Back to the Roots of the Problem (cross-posted at The Confluence)

I feel a strong need to remind people at this time of the roots of this financial crisis. They are not found beneath Wall Street, but in Washington, D.C. with Freddie Mac and Fannie Mae and the senators and congressman that empowered them.  

The beginning of this crisis was the subprime mortgage market and the loose underwriting standards encouraged by FNMA and FHMLC on mortgage loans.  Fannie (FNMA) and Freddie (FHLMC) are involved with about half of the mortgage loan originations in that market.  Loose standards were set up to expand home ownership to folks who couldn’t pay home loans back and to improve the odds of high compensation for its CEOs.  Before any bail-out, rescue, or whatever you want to call it,  regulation has to be put in place to STOP this from happening again.  It’s really a nice social goal to increase the level of minority ownership in the country and to move the poor into homes of their own, but you can’t force it by giving folks loans they are not prepared to handle.  The House and Senate Democrats, and specifically the Black Caucus, are squarely behind this problem.  It is folks like Chris Dodd and Barack Obama–folks expected to clean up this mess–that were the beneficiaries of Fannie and Freddie largess that created very poor public policy and lack of regulation that led to this problem.

Wall Street did buy up these loans up after they were “packaged” into securities by Freddie and Fannie.  Freddie and Fannie bonds have been assumed to be nearly as safe as Treasury bonds so no one figured there were these toxic loans stuck into the mix.  Banks are also allowed to invest in Fannie and Freddie bonds.  They can’t invest in really risky assets like equities.  Who would have thought that Fannie and Freddie would be so poorly run that what they were investing in, what they were originating and selling to Fannie and Freddie, and what was being put together by Fannie and Freddie, would be so risky as to send their capital into regulator  panicking levels?   Ask Jim Johnson.  Ask Franklin Reines.  Ask Barack Obama and the Black Caucus.  They felt prudent underwriting was basically discriminatory and worked hard to change banks into speculators.

Here’s some examples:

Credit History: Lack of credit history should not be seen as a negative factor…. In reviewing past credit problems, lenders should be willing to consider extenuating circumstances. For lower–income applicants in particular, unforeseen expenses can have a disproportionate effect on an otherwise positive credit record. In these instances, paying off past bad debts or establishing a regular repayment schedule with creditors may demonstrate a willingness and ability to resolve debts….

If you’d like to know more about the loosening of standards,  here’s a really good study to check out:  http://johnrlott.tripod.com/Liebowitz_Housing.pdf

Recently, there were an entirely inexcusable number of underwriting lapses allowed and in fact, encouraged  by Fannie and Freddie (including spurious sources of income and no down payments) that increased the demand for housing by allowing people that should not have been in the housing market, into the housing market.  This drove up prices and led to the bubble and increasing speculation.  Once it became apparent, that there was increasing risk popping up in mortgages,  the financial innovations of derivatives (Wall Street enters now) popped up to help banks manage the risk and pass them on to folk supposedly more able handle the risk.  These things were supposed to act as insurance and were valued based on the idea that traditional Fannie and Freddie were very risk-free and there was implied government oversight, regulation, and back-up.

It is no wonder that the FBI is now looking at Fannie and Freddie.  It should also look at the democratic appointees and the senators and congressman that enabled them.  When credible economist like Greg Mankiw came to the senate and congressional committees to warn of this problem in 2003, folks like Barney Frank yelled at him for worrying more about safety and soundness rather than housing for the little guy.  The Wall Street Journal was all over this back then. 

http://online.wsj.com/article/SB106851042414562400.html?mod=googlewsj

This is the same Barney Frank that is bloviating and stomping his foot about the inability of House Republicans to get with his program.  Well, Congressman, it was your program that put us in this position to begin with so why would we trust you now?

House and Senate Democrats also had a chance in 2005 to increase oversight and regulation of Fannie and Freddie.  John McCain was a co-sponsor of this bill called Federal Housing Enterprise Regulatory Reform Act of 2005.  At the time McMcain made this comment that seems almost psychic now.

“If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.”

You know how Senator Obama is going around saying the Bush administration is the one that hates regulation and led to this?  As a professional economist and Puma, may I just say this: liar, liar pants on fire!

 WASHINGTON – Treasury Secretary John Snow urged Congress to restrain Fannie Mae and Freddie Mac, giving the Bush administration’s blessing to efforts to create a new regulator with broad power over the huge mortgage companies.

http://www.ocregister.com/ocr/sections/business/business_nation/article_473273.php

If you read the article, you’ll see that Allan Greenspan was also in front of congress and the senate begging for more oversight.

More from that article:

“The statements by Greenspan and Snow lent support to a new effort by Republican lawmakers to tighten controls on Fannie Mae and Freddie Mac, which hold or guarantee more than 45 percent of all mortgage loans in the country. Legislation recently proposed would set up a regulatory agency with the power to compel the companies to sell off any assets deemed not to be in line with their mission of making homeownership more widely available.

Notice the guarantee point.  Wall Street and Banks rely on these instruments to be low risk basically because of that guarantee.  This includes AIG and all the investment banks that just crashed.  They undervalued the risk on these instruments because of the implicit guarantee.

My point here?  Congressional republicans (who I usually find a source of great evil) are NOT the bad guys here for once.  They tried but were told they were racist and that they hated poor people if they didn’t go along with the plan of extending house loans to people that basically could not afford them.  Most of the blame for this financial crisis belongs squarely in Washington and the Democrats are relying on our extremely short memories.  Since all of this comes under my teaching and research responsibilities, I cannot have a short memory. The MSM should start asking Biden, Obama, Frank, and Dodd some very tough questions.  First Questions?  Why didn’t you support regulating Fannie and Freddie back before all of this snowballed into a financial crisis?  Why are you now saying that you always supported more oversight and regulation and Republicans and the Bush Administration did not when the record clearly shows it was the opposite?

I’d like to suggest one of the first CEOs to turn back his salary and face the FBI is Franklin Raines.

He turned Fannie Mae into a mortgage factory to get higher bonuses and was investigated for cooking the books.  He is undoubtedly one of the folks that has interested the FBI.  Another person is Jim Johnson. (You’ll recognize these names because they are both Obama friends and advisors).

In late 2004, Fannie Mae was under investigation for its accounting practices. The Office of Federal Housing Enterprise Oversight released a report  on September 20, 2004, alleging widespread accounting errors, including shifting of losses so Raines and others could earn bonuses.

In June 2008, the Wall Street Journal reported that two former CEOs of Fannie Mae, James A. Johnson (1991-1998) and Franklin Raines (1999-2004) had received loans below market rate from Countrywide Financial. Fannie Mae was the biggest buyer of Countrywide’s mortgages.  Don’t forget the three biggest recipient of FNMA money are Dodd, Kerry, and Obama. Dodd also appears to have a sweetheart mortgage deal.  The Democrats are not the white knights in this mess.  They would probably like to get this deal through as quickly as possible so voters do not find out that the bailout is not just a Wall Street Mess.  It is a K Street and Washington-created mess.  There is plenty of blame and greed to go around.

The very same people that created this mess are the ones writing the terms of the bail-out.  Be afraid!  Be very afraid!  I never put a steak on the kitchen counter and leave the dog alone in the room with it.  I would not leave the U.S. economy in the hands of these folks who are deciding the fineprint in a room with closed doors either.


None of the Above …

As this depressingly stupid but important presidential election drones on, I have to say I’m more inclined to opt out by the day.  There are simple truths that both campaigns are avoiding.  Perhaps it is true that common sense is a most uncommon trait.  Let’s look at just a few things my mother taught me that I thought was pretty much common sense.  I wasn’t sure if she got them all from Dear Abby or if they were under the collection of  old wives’ tales, but damned some body in these campaigns needs their mom to tape some old copies of Dear Abby to their bedroom mirrors.  Just like my mom did for me so that I would develop some common sense. 

First, I was taught that People in Glass Houses shouldn’t thrown stones.  That means if every one supporting Senator Barack Obama is going to criticize Sarah Palin for lack of experience, they better take a good long, hard look at the top of the ticket.  Which is worse?  An inexperienced Presidential candidate with a Washington Hack at the second position or an inexperienced Vice Presidential candidate with a Washington Hack at the top of the ticket?  You decide. 

Second, I was taught to not open my mouth when I don’t have a clue what I’m talking about.  Neither McCain or Obama seem to know enough about the economy that either of them can answer questions without sounding clueless.  Maybe I’m being hypercritical here since I am a financial economist, and what’s going on is right up my area of expertise, but PulEEZE tell me that one of these candidates had your basic macroeconomics and microeconomics courses somewhere on their college transcripts?  Oh, right, we have NO idea about that because Obama won’t release his … and McCain was busy crashing planes and trying not to be absolutely dead last in his class.  I’m not expecting a Rhodes Scholar for President, but … wait, we did have a Rhodes Scholar, as I recall, and things went pretty well then … maybe we SHOULD start asking for candidates that did their homework for a change.

Third, I was taught not to talk out both sides of my mouth.   McCain has evolved into a Teddy Roosevelt Republican who likes government oversight seemingly overnight.  None of his primary stump speeches would’ve lead any one to that conclusion.  Obama has taken so many sides on one position, I feel like that little green possessed girl in The Exorcist every time I hear another speech.  I mean, really, how many sides to a single issue can there possibly be?  Obama seems to find a new one with every new audience.

Fourth, i was taught if you keep on lying it increases your chances of being caught and that people really NEVER trust anything a liar says.  I don’t even know where to begin here.  The first thing thing that comes to mind though is the Obama interview with O’Reilly.  He just keeps brushing off those specious friends of his. They just folks he knows in his neighborhood.  That was it, these are the people in his neighborhood, in his nieghborhood, in his neighborhood … yes these are the people in his neighborhood, they’re the people that you meet each day.  I mean, right, we all have thousands of folks we know, and each of know at least one person who tried to blow up the pentagon and was sorry they didn’t blow up more buildings, another person who is in jail for corruption and fraud, yet another person who says Goddamn America and blames the country for 9-11 … sheesh, I know I’m highly odd, that I don’t have any friends like this?  and I mean… you do, don’t you?  Then there’s this week’s McCain thing: the fundamentals of the American Economy are strong and what I meant was the American workers are the most productive in the world.  Yeah, right, that’s not a non sequitur there.

Fifth, I was taught Birds of a Feather flock together.  Neither of these candidates can say they are outsiders looking in on the current financial crisis.  Senator Obama with his limited amount of time in Washington is the number two Senator to get funds from both Fannie and Freddie.  Penny Priztker is the mother of the subprime mortgage meltdown as well as his finance chair.  Half of his finance committee has major connections to most of the big players in the current housing bubble and investment banking blow up.  John McCain relies on Phil Gramm for advice.  Puhleeze!  You think we don’t know if you weren’t part of the problem you at least turned a blind eye to it?  Or were so busy on the campaign trail you wouldn’t even have known what was going on even if you read the news?

This has to be the worst set of candidates I have ever seen or heard of in U.S. History. Why can’t we just have some folks that show a little decency, wisdom, and common sense?  If we don’t get some primary election reform soon, I’m going to expatriate to some place that appreciates democracy pretty soon.  It’s a lost art form here. 


DNC Assimilated by the Oborg

Thursday’s Washington Post stated that the hopium-infused platform of the DNC was the final frontier of assimilation of the DNC by the Oborg.

http://voices.washingtonpost.com/the-trail/2008/08/07/by_jonathan_weisman_barack_oba_1.html

Democrats Release Platform

By Jonathan Weisman

Barack Obama’s takeover of the Democratic Party is nearly complete.

A draft of the Democratic National Committee’s 2008 platform was sent
this morning to platform committee members, and aside from some nods
to the losers, Hillary Rodham Clinton and John Edwards, the 54-page
document reads like a compilation of Sen. Obama’s stump speeches.
There is a section on fatherhood, a definition of patriotism (not
only to declare our love of this nation, but to show it), a section
detailing Obama’s newly rejiggered economic stimulus plan, a call for
more service, through an expanded AmeriCorps and Peace Corps, and a
whole lot of hope.

“It is time for a change,” declares the draft’s preamble.

I don’t know how you feel, but I’m not sure I need the democratic party to define parenthood or patriotism for me.  I look to the DNC platform to define programs and governance approaches.  Senator FeelGood’s patronizing lectures to Americans have now been infused into the platform.  There is also the pander section for Edwards and Clinton backers.

For Edwards, who has bigger issues to deal with at the moment, the DNC makes good on Obama’s pledge to him to elevate poverty eradication as a policy goal. “Working together,” the platform states, “we can cut poverty in half within ten years.”

And Clinton is the star of the platform’s section on expanded opportunities for women.

“”We have produced [the] first woman Secretary of State, the first woman Speaker of the House of Representatives, and, in 2008, [with] Hillary Rodham Clinton, the first woman in American history to win presidential primaries in out nation,” the platform states.

Again,  I feel patronized.  After the nasty campaign tricks used on Senator Clinton, the appalling performance of Speaker Pelosi, and then a nod to Clinton-ally Secretary Albright, I’m not sure how to re-act positively to this.  It appears to be a second hand compliment rather than a true statement of support for women in high places. There are strong statements supporting women’s reproductive rights as well as statements against government encroachments on privacy and constitutional rights.  These too, sound hollow after recent actions and statements by Senator Obama.  Afterall, he just voted to protect those telecoms that helped President Bush spy on American citizens and also mentioned that he thinks women tend to get THIRD term abortions because they feel blue.

Some one needs to step in and save the democratic party from itself.  Unfortunately, I think that could have been Bill Clinton but with this Stalinesque purge, it’s unlikely the hopium-addicted will come out of the fog before the fall election.  By then, they’ll be screaming every one’s a racist as we transition from President Bush to President McCain.


Who Really Supports the Bush-Cheney Energy Plan?

John McCain seems to be gaining traction on Barack Obama in a large part due to the energy crisis.  Senator Obama stumbled by suggesting that we could save the amount of fuel generated by new off-cost drilling simply by maintaining the correct tire pressure for our cars. I remember this energy saving tip was provided as a public service announcement by Mario Andretti back in the day.    For some one who is running to solve some of our country’s biggest problems, it simply didn’t seem too, well presidential. It seems more like a topic for Hints from Heloise.

The Obama campaign must have gotten the message that these household hints during speeches aren’t a substitute for specifics on national energy policy when the McCamp camp started handing out tire gauges with ‘Obama’s energy plan’ emblazoned on the sides.  Obama immediately responded with both an ad and a very long speech.  The few specifics layed out by the plan aren’t very earthshattering. I already attacked one of his suggestions as simply bad economics in my blog yesterday.  Any tax placed on the sellers of a price-sensitive product will be passed on immediately to the buyers.  So, the suggestion of a $1000 tax rebate to the taxpayers based on windfall profits will just eventually come from higher prices at the pump.  So, you get a rebate with one hand and you get higher gas prices with the other hand.  Since we’ve never seen an Obama transcript, I’ll just have to speculate that he never took Economics 101 or 102.  I should know because I’m a professor of economics and I teach those classes.

I reviewed Obama’s ad yesterday and found one attack on McCain.  This was the charge that McCain is simply supporting the Bush-Cheney Energy plan.  I checked into the voting records for the 2005 Bush Cheney Energy plan and found something astounding.  McCain voted against it.  Obama voted for it.  It didn’t take long for McCain to pick up on this.  i heard a McCain speach today in Lima, Ohio pointing out that Obama voted FOR the Bush-Cheney Energy plan while he voted against it.  The Bush-Cheney Energy plan was generally seen at the time as a series of huge handouts to petroleum interests.   So, how is it that Obama voted for it and McCain voted against it?

McCain policy advisor Dough Holtz-Eaken had this to say in a press release reprinted by the Chicago Sun-Times.

While distorting John McCain’s vision for energy independence, Barack Obama is also misleading the American people when he says John McCain supported the Bush-Cheney energy policy. Let there be no mistake: the only candidate who voted to give tax breaks to Big Oil is Barack Obama when he supported the 2005 Bush-Cheney energy bill that gave $2.8 billion in subsidies to the oil companies. John McCain voted against this bill for the very reason that he opposed these tax breaks to oil companies and as president he will ensure their repeal. While he may decry them on the campaign trail, Barack Obama had no problem standing side-by-side with the oil companies while in the United States Senate.

http://blogs.suntimes.com/sweet/2008/08/mccain_policy_advisor_doug_hol.html

I’ve seen the ad playing on CNN.  This has to be a misstep by the Obama campaign.  Why would you actually bring attention to such an obviously questionable charge?  A quick check of campaign contributors also shows that Obama has also taken a lot of money from Big Oil as has the McCain campaign.  Why would you charge your opponent with being in the pocket of big oil with such an obvious elephant in your own room?  (And this could be that Obama, at the time, voted more Republican than McCain) Senator Obama must think the press will cover for him by not pointing out the obvious about the contradictions in his behavior and campaign rhetoric.

Taking on high oil prices is going to play much better in Peoria and Omaha than giving speeches in front of German Victory monuments shouting out with “I am a citizen of the world”.  I can really see a McCain ad coming with this contrast set out for those of us living in the big fly over.

Once again, we see the Audacity of Hype.

The McCain Ad:

and the Obama response:

Again, linking McCain to the Bush-Cheney Energy plan when McCain voted against it and Obama voted for it, seems an odd tactic.  I think this will back fire big time if there’s actually some discussion of the facts-on-the ground.  I’m sure the RNC is just waiting for the DNC convention to nominate this clearly in-over-his head candidate before the attack ads start in full.

Please, delegates, run away from an Obama nomination as quickly as possible.


Obama’s Gas Tax Rebate: A flip flop that’s just Bad Economics

I was some what surprised that Senator Obama proposed rebating consumers $1000 for gas purchases given that he heavily criticized both Senator Clinton and Senator McCain for this just months ago.  He criticized their plan as simple gimmicks that pandered to voters.  Well, it was probably just more symbolic than effective, but at least it did no harm.

Senator Obama’s suggestion appears to have a punishing impact on oil companies which I suppose has an added pandering punch.  My 18 year-old freshmen, first year, macro-economics students could tell you why this is just plain bad economics  If you take $1000 per consumer in taxes from Oil Companies and think you give it to consumers and it stops there, you need to go take some college economics.  This is a complete no-brainer that any entry level micro or macro student should be able to shoot down.  I’m going to try to explain this to you intuitively so you can shoot it down too.  I promise I’ll avoid the supply and demand curves in the process.

Any time you place a tax on a good or service, it is important to know how sensitive the demand for that good or service is to price changes.  This concept is called ‘elasticity’ of demand in microeconomics and it is one of the first things you learn as an entering freshmen in your economics 101 classes.  The demand for some goods are quite price sensitive and others are not.  It’s really dependent on a number of things, but the bottom line is just this:  Is it easy to live with out this good?

Perhaps the most price sensitive good is a drug that you are either addicted to or need to live.  There is absolutely no price that will stop you from demanding that good because it means death or extreme withdrawal.  This is why drug dealers frequently give their drugs away to start with, then gradually increase the price.  They know once your hooked, you’ll give up every thing else to maintain the high and eventually even steal or prostitute yourself to earn the money to by the drug.  If you’re a diabetic and you need a certain level of insulin to stay alive, you will have to do the same. You will die without the drug so consuming other goods and services come after what you have to do to pay for the insulin.

Oil does not have the same price sensitivity as an addictive drug or a drug you need to live, but in the short run, it is very price sensitive.  This is because most folks need to drive to get to their jobs, schools and errands.  You can’t just change to a more fuel efficient car immediately, because that is very expensive, so you have to adjust your behavior to pay for the increased cost of gas.  First you try to drive less.  Then you start giving up other things to buy the gas.  Still, you’re stuck with a certain number of miles you have to drive.  At that point, you just have to suck it up and pay for the gas.

If you tax these price sensitive goods, it’s just like raising the price of them.  This is because there is a certain amount the consumer must buy.  They are stuck with whatever cost the seller wishes to charge which can include a large portion of a tax placed on the seller. The tax on goods with demand that is insensitive to price just basically causes an increase in cost passed to the consumer.  This also means if there is a tax placed on the provider of this price insensitive or “inelastic” good, it is very easy for that provider to pass that tax on to the consumer.  This is because the consumer basically will not have that many alternatives other than to suck it up and buy that same amount of gas every week.  The consumer will have to forgo other goods and will put more of their income towards buying gas.

This is what will happen if Senator Obama’s gas tax on Oil Companies would come to fruition, which is highly unlikely even with a very democratic senate.  The cost of the tax to the producers will just be passed on to the consumers of gasoline in the form of higher prices. This means soccer moms, truck drivers, and truck fleets delivering goods to your local stores.  You may get the $1000 back in a check, but you will pay for it every place else in higher prices. How much that higher price is will depend on the sensitivity of your demand to that good.  For necessary items like gas and food, it will be a lot.  For goods you can live with out, like luxury items, it will be less.  So what this really does is transfer the ‘burden’ of the tax to the heavy users of the most necessary items.

I could use fancy graphs and models to show you how much this would cost.  I’m assuming probably some economists are doing this somewhere and you will hear shortly about the numbers they’ve come up with.  However, I just hope you’ll understand on a very basic level what a very bad idea this is; no matter how appealing it sounds.

I have to tell you that I do not have any sympathy for gas and oil companies which enjoy near monopoly power with a very price insensitive good.  I believe we need to do something with their market structure or place some demands on them if we grant them more drilling rights. However, the idea of taxing them to rebate money to consumers is not a good one.  In the long run, it’s just going to cost you and me.  It’s basically just giving with one hand and taking with the other.