Markets Down Hard, Debt, and Obamanomics

I haven't written here in my blog in a long time. But I've been watching the economic scene. And as you might imagine I've been quite unhappy with our President, his administration, and the results of their economic policies. Here in California the effect is magnified and made even worse.

I see these factors holding back the U.S. economy:

• Debt
• The effects of some misguided corporate rescues
• Market and corporate uncertainty caused by government actions, discussions and personnel appointments
• Present and expected future avalanches of regulations
  

After U.S. markets closed today, after the 512-point Dow drop and 60-point S&P drop, I watched a clip of Obama in 2008 or 2009, in which he said the economy should be much better 3 years out, or his presidency will be a single term. Well, here we are, it seems. I'll soon hoist a martini to his single term.

The pundits' observations I thought most valuable were that the market's fall is not about the U.S. debt deal, but about Euro-zone debt worries, and the growing perception that the U.S. economy is not growing fast and may actually fall into a "double-dip" recession. We'll see what actually happens, but though I've searched and listened to truckloads of commentary, I don't see a catalyst for U.S. growth. Yes, there are some sectors that should grow, and yes, the middle classes may be growing in China and India. But in our present trade environment we can't take proper advantage of it.

Obama said one correct thing, as far as the basic concept. He said Congress should approve the 3 or 4 international trade agreements in its queue. Now the agreements are forgotten and Congress has flown out of town for a month. The trade agreements would be one small catalyst for growth.

Hedge fund manager Phil Falcone was interviewed today on CNBC, mostly about his LightSquared network. In it he said that innovation was the only way for the U.S. economy to get going and grow again. I agree with him.

And what stands in the way of that innovation, or would foster the economic growth we all want (well, everyone except a few Luddites of various stripes)? In short, Obamanomics stands in the way of the innovation Falcone mentioned. Instead, for growth we should be repealing the laws, throwing out, simplifying, and rationalizing the regulations, and basically undoing all we can of the four factors listed above.

As an aside, during the Reagan administration, he said that he would reduce government employees by a significant amount. One evening I was looking up at the federal office building in West Los Angeles and doubted anything would happen. A very few years later the building was 40 or 50% vacant, if I recall correctly. I was very happy to see that Reagan did what he said he would do. Today the size of government employment has grown past any nightmare Reagan ever had. It's time to slim down again. The regulations and other scribblings of the bureaucrats are not needed. In fact, they're harmful.

Again, the bottom line is "back to free markets" to create the growth and jobs we need.

What’s the root cause of the sub-prime and credit debacle?

In the present housing and credit market problem sets, there has been limited commentary about the root causes and in my view over half of it has been completely distorted. The problem’s root cause is a market distortion caused by the government encouraging the residential real estate industry to get a higher percentage of Americans into home ownership. I recall reading about President Carter’s CRA and later about the ramp-up of this initiative in the 1990s. By 1996 this had resulted in President Clinton’s “National Partners in Homeownership” initiative, and a dramatic strengthening of the CRA.

How would this have worked if viewed from a market perspective? If the residential real estate market was generally at equilibrium before the government started this initiative, then who was there to find to increase the percentage of home ownership? Less credit-worthy borrowers was the only place to look. There was almost certainly not a meaningful percentage of Americans who could easily qualify to buy a house who had chosen instead to rent out of ignorance. The “secret” of the advantages of homeownership was pretty well out by the 1990’s. While financial education and increasing prosperity resulting in more homeownership are laudable goals, I lay root responsibility for the housing debacle on the government. And this is before any discussions of mortgage lending regulations and Freddie Mac and Fannie Mae, and cross-incentives at work between those GSEs and members of Congress.

Others have pointed to Wall Street executives’ and firms’ greed as the root cause. They created the loan instruments and derivatives and sold them. Also blamed are the bankers and brokers who originated the loans. Certainly there was some greed and some money made. But before you can conclude that these parties were the root cause, you must first ask yourself: Are bankers idiots? They most certainly are not. They may not be into charity, but they're not idiots. In undistorted markets they act with meticulously calculated self-interest. They make their profits in a world enumerated in Basis Points, which are 1/100^th (one-one-hundredth) of a percent. So you must ask, what made them start making loans that were idiotic by banker's historical credit standards? And the answer is the incentives and controls in the CRA ratings. And, as has been explored elsewhere, no less than four regulating agencies provided the teeth and force that backed up the CRA and its bank rating system.

As the finger-pointing continues over our present problems there are plenty of parties to take the blame. The mortgage industry got creative and sold loans to people who shouldn’t have taken them. Home builders make money by building and selling homes, and were happy to fuel the boom. Realtors and real estate commentators fed the frenzy. Buyers can be excused for financial ignorance only so far. The housing market expansion took on a life of its own. We couldn’t have expected a mortgage lender or broker to be happy reporting lower sales numbers in the middle of a boom, even when the supply of reasonable marginal borrowers was getting thin. But I return to the idea that the original instigation was a market distortion started by the government. The initiative to raise the percentage of American homeowners was good as a starting concept, but very harmful when it devolved into putting unqualified buyers into homes who couldn’t afford them in the long term. And we all can see that now.

Lastly, one thing that surprised, amused, and saddened me was the Democratic campaign’s success in painting Republicans and free-market advocates as the root cause of the debacle. If I had run the Democratic campaign, I’d have pursued the same strategy. But if I had run the Republican campaign, I’d have not let that one go. I’d have made a tremendous amount of noise about the history and issues as they are laid out here. I was surprised to hear John McCain attack Wall Street over the issue instead.

Please read my first post below. That's where I lay out the basic free-market vs. Socialism logic.