Who is to blame?

In the waning days of the 2008 elections, financial meltdown occurred in the course of a heated presidential election. For Democrats, this was the golden opportunity to blame free markets and deregulations; but the realty was this was a government created mess. Republicans may bear their share of the blame but the real truth is that Democrats must share equally in the blame; with policy encouraged from three decades with policies enacted in Clinton administration. As Ian Murray of the Competitive Enterprise Institutes noted, “If we are to find a way out of this crisis, we need to honestly appraise its causes. There is plenty of blame to go around.”

The goal for American politicians was to expand homeownership into the least disadvantaged, an admirable goal. For many Democrats like Barney Frank, this was the expansion of government into forcing banks to lend money in less disadvantage neighborhoods; for many Republicans like George Bush, this was the expansion of the Opportunity. There were many on both sides who saw political advantages as well as vindication of their political philosophy. Policies encouraged banks and lenders to offer loans to individuals who previously unable to qualify with Fannie Mae and Freddie Mac providing back up. New products were designed to expand the market and proved especially attractive to Property speculators but many critics feared that is would weaken underwriting disciplines. Those critics included some in the Clinton Administration, Alan Greenspan and eventually the Bush administration who saw the potential danger in these programs.

The Federal Reserve reacted to the financial crisis by a series of interventions, with the idea of lessening the impact. The fear of computer meltdown going into 2000, the collapse of the dot-com boom, 9/11, and to goal of providing a soft landing saw loose monetary policy which made real estate more attractive. With plenty of money available, lenders had the cash to make loans and the right programs to expand these loans. As property values went up, many consumers were able to keep spending with their increased homes values providing the collateral.

Government Sponsored Entities known as Fannie Mae and Freddie Mac increased in the early part of this decade. While the GSE did not invent subprime loans but Fannie and Freddie became the biggest buyers of these loans; thus the toxic effects would spread through the global financial system. These GSEs had one thing that many government agencies didn’t have, the power to lobby plus they handed out campaign contributions to key congressional leaders. This lobbying effort included many major lenders just as Countrywide; who benefited from these looser lending practices. GSE’S kept their privileges through extensive lobby and campaign contributions.

In 2004, Congressional Republicans warned of distortions occurring in the mortgage markets including the 2008 Republican candidate John McCain (not that it did him any good that he actually tried to reform the system whereas his opponent opposed any reform.)

Congressional Democrats led by Chris Dodd and Barney Frank oppose any reforms; Chris Dodd called many of these policies one of the great success stories of all time” and anti-reformers often accused the reformers of racism when trying to reform the system. Homeownership, like health care, became a right as oppose something to be earned. Congressional Democrats oppose any reforms of the GSE’s, and the crisis simmered. Ian Murray observed, “If we are to solve this problem, the American people must realize how deeply involved government was in creating it. If the new president and Congress fail to admit that, then the recession we are entering can only be prolonged. It is therefore in liberals' political interest to recognize the real causes of the crisis and act accordingly. In that respect, this provides a great opportunity to demonstrate that Americans have indeed got the change they deserve.” Nor can government be absolved as Murray concluded, “blaming the financial mess on “deregulation” is facile (just look at the similar problems in Britain where the financial regulator, the Financial Services Authority, is much more powerful than any previous financial regulator there.) Instead, what happened was that government — successive administrations, Congress, the Federal Reserve — sent bad signals to the market that severely distorted it. The market proceeded to make mistakes that were reinforced by government at every step of the way.”
Speaking of much of the Treasury actions over the summer of 2008, American Enterprise Institute Peter Wallison said, “Barney Frank has made it clear that he would never allow Fannie Mae and Freddie MAC never be privatized, broken up or even slimmed down. Fannie and Freddie Mac as a creation was what Congress wanted and love; unlimited campaign contributions and the chance to sent out funds to favored groups. Backed by the Federal government, Fannie Mae and Freddie Mac borrow money at interest rates lower than other shareholder-owned company and this allowed them to hold cheaper funds with higher yields.”

Wallison observed that under the Paulson plan, FHA became Fannie Mae and Freddie Mac become the conservator of both GSE’s but there were no changes in the business model. On what Paulson should have done, Wallison commented, “A receiver, not a conservator, should have been put in charge of Fannie and Freddie. A receiver could have wiped out the common and preferred shares, repudiated unfavorable contracts, created a good bank/bad bank structure for isolating the bad assets, and otherwise taken steps to reduce the losses to taxpayers.”

Both companies could operate indefinitely under government control until private sector alternatives and Wallison observed, a receiver would have three options in front of it; nationalism, privatization or liquidation. This decision transferred into the hands of the Obama administration. Wallison felt that Secretary of Treasury Hank Paulson missed an historic opportunity to eradicate both government sponsor entities. A future Democratic administration will not reform Fannie Mae and Freddie Mac.

During the 2008 election, many Democrats made reference to the Clinton years and with the appointment of Larry Summers to work as one of leading Obama supporters would indicate a possible return to the Clinton’ s policy. What is often least understood is how much of what Clinton actually did differs from the evolution of the Democratic Party a decade later.

As Competitive Enterprise Institute John Berlau observed, “Namely, the Obama campaign's twin messages of bashing deregulation and embracing the Clinton years were inherently contradictory. Bill Clinton signed nearly every deregulatory measure that John McCain backed—the same measures that are now being blamed (wrongly) for helping cause the current crisis. What's more, Clinton administration officials have credited these policies for contributing to the ‘90s economic boom—the very "shared prosperity" that Obama says he wants to go back to.”

In the late 90’s, the Clinton White House published a document commemorating the high growth rate of the 90’s and part of the credit of Clinton years was credited to deregulation.” The documents acknowledged, “The laws that governed America's financial service sector were antiquated and anti-competitive. The Clinton-Gore Administration fought to modernize those laws to increase competition in traditional banking, insurance, and securities industries to give consumers and small businesses more choices and lower costs." Bipartisan policies led to significant deregulation and while many Democrats decry the deregulation policies, many of those yelling the loudest voted for those policies.

It could be argued that the Clinton years had more deregulation than the Bush years. There was no financial deregulation under Bush! The most significant law passed dealing with financial deregulation was the costly regulation Sarbanes-Oxley accounting mandates. Any retreat from financial deregulation would be a retreat from the reforms passed in the Clinton years, not the Bush’s years. While both candidates talked of re-regulating as well more oversight, there was very little specific. Running against Regulation, Obama and his Democrat supporters were attacking those policies of Bill Clinton, Robert Rubin, Larry Summers as well as Republican Phil Gramm.

The Gramm-Leach-Bliley Act separated traditional commercial banking from investment banking, a bill that passed with overwhelming support from both Parties. Obama bashed these regulations when he argued, “By the time the Glass-Steagall Act was repealed in 1999, the $300 million lobbying effort that drove deregulation was more about facilitating mergers than creating an efficient regulatory framework." Obama advisor Larry Summers disputed his new boss when he told the Wall Street Journal, “The new law spur economic growth "by promoting financial innovation, lower capital costs and greater international competitiveness."

In the 2008 election, Bill Clinton told Maria Bartiromo, “I don't see that signing that bill had anything to do with the current crisis. Its lifting of barriers to financial service mergers may have lessened the crisis. Indeed, one of the things that have helped stabilize the current situation as much as it has is the purchase of Merrill Lynch by Bank of America, which was much smoother than it would have been if I hadn't signed that bill." In a interview with the Wall Street Journal, American Enterprise Institute's Peter Wallison supported this point of view when he "None of the investment banks that have gotten into trouble—Bear, Lehman, Merrill, Goldman or Morgan Stanley—were affiliated with commercial banks. The banks that have succumbed to financial problems—Wachovia, Washington Mutual and IndyMac, among others—got into trouble by investing in bad mortgages or mortgage-backed securities, not because of the securities activities of an affiliated securities firm." While Democrats blamed deregulation, there is no evidence to suggest that this played a significant, or any role of financial meltdown. As pointed out earlier, much of the toxic that started the meltdown was created by Government Sponsored Enterprise.

In 1994, the Riegle-Neal law allowed U.S. to have nationwide banking chains, similar to other nations. While many Democrats blame this law along with Gramm-Leach-Bliley Act as the catalyst for the meltdown, these laws were passed with overwhelming bipartisan laws. Federal Reserve Governor Randall Kroszner credited Riegle-Neal for “higher economic and employment growth, spurred by more-efficient and more-diverse banks and more entrepreneurial activity, as the more bank-dependent sectors of the economy, such as small businesses and entrepreneurs, achieve greater access to credit."

Competitive Enterprise Institute John Berlau wrote, “If President-elect Obama wants to pull the U.S. economy out of its rut, he must face up to the fact that '90s deregulation was an essential ingredient in Clinton's recipe for an economic boom. He also must recognize that substantially undoing the liberalizations that Clinton and the GOP Congress achieved would crimp recovery as well as create new problems.”
John Berlau added, “Deregulation has never meant non-regulation, and my boss, Competitive Enterprise Institute President Fred L. Smith, Jr., has stressed the competitive regulation that comes from market discipline. Creating a modernized regulatory regime for some of the new challenges we face would have been an urgent task of any new administration, but the key is what type of updating would be done. Good updating would take into account government subsidized institutions—such as Fannie Mae and Freddie Mac—that have weakened market discipline, as well as existing regulations that encourage perverse incentives, such as Clinton's expansion of the Community Reinvestment Act, an area where the administration was not deregulatory and actually encouraged bad loans to be made.”

Keynesian pump priming in recession will be the feature aspect of the Obama recovery plan. It has been tried and its purported success often overrated. Wall Street Journal editorial noted, “The money that the government spends has to come from somewhere, which means from the private economy in higher taxes or borrowing. The public works are usually less productive than the foregone private investment.”
Stimulus did not work to bring a robust recovery in the 30’s and a similar program was tried in Japan throughout the 90’s and it failed as well. Throughout the 80’s, Japan was considered a model for United States by many but the 90’s, Japan suffered falling property values and retreating stock markets in addition to a slowing economy. The Japanese embarked upon a great Keynesian stimulus plan.

Japanese stimulus began with an 11 trillion yen (the equivalent to 85 billion dollars) in 1992. At the end of the year, Japanese debt to GDP ratio was 68.7%. Throughout 1993, 20 trillion yen were added but did little to revive the economy and it caused the fall of the government. Not only did the government add more dollars for stimulus, they dropped any plans for income tax cuts. The money went for public works, social infrastructure, small businesses and low-interest home financing but a year after nearly over 30 million yen spent; Japan debt to GDP reached 75%. Over the next two years, more was spent and a modest recovery occurred but it was hardly robust. This modest growth may have been as much due to a one year tax cuts as to increase stimulus but growth started slowing going into 1998 and yet another 17 billion yen were added. When this failed to move the economy much, one more big push was added but in the end, Japan failed to see much dynamism in their economy. The Japanese suffered a decade of anemic growth and saw debt to GDP reached 129%, nearly doubled what it was at the beginning of the decade. The Japanese recover over the past decade when government policies forced banks to acknowledge bad debts as well as privatizing state assets. The question is whether the Japanese will continue on this road or join the United States to repeat the mistaken policies of Japanese lost decade in the 90’s.

The biggest threat to future American prosperity may be future Democratic plan to undermine American retirement plans. In the last weeks of the election, USA News and World reporter James Pethokoukis asked, “I hate to use the "S" word, but the American government would never do something as, well, socialist as seize private pension funds, right? This is exactly what cash-strapped Argentina just did in the name of protecting workers' retirement accounts Now, even Uncle Sam isn't that stupid, but some Democrats might try something almost as loopy: kill 401(k) plans.”
House Democrats invited Professor Teresa Ghilarducci to discuss her ideas on the elimination the preferential tax treatment for popular retirement plans and her plan to substitute these worker retirement for a government guaranteed retirement accounts.
Her plan is to replace 401(k) plans with government deposit of $600 every year in these Government Retirement Accounts (GRA). Each worker is required to save 5% of their pay into the accounts and receive 3% in return. Democrat Representative Jim McDermott declared, “The savings rate isn't going up for the investment of $80 billion [in 401(k) tax breaks], we have to start to think about whether or not we want to continue to invest that $80 billion for a policy that's not generating what we now say it should."

The problem in discussing saving rates, as James Pethokoukis observed, “the savings rate doesn't include gains to money you invest in the stock market. It ignores the buildup of net worth. (If you bought a share of XYZ Corp. in January at $100, for instance, and its value doubled by December, the savings rate measure would still value that investment at $100. In short, the savings rate is a phony number.)” Pethokoukis added that Ghilarducci would have workers abandoning the stock market when it is at its lowest and on top of that, workers would only earn a 3% rate. As Pethokoukis noted, “The long-run return of the stock market, adjusted for inflation, is more like 7 percent. Look at it this way: Ten thousand dollars growing at 3 percent a year for 40 years leaves you with roughly $22,000. But $10,000 growing at 7 percent a year for 40 years leaves you with $150,000. That is a high price to pay for what Ghilarducci describes as the removal of a source of financial anxiety and...fruitless discussions with brokers and financial sales agents, who are also desperate for more fees and are often wrong about markets." Pethokoukis quipped, “I'll take a bit of worry for an additional $128,000.”

This proposal would not only put a death knell in the stock market but make the worker dependent upon the government for its retirement. With the government attempt to socialize health care and retirement, the results will be dependency. What is at stake is the development of an Opportunity state versus the Dependency state.