One of the things that almost went unnoticed was when White House Chief Economist Christina Romer went on "Meet the Press" last Sunday and said, "Of course, the fundamentals [of the economy] are strong", following Obama's own words days earlier regarding "all the fundamentally sound aspects of our economy". And how did Romer describe those fundamentals? "The American workers."
Does this sound familiar? It should. During last year's campaign, on September 15, McCain insisted that "the fundamentals of our economy are strong" and then later in the day clarified his remarks: "My opponents may disagree, but those fundamentals, the American worker and their innovation, their entrepreneurship, the small business, those are the fundamentals of America and I think they're strong."
And just how did Obama respond to McCain's message? "Out of touch." "Stubborn." "Incapable of understanding" the economic crisis. You know, the kinds of words that embody the Obamaian ideals of non-partisanship, mutual respect, and a different tone in Washington.
After a de facto bear market by itself just in this year alone (a 20% drop in the stock market), weeks of talking down the economy and a sharp jump in the unemployment rate and the budget deficit, Obama has finally come to the same conclusion McCain came to 6 months ago. That's leadership for you. I wonder if Obama was honest with himself, would he evaluate himself to date as "out of touch", "stubborn", and incapable of understanding the economic crisis?
Presentism
I think one of the rituals of every election is that each candidate soberly tries to convince the voters that the challenges he or she faces are the most daunting in the history of the republic and the candidate has just the right knowledge and skills to lead us out of the morass.
However, one could beg to differ. For example, when FDR took office, two-thirds of the states had closed their banks, millions were homeless, a quarter of the workforce was unemployed, and industrial production and farm prices had contracted by over half, devastating farmers.
There is a similarity in the strident populism espoused by FDR, McCain and Obama: the need to create a bogeyman, the greedy, corrupt capitalists run amuck. In a certain sense, just as there are unfounded conspiracy theories regarding the assassination of JFK or even the events of 9/11, there is this feeling that the housing bubble and its burst were somehow mastermined by a conspiracy of moneyed interests.
But in fact is that just a few people can cause disproportionate impact; they skirt about the soft spots in our regulatory systems and are often exposed only when they are cornered by overwhelming circumstances. A case in point is Ponzi schemer Bernie Madoff whom did not have the liquidity to cover mass redemptions. Another example is the rogue currency trader Nick Leeson in 1995 whom single-handedly brought down vunerable Barings Bank, founded in 1762. Leeson was supposed to hedge his trades (to minimize downsize risk) but emboldened by initial winning trades, began making riskier bets and started losing. Largely unsupervised and using a hidden account to mask his accumulating losses, Leeson was basically exposed by the Kobe earthquake in early 1995 and a collapsing Asian market, resulting in a $1.4B shortfall.
No doubt the response of Obama and other demagogues is to demonize the regulatory system (or alleged lack of a regulatory system). Yes, there are lessons to be learned from the examples of Leeson and Madoff. It involves the need for proactive vs. reactive management and control, and individual or business trust is subordinate to auditability of transactions.
I learned a related lesson years ago when I discovered students cheating in my classes at UWM and UTEP. The students seemed more concerned with their loss of face in being caught than in admitting what they did was wrong. They were more interested in how I caught them, no doubt so they could work around my methods. Regulations are similar in nature; they are necessary so we can make contracts in good faith and enforce them.
I also once shared an office at the University of Houston with an MBA student whom couldn't solve the most basic problems in managerial finance and had come to me for help. I had earned an A under the same professor and knew he gave wicked multiple-choice problems. What I didn't know is that this professor was reusing exams between semesters, and there was a small black market selling the exams to a select number of students to avoid detection. So the same student told me how he had finished his first exam in 5 minutes, purposefully marked one of his answers wrong and turned in his exam a half hour later. I was troubled with what I heard and sought to tip off the professor, more in terms that unnamed students had access to his old exams. At first, the professor's response to the situation was that the students were showing laudable initiative and implied there wasn't that much he could do about it. I suggested that perhaps he could invite some of the stellar students to the blackboard to show the rest of the class how they went about solving the problems. A few weeks later, the same professor, visibly shaken, stopped me in the hall and said that he now understood what I was talking about, and he was taking steps to remedy the problem. The issue here was not so much the fact of the black market but the culpablity of the professor in being too lazy to rewrite exams between semesters, and certain students exploited that vulnerability. I myself have no problem with students looking at old exams--but there's a difference between learning from taking a practice test and memorizing an exam key.
What we know is the housing bubble was caused by too much money chasing a limited number of houses. In latter phase of the cycle, this was made possible by making cheap money available to new buyers not qualifying under traditional criteria, such as 20% down. Loan gimmicks emerged to service this new class of risky buyers, fed by easy funds from the government and also foreign investors snapping up mortgage securities and T-bills. This was never going to end well, just as Madoff admitted the exposure of his Ponzi scheme was just a matter of time. Even with a modest regression back to historical mortgage rates, the terms of these loans would overwhelm lower-income homebuyers. All of this depended on interest rates remaining under historical norms for an extended, indefinite period of time, during which new homeowners hoped that their incomes would rise sufficiently to accommodate higher payments or they could sell out for roughly what they paid for the property. In fact, in more than a few cases, with no down payment and declining property values, homeowners were in a de facto negative equity position, with heightened risk of default to the note holder.
Several people, including myself, were insisting years ago that these assumptions were unrealistic. But politicians from both parties were in a state of denial. In particular, the Democrats had no incentive to jawbone lower-income Americans from taking on gimmick mortgage loans and thus participate in the American dream of homeownership. No, if anyone is to blame, it's the "greedy" lender, not the real estate agent, whom looked the other way when the bad faith homebuyer misrepresented his or her credit record and/or ability to pay on his mortgage, fast-talked him buying a home he really couldn't afford.
Does that mean the lender was not blameless? No, he had a responsibility to the bank and its shareholders to perform due diligence on creditworthiness of the buyer. In turn, the secondary market, in buying the note, had a fiduciary responsibility to its investors and other partners. (In particular, I'm referring to Fannie Mae and Freddie Mac, which as GSE's have had access to low-cost funds from the Treasury and hence put taxpayers at risk.) But unlike McCain and especially Obama claimed, it wasn't a just a failure of "greedy" capitalists. For example, I don't think Leeson intended to bring down Barings Bank. He got undisciplined and then dug himself into an even bigger hole by compounding speculative currency bets. He had deluded himself into believing his trading skills alone could make him whole--not unlike addicted gamblers running amuck in Las Vegas. There are few "sure bets" on currency trades other than the parties servicing the trade, like the vendors selling Levi's or pans and shovels during the California gold rush. (And even parties servicing trades find it difficult to make profits with lower volumes and/or increased competition.)
There were multiple points of failure with various parties not engaging in due diligence and no one wanting to admit the emperor was wearing no clothes.
The Comparison with FDR
Whereas the frenetic pace of spending initiatives under FDR has a parallel under Obama's, there are distinct differences. First of all, FDR had run against the federal deficit and did things like slash federal salaries, cut the military budget, even attempting to reduce military/survivor pensions. There was no attempt to misrepresent funding of public sector positions (e.g., for state and local positions) as a macroeconomic stimulus. Obama, on the other hand, through the stimulus and omnibus budget bills, expanded some agencies by up to 500% and then added roughly 8% in operating budgets beyond that.
Second, FDR made getting banks operational his first priority. Presumably we'll see Geithner start to flesh out his proposal this coming week--in the aftermath of Obama scapegoating the greed of banks and other financial services companies in attacking the AIG bonuses. This is on top of the stock market tanking another 20% this year under Obama, clearly reflecting the market's lack of confidence in Obama's approach, which seems to be based on punishing sources of growth, e.g., higher investment taxes and higher marginal income taxes on job creators.
Third, FDR struck a more positive message at his inauguration, i.e., "the only thing we have to fear is fear itself." It is true, of course, like Obama, he refused to work with his predecessor in the waning days of that administration, and he also blasted the greed of Wall Street.
Fourth, FDR's social net was relatively modest. For example, at the beginning of Social Security retirement, there was something like 16 workers for every recipient.
Finally, FDR had more of a concept of shared sacrifice, e.g., war bonds and rationing. I'm certainly not advocating steps like rationing. But Obama has been focusing on revenue raisers like investment and upper income tax rates, particularly for the top 5% of American workers, and income redistribution: Obama made a priority of increasing the percentage of households paying no net federal income tax to almost half and increasing the amount of federal credits and programs to the same population by significant numbers. Thus, Obama is shoving the idea of sacrifice strictly to upper-income households. He has attempted to justify this on ideological grounds of "class exploitation".
