One of the striking things to me about this campaign season, and about the conventions in particular, is the degree to which the real issues that face us as a nation are not much of a topic of conversation – not even when the topic of conversation is “issues.”
For the most part, both candidates delivered “greatest hits” types of speeches that could really have been given at almost any point in recent history. In Obama’s case, it was striking how little he varied his pitch from the Gore and Kerry pitches, and how much of his platform consists of the sorts of things Democrats would have been in favor of twenty years ago. In McCain’s case, it was striking how little he said at all about anything of substance.
The point is not that we need “new ideas” but that we deserve topical discussions.
Here’s an example of what I mean. What do the two candidates think about the current housing and financial crisis?
Obama thinks that we need to do more to protect people against deceptive marketing of mortgage products. That’s laudable, and I agree with it, but does he believe that we are in the crisis we are in largely because of fraud? McCain thinks that any effort to address the crisis should focus on systemic risks to the financial system – i.e., large financial institutions, not individual homeowners. There’s moral hazard in any kind of bailout, of course, whether of individuals or institutions, and he’s basically said he thinks the moral hazard is worth it if the failure of an institution could seriously damage the financial system. That’s a defensible position, though one that you would think the Democrats could make political hay out of. But it’s also an entirely reactive position. Does McCain have any thoughts on how we got here? How we could avoid winding up here again?
We are in this housing mess in part because of a policy of easy money by the Greenspan Fed in response to the stock market slump at the beginning of the decade, and actual encouragement by the Fed of novel mortgage products to help keep up consumer spending and thereby avoid or shorten a recession; in part because of pervasive conflict of interest at the ratings agencies, and the willingness of a wide variety of financial institutions to outsource their risk-management function to those agencies (and note that the international agreements of this decade designed to modernize the calculation of bank capital increased the role of the agencies even further); in part because of a longstanding public-policy preference for greater homeownership rates (especially but certainly not limited to increasing homeownership rates for lower-income Americans and racial minorities); in part because Fannie Mae and Freddie Mac, who dominate the “prime” mortgage market, were encouraged by a compliant political class to grow their books virtually without limit on a very thin capital base . . . there’s a long list of reasons why we are where we are, and many of these reasons have policy implications.
The housing crisis completely punctures the Bush Presidency’s prior claims (such as they were) to broad-based prosperity, as the collapse in housing prices has ended the borrow-and-spend strategy for keeping up with the Joneses lifestyle-wise and eliminated a good chunk of the wealth accumulated by the middle class on paper since 2002. It’s particularly striking, therefore, that the Democrats have failed to make serious hay out of it. I assume the reason is that Democrats are to varying degrees implicated in all of the policy decisions above – in some cases more so than the Republicans, in other cases less so. But that shouldn’t stop them from making a case for how to get out of the mess we’re in and how to avoid such messes in the future; it just means that both parties theoretically have the ability to make such a case.
What should be the future role of Fannie and Freddie in the mortgage market? Should they be reprivatized after the housing market stabilizes? Or should they be slimmed down to their original function and renationalized? (I lean towards the latter, by the way.)
We just “bailed out” Fannie and Freddie by drawing a line between subordinated debt and preferred stock, providing what amounts to a government guarantee of the former and virtually wiping out the latter. That’s a more aggressive approach than I expected, which makes me feel basically good from a policy perspective (I thought the Treasury would be leery of wiping out preferred holders because so many regional banks own preferreds, so wiping them out would potentially make for more bank failures, but I also worried that bailing out the preferreds would be a stealth bank bailout that would create more moral hazard than an above-board bailout would). But what are the rules of the road now for bailouts? What principles – other than the desire to avoid a total meltdown of the financial system – are going to govern our approach to the credit crisis that continues to unfold?
What should be the future role of the ratings agencies? Banks depend on ratings to determine whether they are holding adequate capital; insurance companies, pension funds and money-market funds are mandated to invest on the basis of ratings. Can we continue to rely on these private utilities to perform their function of “objectively” assessing credit risk given the inherent conflict of interest in their business model? If not, what do we do without them?
Structured finance was supposed to be what prevented a repeat of 1990-1991, as the repackaging and distribution of credit risk enabled financial intermediaries to spread that risk widely across the financial system, and thus avoid the risk of large financial institutions going under due to concentrated risk. It worked out pretty much that way in 2001-2002 in the wake of Enron and Worldcom. The opposite is happening now, as the risks that were spread around, thought to be relatively uncorrelated, have proved to be highly correlated, so structured finance just gave market participants false comfort about the amount of risk they were really taking. What are the lessons here for regulation of the derivatives market, if any?
Encouraging homeownership was one major way the government attempted to promote social mobility, on the Trading Places theory that once you own the floor, you won’t tolerate your friends putting out their coals on it. Does that theory have good empirical warrant at this point? Do we need to adjust our policies in this regard in the wake of the current housing mess (which has disproportionately hit homeowners who were poorer credit risks, as one would expect)? If so, how? By putting less emphasis on encouraging homeownership? By greater public subsidy? By greater paternalism accompanying the subsidy? What?
The Fed has held a consistent bias in favor of easy money for a couple of decades now, reasoning that we know how to stop inflation (raise interest rates) but not how to stop a deflationary spiral. Bernanke has made this explicit. The risk, of course, is that such an easy-money bias leads to periodic asset bubbles that, when they burst, threaten the real economy, requiring more easy money to prevent a deflationary recession. That may well be what we’ve been seeing: certainly we saw a housing bubble inflate immediately after the collapse of the dot.com bubble. The officially-endorsed rates of inflation are decreasingly credible in the market; most people I know believe we are in a recession, even though the official statistics say we are not, because they believe inflation is underestimated. If we are indeed experiencing inflation along with a credit crunch and weak nominal growth, along with stagnant wages and rising unemployment, what should the Fed’s policy be?
Now, obviously I don’t expect the candidates to answer these kinds of questions. But I’d like to understand better than I do how, in general, the candidates are thinking about them. The crisis we are in is in substantial part the consequence of specific policies. And the crisis is really bad. This is much, much worse than the dot.com bust. It’s much, much worse than the brief liquidity crisis after the Russian default and the Long Term Capital Management collapse in 1998. I think it’s worse than the S&L crisis. It’s serious stuff. So we should be reevaluating the policies that contributed to it and, more to the point, thinking about what the crisis says more generally about our ability to foresee the risks attendant on these kinds of policy choices.
But this kind of thing is not what we talk about when we talk about issues.
Which makes this campaign very frustrating for me.