One of the major contributing factors to the current economic crisis I believe is the lack of true leadership from the current President and his economic team of Hammerin’ Hank Paulson and Helicopter Ben Bernanke. The problems have reached far above the plane of mere economic policy and the necessary solutions encompass the realm of major political policy and decision-making at the highest of levels.
In other words, this Presidential election year we need to worry about what our next President will do to help the country weather the crisis. Given that Bush will do nothing useful in this arena, it falls to the next person in the Oval Office to handle what will be the second year of a major recession in 2009 and take almost immediate steps to start helping us find a way out. Yes, the markets and the economy will self-correct to a point, they have in the past, but this time around the damage to the economy’s equilibrium could very well be so severe that extraordinary actions may need to be taken.
I’ve been saying for a long time now that these problems are largely systemic. They are the result of decades of a Wall Street system designed to make as much money for Wall Street as possible at the expense of everything else, the system itself is the problem. Correcting the brutal mess this has created will be time-consuming and politically brutal. It will take a force of political will and cooperation the likes we haven’t seen in a couple generations.
Thus, we take an objective look at the candidates’ economic policies. Especially in the last few weeks, we’ve seen all three candidates, McCain, Clinton, and Obama, each take a look at the growing economic crisis. Despite how you feel about the candidates personally, pay attention to their economic stances. That will be the major issue of the next President’s term. With that in mind, we dive in.
First…John McCain. There’s not much to say about McCain’s economic policy other that like Bush, he doesn’t believe there is much of an economic crisis. At the heart of McCain’s plan revealed on Tuesday was the belief that the blame for the issue rests with homeowners, not with lenders.
A sustained period of rising home prices made many home lenders complacent, giving them a false sense of security and causing them to lower their lending standards. They stopped asking basic questions of their borrowers like “can you afford this home? Can you put a reasonable amount of money down?” Lenders ended up violating the basic rule of banking: don’t lend people money who can’t pay it back. Some Americans bought homes they couldn’t afford, betting that rising prices would make it easier to refinance later at more affordable rates. There are 80 million family homes in America and those homeowners are now facing the reality that the bubble has burst and prices go down as well as up.
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?
McCain does have a point on the moral hazard issue, after all rampant derivative speculation and arcane mortgage packaging games created this mess in the first place, but his words do ring a bit hollow given that he had no criticism of the “vigorous government action” that rescued Bear Stearns at a price tag of $30 billion.
The other part of what happened was an explosion of complex financial instruments that weren’t particularly well understood by even the most sophisticated banks, lenders and hedge funds. To make matters worse, these instruments – which basically bundled together mortgages and sold them to others to spread risk throughout our capital markets – were mostly off-balance sheets, and hidden from scrutiny. In other words, the housing bubble was made worse by a series of complex, inter-connected financial bets that were not transparent or fully understood. That means they weren’t always managed wisely because people couldn’t properly quantify the risk or the value of these bets. And because these instruments were bundled and sold and resold, it became harder and harder to find and connect up a real lender with a real borrower. Capital markets work best when there is both accountability and transparency. In the case of our current crisis, both were lacking.
Because managers did not fully understand the complex financial instruments and because there was insufficient transparency when they did try to learn, the initial losses spawned a crisis of confidence in the markets. Market players are increasingly unnerved by the uncertainty surrounding the level of risk, liability and loss currently in the financial system. Banks no longer trust each other and are increasingly unwilling to put their money to work. Credit is drying up and liquidity is now severely limited – and small business and hard-working families find themselves unable to get their usual loans.
The net result is the crisis we face. What started as a problem in subprime loans has now convulsed the entire financial system.
Some credit has to be given to McCain on this point, he is very much correct on the cause of the issue and coming from a Republican, that’s saying something. However his response about what should be done leaves much to be desired. McCain, unlike Bush, seems to recognize that we have a serious problem on our hands.
Let’s start with some straight talk:
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.
In our effort to help deserving homeowners, no assistance should be given to speculators. Any assistance for borrowers should be focused solely on homeowners, not people who bought houses for speculative purposes, to rent or as second homes. Any assistance must be temporary and must not reward people who were irresponsible at the expense of those who weren’t. I will consider any and all proposals based on their cost and benefits. In this crisis, as in all I may face in the future, I will not allow dogma to override common sense.
McCain’s response is actually rather surprising. He seems to understand that there is systemic risk and he is most certainly correct. Again, a far cry from Bush…but it’s what McCain has for a solution that bothers me.
In financial institutions, there is no substitute for adequate capital to serve as a buffer against losses. Our financial market approach should include encouraging increased capital in financial institutions by removing regulatory, accounting and tax impediments to raising capital.
I am prepared to examine new proposals and evaluate them based on these principals. But I think we need to do two things right away. First, it is time to convene a meeting of the nation’s accounting professionals to discuss the current mark to market accounting systems. We are witnessing an unprecedented situation as banks and investors try to determine the appropriate value of the assets they are holding and there is widespread concern that this approach is exacerbating the credit crunch.
We should also 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. They should pledge to do everything possible to keep families in their homes and businesses growing. Recall that immediately after September 11, 2001 General Motors stepped in to provide 0 percent financing as part of keeping the economy growing. We need a similar response by the mortgage lenders. They’ve been asking the government to help them out. I’m now calling upon them to help their customers, and their nation out. It’s time to help American families.
Convene meetings? Remove regulatory hurdles to raising capital? What kind of silly responses are those? We’re far past the time for convening meetings and tinkering with capitalization requirements. Much more strenuous actions need to be taken by the next President.
McCain understands the problem, but has no idea on the solution.
That brings us to Hillary Clinton who on Monday laid out her response.
Ultimately the true currency of today’s American economy is confidence. When people lose confidence in the economy and our president’s ability to manage it, problems become crises and crises lead to more crises. So we need a president who can restore our confidence, a president who is ready to confront complex economic problems with comprehensive solutions, a president who will act at the first signs of trouble, working with experts to identify the problem, with agencies to adapt regulations, with congress to pass necessary legislation, working to prevent crises rather than just reacting too little too late. We need a president who is ready on day one to be Commander-in-Chief of our economy. If you give me the chance, I will be that president. I will start by facing our economic situation as it is, not as we wish it would be.
That means acknowledging that our economic crisis is, at its core, a housing crisis, a crises caused in part by unscrupulous mortgage lenders and brokers and unregulated transactions in mortgage-backed securities, in part by speculators who were buying multiple houses to sell for a quick buck and other buyers who didn’t act responsibly. And in part by a president and administration who failed to anticipate and continue to downplay the problems we face. Unlike what happened here in Pennsylvania, when Governor Rendell started seeing problems – and I remember those articles we had in the newspaper, governor, where the housing supply was being, you know, expanded and people were putting zero money down and they were trying to once again get the American dream, they were commuting sometimes two hours to be able to afford that house. Well, those warning signals went unheeded in Washington. But thankfully, not in Harrisburg. And what we have to do now is to look at our housing crisis in greater detail. And I’d like to outline my plans to address it.
2.2 million foreclosure notices went out last year – up 75% from 2006. Communities of color have been especially hard hit. Subprime loans are five times more common in predominantly African American neighborhoods than predominantly white ones. And 41% of loans to Hispanics are subprime compared to only 22% to whites. But this crisis isn’t just about the more than 2 million households at risk of losing their homes and, of course, 2.2 million foreclosure notices means many more people than that because obviously you have homes where anywhere from two to ten people live. It’s about the tens of millions of families who have lost value in their homes.
When I talk about the home foreclosure crisis, sometimes people, I can tell, look at me a little skeptically because they, I can tell, they’re thinking to themselves, I didn’t buy one of those mortgages, I don’t have an ARM, I’m not at risk. But, in fact, that is just not the case. Home prices dropped almost 9% last quarter. Home prices for everyone. If you have paid off your home, if you have a fixed rate mortgage with a manageable interest rate, you have suffered the steepest decline on record. That means families have lost at least $1.9 trillion in housing wealth so far, nearly two-thirds of the size of the entire United States government budget. And today, nearly 9 million families are struggling with mortgages that are under water. They actually owe more for their mortgages than their homes are worth. So what was once their biggest financial asset is now a financial liability.
A valid point here. In fact, the housing depression is right now the major cause of the economic disaster we’re facing. Trillions in home equity is vanishing from the economy and that’s taking a massive toll on everyone. I’ve said much the same myself and again, Clinton gets the problem.
Her response however is curious.
Today, I am announcing my four part plan to Protect American Homeowners: A plan to help our families keep their homes and help communities hard hit by the housing crisis.
My plan starts with an aggressive new effort to help millions of at-risk families restructure their mortgages and stay in their homes. Of the tens of millions of Americans who have lost value in their homes, 8.8 million are struggling with these mortgages underwater. That is more than 10 percent of all homeowners — the highest percentage since the Great Depression. If home prices fall another 15 percent, one third of all homeowners will find themselves in the same boat.
The time for action is now – not a month from now, or a year from now – but now. And the reality is that many of our families need more than just basic refinancing. That’s why I support new legislation proposed by my colleagues, Representative Barney Frank and Senator Chris Dodd that would expand the government’s capacity to stand behind mortgages that are reworked on affordable terms.
Currently, families apply to the government, and the government decides on an individual basis whether to work with them to restructure their mortgages. You heard the governor say that maybe there will be 1,000 families that will be helped in Pennsylvania. This is a slow process that helps relatively few families, and it simply isn’t enough to revive our housing market.
The Frank-Dodd legislation would move beyond this incremental approach by setting up an auction system for mortgage companies that hold hundreds of thousands of these mortgages. Through this system, these companies could sell mortgages in bulk to banks and other buyers. The buyers would be willing to purchase these mortgages – and restructure them to make them affordable for families – because they know the government will guarantee them once they are refinanced.
Now here’s where I have a bit of a problem. Yes, buying mortgages through the FHA would help homeowners, but the fact of the matter is the government would be paying for it, which means the taxpayer would be footing the bill. While this will help at the micro level, at the macro level it’s just throwing money at the problem. Unless that effort is backed up by the kind of truly meaningful systemic changes in the financial system that the country needs, it’s just another band-aid on the sucking chest wound. Major surgery is needed here. A better response than McCain certainly, but more is needed.
That’s why I’m proposing an Emergency Working Group on Foreclosures. It could be led by a distinguished, non-partisan group of economic leaders like Alan Greenspan, Robert Rubin, Paul Volcker. It’s the kind of proactive step that would help re-establish confidence in our economy by showing that the President and the Administration was taking our economic crisis seriously.
Volcker, yes. Rubin…no. He’s largely responsible for the repeal of Glass-Steagall through Bill Clinton. Alan Greenspan? Hell no with a billion mini-nos orbiting it. The man shouldn’t be allowed to make change for a five.
Rubin and especially Alan Greenspan are the folks who got us into this mess. There’s no way they would be part of a true, rip out the guts and start over again style solution that we must have.
Next!
The third part of my plan is a new housing stimulus package to provide $30 billion directly to states and localities, like Pennsylvania and Philadelphia, hard hit by this crisis.
Right now, concentrated clusters of foreclosures are devastating some communities. A recent study of ten states by the U.S. Conference of Mayors found that the foreclosure crisis will lead to 6.6 billion dollars in lost tax revenues in just those ten states alone.
Just over a month ago, Congress passed, and President Bush signed, a $168 billion stimulus package. But this package did next to nothing to help homeowners and communities struggling with foreclosures. I said at the time, if we did not address the housing crisis, we would not be able to stem the bleeding. Congress is trying to combat a recession caused by the housing crisis without doing anything to address that crisis.
Well, if the Fed can extend $30 billion to help Bear Stearns address their financial crisis, the federal government should provide at least that much emergency assistance to help families and communities address theirs.
She’s right on the point but again wrong on the solution. Tossing more money at the problem will not fix it.
The fourth and final part of my plan involves passing new legislation to clarify legal liability for mortgage companies that act to help more borrowers stay in their homes.
Right now, many mortgage companies are reluctant to help families restructure their mortgages because they’re afraid of being sued by the investment banks, the private equity firms and others who actually own the mortgage papers. Because remember, all of these mortgages were bundled up in these huge packages and sold around the world. So you can’t just go down to see your mortgage broker or your bank or your other lender to work out a deal because they no longer own the paper. This is the case even though writing down the value of a mortgage is often more profitable than foreclosing – both for mortgage companies and for most of those who own the mortgages.
That’s why I will be proposing legislation when Congress returns to provide mortgage companies with protection against the threat of such lawsuits. I know this kind of policy isn’t particularly glamorous and it probably won’t make headlines. But it will make a critical difference in helping families save their homes and getting our economy back on track.
Lawsuits? Those aren’t the issue. The system is the issue. The Greenspan housing bubble is the issue and having it happen again and again is the issue. Again, Clinton understands the problem but not the solution.
And as the article mentions, Barack Obama is a co-sponsor of the Dodd-Frank legislation, but at least he has a somewhat better take on the fact that more is needed other than stimulus packages and other temporary measures, he seems to understand there’s a major crisis here.
Unfortunately, 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.
Deregulation of the telecommunications sector, for example, fostered competition but also contributed to massive over-investment. Partial deregulation of the electricity sector enabled market manipulation. Companies like Enron and WorldCom took advantage of the new regulatory environment to push the envelope, pump up earnings, disguise losses and otherwise engage in accounting fraud to make their profits look better – a practice that led investors to question the balance sheet of all companies, and severely damaged public trust in capital markets. This was not the invisible hand at work. Instead, it was the hand of industry lobbyists tilting the playing field in Washington, an accounting industry that had developed powerful conflicts of interest, and a financial sector that fueled over-investment.
A decade later, we have deregulated the financial services sector, and we face another crisis. A regulatory structure set up for banks in the 1930s needed to change because the nature of business has changed. But by the time the Glass-Steagall Act was repealed in 1999, the $300 million lobbying effort that drove deregulation was more about facilitating mergers than creating an efficient regulatory framework.
Obama gets it, I think. He understands what’s at the root of the problem and the problem is the system itself. Like the other two candidates the cause of the problem is readily apparent.
Since then, we have overseen 21st century innovation – including the aggressive introduction of new and complex financial instruments like hedge funds and non-bank financial companies – with outdated 20th century regulatory tools. New conflicts of interest recalled the worst excesses of the past – like the outrageous news that we learned just yesterday of KPMG allowing a lender to report profits instead of losses, so that both parties could make a quick buck. Not surprisingly, the regulatory environment failed to keep pace. When subprime mortgage lending took a reckless and unsustainable turn, a patchwork of regulators were unable or unwilling to protect the American people.
The policies of the Bush Administration threw the economy further out of balance. Tax cuts without end for the wealthiest Americans. A trillion dollar war in Iraq that didn’t need to be fought, paid for with deficit spending and borrowing from foreign creditors like China. A complete disdain for pay-as-you-go budgeting – coupled with a generally scornful attitude towards oversight and enforcement – allowed far too many to put short-term gain ahead of long term consequences. The American economy was bound to suffer a painful correction, and policymakers found themselves with fewer resources to deal with the consequences.
Today, those consequences are clear. I see them in every corner of our great country, as families face foreclosure and rising costs. I seem them in towns across America, where a credit crisis threatens the ability of students to get loans, and states can’t finance infrastructure projects. I see them here in Manhattan, where one of our biggest investment banks had to be bailed out, and the Fed opened its discount window to a host of new institutions with unprecedented implications we have yet to appreciate. When all is said and done, losses will be in the many hundreds of billions. What was bad for Main Street was bad for Wall Street. Pain trickled up.
Obama understands the problem is systemic. Good. So what do we do to fix it?
Most urgently, we must confront the housing crisis.
After months of inaction, the President spoke here in New York and warned against doing too much. His main proposal – extending tax cuts for the wealthiest Americans – is completely divorced from the reality that people are facing around the country. John McCain recently announced his own plan, and it amounts to little more than watching this crisis happen. While this is consistent with Senator McCain’s determination to run for George Bush’s third term, it won’t help families who are suffering, and it won’t help lift our economy out of recession.
Over two million households are at risk of foreclosure and millions more have seen their home values plunge. Many Americans are walking away from their homes, which hurts property values for entire neighborhoods and aggravates the credit crisis. To stabilize the housing market and help bring the foreclosure crisis to an end, I have sponsored Senator Chris Dodd’s legislation creating a new FHA Housing Security Program, which will provide meaningful incentives for lenders to buy or refinance existing mortgages. This will allow Americans facing foreclosure to keep their homes at rates they can afford.
Senator McCain argues that government should do nothing to protect borrowers and lenders who’ve made bad decisions, or taken on excessive risk. On this point, I agree. But the Dodd-Frank package is not a bailout for lenders or investors who gambled recklessly, as they will take losses. It is not a windfall for borrowers, as they will have to share any capital gain. Instead, it offers a responsible and fair way to help bring an end to the foreclosure crisis. It asks both sides to sacrifice, while preventing a long-term collapse that could have enormous ramifications for the most responsible lenders and borrowers, as well as the American people as a whole. That is what Senator McCain ignores.
For homeowners who were victims of fraud, I’ve also proposed a $10 billion Foreclosure Prevention Fund that would help them sell a home that is beyond their means, or modify their loan to avoid foreclosure or bankruptcy. It’s also time to amend our bankruptcy laws, so families aren’t forced to stick to the terms of a home loan that was predatory or unfair.
Again, that’s a start, but not enough.
For homeowners who were victims of fraud, I’ve also proposed a $10 billion Foreclosure Prevention Fund that would help them sell a home that is beyond their means, or modify their loan to avoid foreclosure or bankruptcy. It’s also time to amend our bankruptcy laws, so families aren’t forced to stick to the terms of a home loan that was predatory or unfair.
To prevent fraud in the future, I’ve proposed tough new penalties on fraudulent lenders, and a Home Score system that will allow consumers to find out more about mortgage offers and whether they’ll be able to make payments. To help low- and middle-income families, I’ve proposed a 10 percent mortgage interest tax credit that will allow homeowners who don’t itemize their taxes to access incentives for home ownership. And to expand home ownership, we must do more to help communities turn abandoned properties into affordable housing.
The government can’t do this alone, nor should it. As I said last September, lenders must get ahead of the curve rather than just reacting to crisis. They should actively look at all borrowers, offer workouts, and reduce the principal on mortgages in trouble. Not only can this prevent the larger losses associated with foreclosure and resale, but it can reduce the extent of government intervention and taxpayer exposure.
Sigh. Again, this is nothing more than a band-aid so far.
Beyond dealing with the immediate housing crisis, it is time for the federal government to revamp the regulatory framework dealing with our financial markets.
Our capital markets have helped us build the strongest economy in the world. They are a source of competitive advantage for our country. But they cannot succeed without the public’s trust. The details of regulatory reform should be developed through sound analysis and public debate. But there are several core principles for reform that I will pursue as President.
First, if you can borrow from the government, you should be subject to government oversight and supervision. Secretary Paulson admitted this in his remarks yesterday. The Federal Reserve should have basic supervisory authority over any institution to which it may make credit available as a lender of last resort. When the Fed steps in, it is providing lenders an insurance policy underwritten by the American taxpayer. In return, taxpayers have every right to expect that these institutions are not taking excessive risks. The nature of regulation should depend on the degree and extent of the Fed’s exposure. But at the very least, these new regulations should include liquidity and capital requirements.
Second, there needs to be general reform of the requirements to which all regulated financial institutions are subjected. Capital requirements should be strengthened, particularly for complex financial instruments like some of the mortgage securities that led to our current crisis. We must develop and rigorously manage liquidity risk. We must investigate rating agencies and potential conflicts of interest with the people they are rating. And transparency requirements must demand full disclosure by financial institutions to shareholders and counterparties.
As we reform our regulatory system at home, we must work with international arrangements like the Basel Committee on Banking Supervision, the International Accounting Standards Board, and the Financial Stability Forum to address the same problems abroad. The goal must be ensuring that financial institutions around the world are subject to similar rules of the road – both to make the system stable, and to keep our financial institutions competitive.
Third, we need to streamline a framework of overlapping and competing regulatory agencies. Reshuffling bureaucracies should not be an end in itself. But the large, complex institutions that dominate the financial landscape do not fit into categories created decades ago. Different institutions compete in multiple markets – our regulatory system should not pretend otherwise. A streamlined system will provide better oversight, and be less costly for regulated institutions.
Fourth, we need to regulate institutions for what they do, not what they are. Over the last few years, commercial banks and thrift institutions were subject to guidelines on subprime mortgages that did not apply to mortgage brokers and companies. It makes no sense for the Fed to tighten mortgage guidelines for banks when two-thirds of subprime mortgages don’t originate from banks. This regulatory framework has failed to protect homeowners, and it is now clear that it made no sense for our financial system. When it comes to protecting the American people, it should make no difference what kind of institution they are dealing with.
Fifth, we must remain vigilant and crack down on trading activity that crosses the line to market manipulation. Reports have circulated in recent days that some traders may have intentionally spread rumors that Bear Stearns was in financial distress while making market bets against the company. The SEC should investigate and punish this kind of market manipulation, and report its conclusions to Congress.
Sixth, we need a process that identifies systemic risks to the financial system. Too often, we deal with threats to the financial system that weren’t anticipated by regulators. That’s why we should create a financial market oversight commission, which would meet regularly and provide advice to the President, Congress, and regulators on the state of our financial markets and the risks that face them. These expert views could help anticipate risks before they erupt into a crisis.
These six principles should guide the legal reforms needed to establish a 21st century regulatory system. But the change we need goes beyond laws and regulation – we need a shift in the cultures of our financial institutions and our regulatory agencies.
And here is where Obama separates himself from both Clinton and McCain. Indeed, these six principles are all badly needed sea changes to the existing financial system, and that’s the level of overhaul we will have to go through in order to not only get through this current mess but to prevent it from happening again ten years hence. That last one, identifying systemic risk, shows Obama knows the magnitude of the problem and the magnitude of the steps needed to solve it.
And that last sentence — “[W]e need a shift in the cultures of our financial institutions and our regulatory agencies” — is the most succinct and heartening thing I have heard any candidate say about this financial crisis yet. It is absolutely the truth. Obama expands on this point:
Financial institutions must do a better job at managing risks. There is something wrong when boards of directors or senior managers don’t understand the implications of the risks assumed by their own institutions. It’s time to realign incentives and compensation packages, so that both high level executives and employees better serve the interests of shareholders. And it’s time to confront the risks that come with excessive complexity. Even the best government regulation cannot fully substitute for internal risk management.
For supervisory agencies, oversight must keep pace with innovation. As the subprime crisis unfolded, tough questions about new and complex financial instruments were not asked. As a result, the public interest was not protected. We do American business – and the American people – no favors when we turn a blind eye to excessive leverage and dangerous risks.
Finally, the American people must be able to trust that their government is looking out for all of us – not just those who donate to political campaigns. I fought in the Senate for the most extensive ethics reform since Watergate. I have refused contributions from federal lobbyists and PACs. And I have laid out far-reaching plans that I intend to sign into law as President to bring transparency to government, and to end the revolving door between industries and the federal agencies that oversee them.
Maybe, just maybe, Obama understands better than anyone else that the problem is political as well as financial, fiscal, and economic. The endemic Bush outlook of regulatory agencies as the enemy, that regulation is nothing more than an impediment to the free market, and most of all that the free market can do no wrong, is inherently wrong. The free market is still run by powerful people, and those people make selfish and erroneous decisions at times. The ability of the market to correct itself has been tested and been found sorely lacking.
Where McCain does next to nothing and Clinton fails to go far enough, Obama has the best economic plan of the three candidates. Bold action is needed and what Obama proposes is the level of wholesale change that we’ll sorely need over the next four years.
Will the rest of Washington have the same political will to make those changes?
Time will tell.
Be prepared.
