The economy and the campaign

So, maybe I wrote in this blog that inflation was the next big thing for the economy. I thought we could maintain some confidence in our semi-regulated capitalism. And, I thought this would be a different campaign. Boy was I wrong.

First, inflation did start to rear its ugly head especially when oil climbed to over $140 per barrel. Food prices rose and companies hiked fuel surcharges, so people began cutting back. We're now seeing people drive less often and spend less when they do go out. So inflation is in check. Now there's concern about deflation as consumer spending has slipped and confidence continues to fall. We're in a recession. Alone, that would not be a problem -- we could recover pretty easily over just a short period of time. However, higher oil prices in July and further investigation into the credit derivatives and other crazy financial product innovations has resulted in consumers tightening their belts and banks and investment firms doing the same.

That brings me to the lack of confidence in the economy. Really, it doesn't make sense for people to be so scared that the Dow Jones Industrial Average fell more than 5,800 points from its all-time high hit last year. That's a loss of 41%. Of course, some hesitation is to be expected. More information or more clarity is needed.
Now, I think part of this has to do with some confusing accounting rules imposed over the past year. Under the old rules, a business would account for assets by reporting the cost of purchase (so called historical cost accounting). The new rules have just begun to require banks and other financial businesses to 'mark-to-market' or report the value of assets at the current market value. As a result of government intervention and new found wealth in the Middle East, China, and Eastern Europe, the U.S. market (including banks, investment firms, and mortgage brokers) created innovative products and/or ignored tradition to satiate the desires of overseas investors. Banks and others grouped mortgages together creating something similar to a mutual fund, selling shares. Further, the U.S. and European firms (like AIG and UBS) began offering insurance (or heavily marketing an older, little-used product) on those mortgage pools and corporate bonds and other debt. No one knows exactly what the U.S. and European firms sold and the investors don't know what they bought. With the new accounting rules, the market is struggling to properly price the assets. Besides not knowing what is actually in the pools, Standard & Poor's, Moody's, and other agencies initially identified many of the newly created assets (pools of assets) as investment grade, meaning they were pretty safe bets. Now, the agency ratings have been called into question and the market has largely discounted them.
To review: we've got a demand for new, higher risk-reward products; we've got banks and others willing to supply the demand; and now there have been accounting rule changes leaving questions about proper asset valuation. So the problem we're encountering now is a result of banks and others writing sales contract so that they keep some of the risk (and therefore some more of the reward). The market realized assets were not properly valued, so banks and others began writing down the value of the assets, taking a direct hit in their profitability. This is a double whammy -- investors now don't like the new, innovative assets and investors don't like lower profits and cuts in stock dividends. For some time (most of 2008), the market has held fairly steady, thinking that many banks either had exposure and quickly identified the problems and corrected them, or those that hadn't were not at risk. This was despite the March failure of Bear Stearns, quite the venerable Wall Street investment firm. JPMorgan Chase stepped in and bought Bear Stearns with the help of the Federal Reserve. Credit markets, in which bonds, insurance, lending, and other products are traded, began to seize up. Credit market participants became extremely weary of future losses and failures. However, they were assuaged for a while as there were no other big failures (though Bank of America stepped in and saved Countrywide, one of the leading mortgage lenders). Everything changed when IndyMac (another very large mortgage lender) began showing signs of tremendous stress in June and at the end of the month, Senator Charles Schumer publicly released a letter condemning IndyMac to imminent failure. Before the letter was released, depositors began withdrawing money from their accounts, but only after the letter hit the press did more than $1.3 billion leave the bank. This was a big blow to confidence in the financial system. The Federal Reserve and other central banks introduced additional measures to offer liquidity and confidence. The third straw came with the Federal Government takeover of Fannie Mae and Freddie Mac (the former Government Sponsored Entities were given preferential treatment in offering traditional mortgages at lower interest rates despite being privately owned). The final straw the broke the camel's back was the failure of Lehman Brothers, a troubled investment firm like Bear Stearns. Then the government offered significant support for American International Group (AIG).
Another review: We've got questionably valued assets on the books of banks and others; several banks and investment firms have failed; an insurance giant is receiving about $100 billion in U.S. support; and despite Federal Reserve and other government actions, there is no confidence so no one is lending to anyone. The result? How about a $700 billion restoration plan (commonly mislabled as a bailout even though the U.S. will receive an equity stake for every investment, just like any other investor). Now, on the surface this money would seem to be enough to jump start seized credit markets. But there is still no confidence. The giant stock market losses do not help the consumer perception of economic 'armegeddon' as some prognosticator mentioned. Even now, after Congress passed the $700 billion bill, no one knows exactly what to do.

What's the result? The Presidential campaigns have had to focus on the economy. It has been especially difficult for John McCain -- he has admitted having some difficulties with economic policies. And the rhetoric offered on the trail and during debates has not been all that insightful. In fact, it really does sound like the economic policies of George W. Bush. Now, Bush's policies are not really bad -- it's just their execution. How do you, as a Republican who ran against government spending, create the largest federal government in U.S. history? How do you take a budget surplus and turn it to a huge deficit? McCain would like to keep taxes low and cut spending. But that isn't enough. The American public wants to hear specific plans to get us out of this current crisis. They want specifics on how to bring more investment to the U.S., and therefore, create jobs. Further, they want to know how we can prevent this in the future. It seems as if Barack Obama has stepped up to the plate. He offers some specifics, including letting the tax cut on the highest earners expire and using that money to cut taxes on 'middle-income' families. (Maybe at some point, in another post, I'll try to figure out who are 'middle-income' families.) And Obama offers specifics about increasing regulations and not allowing banks and others to get away with these shennanigans ever again. But Obama's plans are all wrong. It is because of crazy half-assed regulations that we got into this mortgage mess. It is because we have such idiotic tax laws that allow the rich to get away with not paying taxes. So McCain's ideas are correct, but he hasn't figured out how to effectively attack Obama and Congress so as to further his cause. No matter who gets elected, though, the first two or more years will be tied directly to the economic recovery. And the policies directing the recovery have been set over the past few weeks. We really need a shake-up in Congress. We need term limits and four-year terms for Representatives. This will remove the constant campaigning culture and special interests. Maybe Congress would see new faces, new ideas, and a return to doing the work of their constituents. I don't see how John McCain can win this election, a disappointing prospect. But then again is the fact that we're not likely to see much change in Congess either.

Maybe with an all-Democratic government we can get full DC voting rights and representation?

I'm keeping some faith -- at some point my generation will seek elective office and will take over at the head of major companies. We'll make some changes because we know the mess we've been left with. We know the good and bad of this era. We'll bring the change we need soon enough.