Who would have been much tougher opponent for McCain? A pro-military, pro-growth JFK-style Democrat. There aren't any today in the Senate. Even Ted Kennedy isn't a JFK Democrat. I would say probably the toughest competition would have Senator Ben Nelson or Governor Bill Richardson (with a more constructive Iraq perspective). They've both had gubernatorial experience with more moderate, fiscally conservative records. The problem is that someone like Bill Clinton, a centrist governor, could not make it past today's Dem liberal bloggers and activists. Not one national Democratic candidate took a more centrist position on Iraq, e.g., we'll give the surge 6 to 9 months to work, and the Administration is not going to have a blank check. Instead the Democrats went for "all-or-nothing". Not one of them--certainly neither Obama nor Clinton--seemed to hedge their bets in the event the surge turned out to work. They argued that the surge wouldn't work--and now Obama has permanently lost credibility as a potential Commander in Chief.
McCain's vacillating positions last week (e.g., his position on AIG and his populist rhetoric on the strength of the American economy and workers) and his scapegoating of Big Business and SEC Commissioner Christopher Cox were incoherent and lacked the sureness of his earlier deft reaction to the Georgian invasion crisis. However, I thought he recovered somewhat by outmaneuvering the Obama campaign late last week, which I think was content with letting McCain overplay his hand, only to be caught empty-handed as Obama continued to study the matter--and then scream that McCain had stolen some of their best ideas!
Bashing Wall Street Greed?
First of all, ENOUGH of McCain and/or Obama bashing "greedy" Wall Street. Personally, I see the whole thing of CEO compensation as little more than than a "good old boy" network. I do not like golden parachutes, mostly from the perspective it's unfair to shareholders. I think most people with a million dollars in T-bills and blue chip dividend-paying stocks are probably set for life. I mean, really: how many houses do you need to live in? How many cars can you drive? Warren Buffett, one of the richest men in the world, reportedly still lives in the same simple house he bought years ago and drives an older, unassuming vehicle. I think, perhaps, the accumulation of wealth is a way of keeping score. But I don't think you should blame "greed"; it's more likely these companies were selling increasingly complex financial instruments (derivatives, etc.) where it was difficult to get at the underlying asset and to properly valuate the risk.
I remember around 3 years back hearing reports of people flipping Florida condos before the condos were even completed. I've lived in Silicon Valley, the better suburbs in the Chicago area and in the Baltimore/DC area with houses starting near the $450K level--almost 10 years ago. If you take into account the median household income last year was just over $50K, and income growing slower than housing prices at the time, a lot of us were talking about a housing bubble, just like sky-high Nasdaq prices and unprofitable Internet companies were claiming a new stock market paradigm as we heralded the new century.
I think it's more of a mixed message here. Clearly, there is some business culpability here. People like myself have been saying for years this is a crisis waiting to happen. Anyone who has ever taken a management finance course understands the concept of diversification of risk. But risk goes beyond spreading across, say, a basket of mortgages. The reason is because mortgages themselves share a systematic risk, namely the housing market. The housing market, like any market, goes through corrections. You can possibly gain additional return, but only at greater risk.
I have not worked in the financial services sector, so I cannot speak to what kind of simulation modeling went into instruments like derivatives. Presumably they had priced products in part based on simulations through, say, the early 1990's correction in the California housing market and/or elsewhere. And I don't doubt, in a falling market, these instruments could be difficult to unwind with no buyer willing to catch a falling knife. Did CEO's of these firms knowingly take on greater risk at the top of the housing market? I don't think so. For one thing, it's always tough to call market tops, and I don't think they want their legacy to be having presided over the sudden collapse of a prestigious Wall Street firm.
I do not disagree that Wall Street should pay a price for taking on undue risk, and company officers should man up and accept responsibility for what has happened to their company and their part of it.
Other Villains
- Homebuyers. Buying homes beyond one's means and accepting "too-good-to-be-true" terms like no money down or variable interest rates, with teaser rates below historical norms. If you can't afford the upper-limit mortgage payment, you don't buy the house, but wait until you've saved enough to afford a fixed-rate mortgage and terms that you can afford. This is not an investment--it's your home. I do not buy into the Obama rhetoric that consumers need a nanny state to keep them from making a bad decision. A foreclosure is a terrible personal tragedy.
- Primary Mortgage Lenders. Resorting to sales gimmicks to sell loans that the homebuyer really can't afford with no collateral, no deposit, no emergency funds in the event, say, of a job loss? What happens if the new owners end up with negative equity and talk away from the loan?
- Secondary Market: Fannie Mae/Freddie Mac. These GSE's are rightly criticized by John McCain for being undercapitalized and owning too big a chunk of the $12T US market. Their implicit government guarantees are really what put the government on the hook for a bailout.
- The Congress. Clearly there had been political pressure for the mortgage lenders to extend loans to lower-income Americans whom really couldn't afford to buy a home. Also, despite warnings by McCain and the Administration, the GSE's were allowed to get too big and basically took away business from the private sector by using access to cheaper government money.
- The Federal Reserve. Did easy money from the Fed Reserve goose up the housing bubble like it did the overheated Nasdaq during the over-hyped Y2K process?
- Regulation. I do not mean this in the demagogic sense of Democrats, that somehow in allowing new businesses/models to emerge, the GOP opened Pandora's box. I haven't read the audited financial statements of the companies in question, e.g., Bear Stearns, Lehman Brothers, and others, but before the sudden collapse, only 1 of 19 analysts following Lehman rated it an underperform or sell. Was there a problem with underlying financial statements? Was this an unanticipated liquidity issue for which the government had no contingency plan, e.g., like a bank run? Are accounting methods and/or financial reporting requirements aggravating the problem?
McCain's Missteps
- The Mixed Messages About the State of the Economy. "Fundamentals of the economy are strong." "I believe in the American worker." This was so muddled, I have no idea what it means. What does the American worker have do with the general state of the economy? Is he saying that recessions come about when the American worker slacks off? McCain needs to realize he cannot out-demagogue a Democrat. McCain also needs to give credit to American entrepreneurs, businesses, investors, and consumers of goods and services. I'm not a politician, but here's what I would have said, "There Obama goes again, ladies and gentleman. Running down the economy-AGAIN. Is that what America wants in a leader? Someone who knows how to criticize the economy without any constructive solutions? Where's the hope? Where was this guy when I told the country Fannie Mae and Freddie Mac were too big and inadequately capitalized? Could it be because he got a sweetheart mortgage rate on the jumbo loan for his $1.6M mansion? Did he jawbone Senate Banking Committee Chris Dodd over his sweet mortgage deal with Countrywide? When did he decide Lehman Brothers and Fannie Mae and Freddie Mac needed more regulation? After he cashed their campaign checks and considered their advice in picking Joe Biden? But to the point at hand, look: in the last quarter, we experienced a 3.3% growth rate, which is better than many of our European allies. We are facing a serious challenge to our financial services industry, fundamentally based on liquidity problems in the mortgage market. We've faced challenges before; the Administration is proposing a solution. What we need to do is be careful that we don't make a habit of bailing out industries and companies. A meltdown in the financial sector affects more than just a few Wall Street firms but could cause mayhem in the overall economy. We have to worry about these problems spreading to other areas of the economy."
- Against the AIG Bailout, For the AIG Bailout. This is awkward. It makes McCain look impulsive and indecisive, the exact opposite of what we got from McCain's sure-footed response to the Russian invasion of Georgia. I think if AIG was just one of a bunch of blackberries, and the other blackberries were healthy, you could justify letting AIG die as the result of bad management decisions. However, when you see AIG and the financial services industry all sinking at roughly the same time, I just don't believe it's the disease, but a symptom, the symptom being due to a crisis in mortgage liquidity. I mean, were these players responsible for writing and approving subprime mortgages?
- For the Termination of SEC Commissioner Cox? This looks like McCain is making Christopher Cox a scapegoat for the sins of a housing bubble that he himself did not preside over. Is McCain saying Cox fell asleep at the switch, that the SEC was not conducting its work with respect to the financial services industry with due professional care? I think I share Rush Limbaugh's opinion here that McCain threw Cox under the bus.
- Deregulator or Regulator? I don't think that McCain has responded effectively to Obama's implicit allegation that this crisis was due to deregulation and McCain likes to be known for deregulation. I think McCain should have responded by noting he was not talking about necessary regulation but market-interfering regulation. He should then have counterattacked that the solution to the current crisis was not to micromanage the financial services industry, which reflects the counterproductive approach of Democrats in general, obstructing the globally competitive rebuilding of the financial services sector. Similarly, McCain by insisting on low taxes does not argue for the elimination of taxes but just enough taxes to effectively meet necessary government goods and services.
Conclusion
I thought that given McCain's nomination acceptance speech openly talked about tough times for families, he would be given more of a break by Obama and the media, and his talk about the fundamentals of the economy being strong was more of a general expression of confidence in the resilience of the economy to prevail over difficult challenges. Instead, it seemed like Obama used the quote to attempt to suggest, once again, that McCain was "out of touch".
It looks as though there's been about a 7-point swing in the national polls since the financial services meltdown, with Obama holding about a 4-point lead nationally. This is not bad given the circumstances.
I am encouraged the framework McCain outlined last Friday: (1) the MFI, a proactive financial services and mortgage authority; (2) improved transparency for financial services firms; (3) an integrated regulatory structure, free of bureaucratic turf battles; (4) regulation against misleading investment and mortgage lending contracts, pressure sales tactics, and promotional gimmicks; (5) a standarized approach to government assistance and bailouts; (6) limit the scope of the Federal Reserve to its traditional role, not taking the lead in bailouts.
