highly leveraged traders in mortgaged backed derivatives. But McCain is blind to all that. In fact, he suggests that the root cause was greedy individuals trying to buy homes they could not really afford.

“Of those 80 million homeowners, only 55 million have a mortgage at all, and 51 million are doing what is necessary -- working a second job, skipping a vacation, and managing their budgets -- to make their payments on time. That leaves us with a puzzling situation: how could 4 million mortgages cause this much trouble for us all?... Homeowners should be able to understand easily the terms and obligations of a mortgage. In return, they have an obligation to provide truthful financial information and should be subject to penalty if they do not.”

That analysis is stunning in its naivety. Of course there is some truth to it, yet financial education is virtually non-existent in America. People do not know what they can and cannot afford, and lenders are in the financial, not the education business. Blaming the victim is not a very edifying way to understand the problem.

In any case, what would McCain do about the current financial crisis? Basically nothing! He says,

I will not play election year politics with the housing crisis. I will evaluate everything in terms of whether it might be harmful or helpful to our effort to deal with the crisis we face now. …I have always been committed to the principle that it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers. Government assistance to the banking system should be based solely on preventing systemic risk that would endanger the entire financial system and the economy.

He will “consider and evaluate” any proposals that come his way. That is hardly reassuring.

McCain offers a few concrete proposals of his own. One is to require an increase in the minimum down payment for getting a mortgage. That certainly would eliminate the “interest-only” loans that cause a lot of trouble, but it would do nothing about people currently facing foreclosure, and it would limit access to housing by those in the lower economic strata.

Anyway, I don’t think there is anything wrong with interest-only loans, as long as the costs and payment schedules are clear and the borrower is qualified to make the payments. The whole idea of housing equity as an off-the-books savings account is a concept that needs to be questioned. The problem with subprime mortgages is not the concept of interest only loans, but fraudulent lending practices. McCain has misidentified even the most obvious source of the problem.

More promisingly, McCain would increase capitalization requirements for financial institutions, but predictably, he would accomplish that not with actual regulation, but by “removing regulatory, accounting and tax impediments to raising capital.” Of course! More tax breaks for the wealthy! McCain would also eliminate “the Alternative Minimum Tax that the middle class was never intended to pay; [and] improve the ability of our companies to compete by reducing our corporate tax rate” No election year politics here!

How would McCain proceed with his suggested reform? Well first, he would do the obvious thing, call in the accountants! He would “convene a meeting of the nation's accounting professionals to discuss the current mark to market accounting systems.”

Then he would “convene a meeting of the nation's top mortgage lenders. Working together, they should pledge to provide maximum support and help to their cash-strapped, but credit worthy customers.”

Ah yes, a “pledge” from the predatory lenders to do better next time. That should do it!

McCain proposes no legislation and, heaven forbid, not even any new regulation on the financial systems.

McCain has said that the economy is not his strong suit, and this speech gives ample evidence of that.

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