Thursday, September 18, 2008

Johnny Mac, Your Economic Ignorance Is Showing

Taking his pander act to a new level of inanity, John McCain has blamed SEC Chairman Christopher Cox for the current financial meltdown. McCain said if he were Bush, he'd fire Cox.

The idea that one person could have prevented the vast assortment of ill-advised investments and schemes that has made markets around the world shudder is nonsense. And attacking Cox, a champion of the free-market policies McCain supposedly supports, is something one would expect of leftists Democrats who know nothing about economics, not a Republican presidential nominee.

If any one person deserves blaming for our economic mess, it's not Cox, but Alan Greenspan. The former Federal Reserve Chairman -- who had a lot of help --inflated two bubbles, each bigger than the other.

The first was the tech bubble, which collapsed in 2001. The second was the credit bubble, of which the subprime market was just a part. Desperate to avoid a nasty recession, Greenspan got the Fed to lower interest rates in a dizzying downward staircase spiral from 6.5 percent, bottoming out in 2003 at 1 percent.

Taking inflation into account, 1 percent or anything in that territory was a negative interest rate. The staggering implications of this were overlooked at the time, until Economics 101 caught up with us: What you owe you will eventually need to pay back.

A negative interest rate means that saving money is punished, and taking out debt is rewarded. It's the very opposite of sound financial policy, and millions of Americans were encouraged to go into debt, supposedly for the good of the economy. Elaborate rationalizations were invented for this debt, the fallacy that residential real estate is a surefire investment being the biggest of them.

By the time Cox was appointed to the SEC, in 2005, the real estate and credit markets were topping out. There were no more vast pools of homebuyers to be tapped, because credit requirements were so lax.

There were not only subprime loans, but even scarier loans that required no documentation of income. Borrowers merely had to state their income, with no documentation required, to get a loan. These stated income loans popularly became known as "liar loans," because lying was implicitly encourged. After all, if a borrower couldn't pay, another borrower would come around ready to take the home off his hands, for an even higher prices.

At the end, "liar loans" were topped in audacity by loans that could be obtained without any verification: no income, no job no assets - so-called "NINJA" loans.

All these mortgages were used as the base of toxic debt securities repackaged and sold around the world. And in other parts of finance, other insane financial models were built on the assumption of ever-increasing wealth. Cox didn't crack down on these, of course, but had he tried opposition would have been fierce. And it wasn't an issue the likes of McCain were concerned with anyway.

The most vexing lie from all of this is the "lesson" that government regulators were lax, and should have intervened more diligently to prevent this financial excess. Government intervention brought on this mess by deranging economic fundamentals in a way that was doomed to collapse catastrophically once the greatest fool had entered the market and bought a home he couldn't afford.

Short-selling, the bugaboo McCain and some leftist Democrats invoke as the reason for the financial market's latest turmoil, is a symptom of what had gone wrong. In a market blinded by unthinking optimism, short sellers were the skunk at the garden party, revealing the nasty truth.

So-called "naked shorting," in which the seller of securities doesn't even arrange to borrow them or ensure a later purchase, is controversial, and McCain is reasonable when he condemns the practice. But he also condemned the entire practice of short-selling for supposedly destroying good companies. As the Wall Street Journal pointed out, that's a fundamental misunderstanding of what short-selling does for a market economy:

"It adds valuable information to the market about what investors believe to be the price direction of a stock. Demonizing short-sellers as a band of criminals, or barring short-selling outright in financial stocks, as regulators in the U.K. did Thursday, removes information from the market," the WSJ stated.

Removing information reduces market transparency and increases risks for investors. The logical result will be risk-shy investors, who already take enough risk in the market as it is, will be frightened out of stocks altogether, or at least lower the price they'll pay for them.

That's easy to understand for anyone except a pandering politician like McCain who is so desperate to become president he will say nearly anything if he thinks it will get him votes. (I'm being charitable to McCain here, by assuming he knows he's spouting nonsense. More chillingly, McCain may be truly ignorant of the basics of a free-market economy. Just like Barack Obama.)

The WSJ adds a further zinger to correct McCain's torrent of economic malarkey:

In case Mr. McCain is interested, overall short interest in financial companies actually declined by 20% between July and the end of August. That's right: Far from driving this crisis, shorts were net buyers of financial stocks this summer, as they must buy stocks back to close their positions and realize their gains (or losses).

McCain has previously admitted economics is not his strong suit. If McCain is to be worthy of the presidency, he should go back to school on the subject and stop proposing remedies that won't work for issues he doesn't understand.

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