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Oct 14 2008

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Consequences

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If this were a carnival ride, we would all ask to simply get off.

Last week the Dow Jones Industrial Average lost $2.4 trillion in value. By way of comparison, it took five years of combat operations in Iraq for the Pentagon to spend $600 billion.  True, the Dow re-launched on Monday, making up in a day almost half of last week’s losses, but that provides no certainty that the turbulence is behind us.

The stock market is off about $7 trillion in a year, give or take a hundred billion. All five of America’s great investment banks – Bear Sterns, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs, have gone under, been taken over or restructured. Both the nation’s largest insurer, AIG, and its largest savings and loan, Washington Mutual, have gone belly up.

In response, the normally free-market Bush administration has staged the greatest government intervention in the private sector in American history. The US government has take over half the $11 trillion mortgage market, become the owner of the world’s largest insurance company, infused investment banks with cash and enacting an unprecedented financial bailout to decouple credit markets from toxic mortgage debt. Now it is taking equity stakes in private financial institutions in an effort to restore stability and generate lending.

Suddenly, political labels mean less when action and results are at a premium to prevent further economic jeopardy for the nation’s economy.

At the same time, America is preparing to elect a new president. Against the backdrop of this historic financial crisis, the solemn quadrennial campaign seems oddly vapid and frivolous by comparison. For voters, this will necessarily be a choice on the fly. The crisis won’t be over by November 4th. The impacts and implications down the road are unknowable.  But, how to decide?

An emotional rush to judgment is most direct and satisfying, playing off the very real fears and anger of the moment. Here President Bush is an obvious villain. Deeply unpopular to begin with, there is a certain historical logical in blaming Bush, and therefore holding his designated understudy, John McCain, responsible too.

But the actual history of the crisis does not bear out this blame.

That Wall Street was on a bender is not in doubt; a financial Las Vegas where standards, procedure and analysis were all but subordinated to the lucky bet. The proliferation of new and untested trading vehicles only added fuel to the fire. The stories of narcissistic excess at the expense of shareholders are nothing short of breathtaking, and responsible executives should be held to account, by their boards, shareholders and the law.

But Wall Street didn’t create the problem of bad debt, it only monetized – and through lax market pricing standards exacerbated – a policy failure that originated in Washington, authored and managed by the Democrats.

From the late 70s forward, the term “affordable mortgage” had become a staple in Washington policy circles and an axiom for Progressives and liberal Democrats. In practice, it required banks to provide credit to “under-served populations.” By 1995 Clinton administration was requiring expanded mortgage credit for inner city and distressed rural communities. Importantly, it also allowed for the “securitization” of this debt to spread risk more broadly, and incentivized Fannie Mae and Freddie Mac to increase its portfolio of sub-prime debt.

The result was an expanded federal policy to require sub-standard private sector mortgage lending with new debt instruments to securitize and collateralize those mortgages on Wall Street. It fueled a housing boom based on a co-dependent and unprincipled cycle of real estate appreciation and bad debt. When the housing bubble burst, it was simply a matter of falling dominos before the consequences of social lending caught up. The full fledged credit crunch and the financial meltdown on Wall Street and global capitals are the result.

The irony here is that it was the Bush administration, and John McCain specifically, who warned about the looming disaster. In 2003, Bush proposed the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis of the 80s.1 In 2005 and again in 2007, McCain co-sponsored legislation which provided increased oversight for Freddie and Fannie.  These efforts at tighter oversight and regulation were opposed by those who feared the efforts would curtail affordable mortgage lending; the very Democrats who railed against Bush administration policies when meltdown began.

Consider that Representative Barney Frank and Senator Chris Dodd, congressional co-authors of the $850 billion financial rescue package requested by the Bush administration were among Fannie and Freddie’s most voracious defenders. When the Bush administration introduced its housing reform plan in 2003, Representative Frank said, “These two entities – Fannie Mae and Freddie Mac – are not facing any kind of financial crisis. The more people exaggerate these problems, the more pressure there is on the companies, the less we will see in terms of affordable housing.”2

In a deeply flawed and ethically questionable activity, both Freddie and Fannie donated big money to political benefactors who deflected efforts to more tightly regulate the agencies, and who promoted their expanded housing agenda.  Top recipients?  Senators Chris Dodd, John Kerry and Barack Obama.3

And in a turn that is rich with irony, Barack Obama’s informal housing advisor is Franklin Raines, former CEO of Fannie Mae from 1999 to 2004, who was forced from office in an accounting scandal. And the original head of Obama’s vice presidential search committee? Jim Johnson, former head of Fannie Mae from 1991-1998, and a former managing director of Lehman Brothers.

Given these facts, it is no small wonder that the Obama campaign wants to blame Bush.

If voters wanted to exercise an emotional reaction to and kick out those responsible, they’d vote Republican

But as Obama likes to say, so much of this is “inside baseball”.  In any event, no amount of discussion will change the past, so focusing on the future, who has the best plan to stabilize the markets and grow the economy? Here Obama has the more emotionally satisfying plan.

First, Obama will raise taxes on those making more than $250,000. In tandem, Obama will increase the capital gains tax, to tap into extra revenue from stock profits. He would prevent the repeal of the death tax on estates that is scheduled for next year.  He would increase taxes on corporations, and single out the oil industry for a special windfall profits tax that would fund a $1,000 rebate to American families.

Obama would protect American jobs and promote a cleaner international environment by renegotiating existing trade agreements and placing more comprehensive labor and environmental standards on any new agreements.

At home, Obama would create “green collar” jobs by investing $150 billion in new renewable technologies, to end dependence on foreign oil. In tandem, he would institute a Cap & Trade system to limit greenhouse gas emissions for the country.

What’s not to love here? The greedy rich pay, workers are protected from foreign competition and the environment gets cleaner. Everyone else gets some form of money back, even voters who don’t pay federal taxes. But like the financial crisis itself, a closer look at the Obama plan forces a voter to ask that if this is the answer, what was the question.

Start with the $250,000 and above tax increase. Visions of the super rich with limos and luxury homes abound. They can afford to pay, indeed, they deserve to pay and pay a lot.  But they are not the only ones subject to the tax. Small and medium sized businesses will also be hit. It has become a cliché, but small business really is the engine of the American economy, creating more jobs than any other sector.

The Obama appeal to soak the rich by forcing them to “pay their fair share” will be a net job destroyer for the economy as small businesses don’t hire workers or delay expansions. What is the logic on raising taxes on the very businesses we depend upon to grow the economy? This is why McCain leaves the tax rate in place.

The capital gains tax?  More retribution for the greedy with all those under-taxed profits sliding through, funding yachts and trips to San Moritz. However, when President Bush cut the capital gains tax, revenue flowed into the Treasury as it stimulated buying and selling in the market, creating profit, business revenue and economic growth. Raising the tax will have the opposite effect, at an especially delicate time when the stock market needs confidence, not uncertainty. This is why McCain supports a further reduction in capital gains and dividend income, to keep people investing.

It is also satisfying to tax corporations and particularly those oil companies that walk away with record profits.  But to make the obvious point, corporations are not living breathing entities.  American Express and Google don’t vacation at Bora Bora. They are legal vehicles designed for a specific product or service. When corporate taxes go up, that cost is passed down to consumers. The US corporate tax rate of 35% is the second highest in the world. It already makes American companies less competitive internationally and it prevents those very companies from hiring more workers and investing in innovation. Increasing the tax rate won’t increase jobs, competitiveness, or in the long term, revenue.

The windfall profits tax on energy companies is also particularly satisfying, but economically counter productive. Consider than in 2006, when Exxon-Mobil made huge profits, it paid $27.9 billion in taxes, an amount equal to half of all individual tax returns for 2004.4 Despite Exxon’s larger haul in 2007, its profit margin was 10%.5 GE’s profit margin was 10.3%.  From a policy perspective, is this a new standard for “excessive” profit in America? And if sector-specific taxes are all the rage, who will be next? All you budding entrepreneurs consider yourself warned.

And as the proposed increase in the capital gains tax is the wrong solution at a time when the stock market is in shock, a windfall profits tax looks ill-timed at best when energy security has become a vital element of national security. It is the energy companies, after all, that will need to make the investments in domestic drilling to begin the process toward energy security. And in many instances, these same companies are providing research and development into energy efficiency and alternate fuels.

Moreover, America has tried a windfall profits tax for exactly the same reasons articulated by Obama, back in 1980. It not only decreased American domestic drilling production, it ended up collecting less than 25% of the revenue that was expected. The tax was repealed in 1988. For these multiple reasons, McCain does not support the tax.

Providing the warm blanket of protection to America’s working class who are losing jobs to globalization is reassuring in the abstract, but unfocused and counter-productive in Obama’s words and proposed policies.

During a time of instability in the global market, the Obama strategy shifts momentum from open markets and repeal of trade choking regulations to the opposite direction and away from years of efforts by world governments.

Renegotiating FTAs that exist and scrapping those under discussion in favor of a new, restrictive model will hamper efforts to jump start world trade talks and complicate our bilateral relationships. The fallout from these efforts will fall heavily on export-driven US companies, which have been at the forefront of US economic growth when the dollar traded low against other currencies recently. It will have a potentially profound effect on US jobs, particularly in our own hemisphere with Canada and Mexico just for starters.

As the Obama tax strategy stokes voter resentment, its trade policy stokes fear, fear of competition, fear of the unknown.

But the reality is different. For instance, Democrats refuse to bring to a vote a trade agreement with Colombia whose net effect is to reduce Colombian tariffs on US goods.  This is why McCain supports FTAs and other bilateral efforts to reduce tariffs and trade barriers to promote trade and create jobs.  McCain also recognizes the reality that certain jobs will not come back and the solution is not to build walls around America but to well fund retraining programs that will allow American workers to continue to compete.

And when one digs deeper on the Obama energy policy, it too comes up short.

Both McCain and Obama support a “cap and trade” system to address the issue of Greenhouse Gas emissions. But the Obama system, far from easing its impact on the economy, would allocate permits to all companies equally, who would have to buy “rights” to pollute through an auction. As a result, the biggest “polluters” would have to pay the most from the beginning. In the abstract, this is fine. In reality, it represents an effective tax on America’s very economic infrastructure, energy companies, industrial companies and transportation companies.

Considering that companies which are already subject to an Obama  Windfall Profits tax will be prime targets under the Obama Cap & Trade system, the problem will only be compounded with negative consequences for American energy security.  This is why the McCain Cap & Trade system allocates the largest permits to those who have the most at stake economically on the imposition of emissions limits. It is a more gradual and thus more economically sustainable approach.

Under pressure and criticism, Obama and the Democrats have publicly committed to increased drilling, development of clean coal, in addition to its renewable program.  However, given past Democratic statements about drilling and coal, it is not a stretch to doubt that anything but renewables would be a priority in an Obama administration. McCain, by contrast, has committed to the full menu of energy options, including domestic drilling, clean coal, nuclear, as well as wind solar and renewables.  It is a serious, comprehensive approach to energy as a national security issue.

So, stripped of its emotional appeal, what does the Obama plan offer?

In fact, the plan represents a variety of increased taxes and policy changes with potentially profound negative impacts on government revenue, employment and economic growth just as the US economy teeters on recession. Far from the catalyst of economic health that Obama proclaims, it is likely to burden an already troubled economy, removing incentives for business creation and expansion that promote growth.

Of the two candidates, only McCain offers a plan that will get America growing again.

So, who are you going to trust?  The emotional response would be to go with someone new. After eight years of Republican control of the White House, the current economic upheavals make it easy to pick the challenger, with what appears to be fresh ideas.

However, it is not an exaggeration to say we are living in historic times and that this election may be one of the most consequential in our lifetimes.  While we have been dealing with economic setbacks at home, we continue to fight two wars overseas. Terrorism remains. The threat of a nuclear armed Iran is on the horizon, a new strategic competition with China for resources and influence has already begun.

As polls have shifted to Senator Obama, Democrats see parallels to 1932; a new leader with a new deal for the American people, perhaps a realigning election for progressives.

But it is worth remembering that before running for president in 1932, FDR had been a state Senator, Assistant Secretary of the Navy during WWI, the vice presidential nominee in 1920 and two time governor of New York. Senator Obama, for all his intelligence, poise and rhetorical gifts has actually worked fewer days in the US Senate then Sarah Palin has as governor of Alaska.

And as we search for a program accomplishment to tie to Senator Obama’s lofty rhetoric in the hopes of better gauging the risk in supporting him, it is worthy of note that the Smoot-Hawley Tariff Act of 1930 and the Revenue Act of 1932 compounded the problems of the Great Depression instead of solving them. Smoot Hawley raised barriers to international trade while the revenue act raised taxes during an economic downturn.

Sound familiar?

McCain has a record. It began with impetuousness and found voice in captivity, as honor before self.

He didn’t mouth a platitude – he lived it.

In the years since, as a legislator, he hasn’t always been right, but he has regularly put his country’s interests before his own.

He fought Abramoff on lobbying.  He fought Boeing on fair contracting.  He stood against his Party on campaign finance reform, immigration reform, and global warming, forming alliances with like minded legislators, across Party lines.

He has stood against pork barrel spending, and stood up for veterans. He has stood by solid conservative judges.

Last year as the majority of public opinion on Iraq went against him and he faced defeat in the primaries, he said that he’d rather lose a campaign than lose a war.

McCain is less polished than Obama. He seems at turns impulsive and incomplete. But words aren’t solutions and polish isn’t nerve or courage.

In a national foxhole facing an unknown future, there is really only one plausible choice given the consequential years ahead.

If you sort out the facts from the emotion, the choice makes itself.


1. New York Times, September 11, 2003

2. New York Times, September 11, 2003

3. Opensecrets.org

4. Investor Business Daily

5. Wall Street Journal August 2008

 

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