The McCain "Transfer of Wealth"

In many ways, John McCain is a symbol of the failure of the Republican Party. He didn't cause the failure, but he is a symbol of the Republican Party's transformation into a party that no longer values fiscal responsibility. In its place, we have a massive National Debt that will be passed on to our children and grandchildren.

This is most evident in McCain's views on tax policy. His views today are dramatically different than they were just a few years ago. In an interesting article documenting these changes ("John McCain: Straight Talk on Taxes?"), Citizens for Tax Justice concludes that's it's impossible to pin down what John McCain really believes.

At a time when the concentration of wealth in America is reaching record levels, we have McCain branding Obama's tax plans as "socialist" and complaining about "transfers of wealth" and "class warfare."

Well, the transfer of wealth already happened, and it has concentrated the share of the nation’s income (20%) flowing to the top 1 percent of Americans to its highest level since 1928, according to a study cited by the Center on Budget and Policy Priorities. It's not a coincidence that the stock market crash of 1929 came just a year later.

The Obama plan to increase the top income tax rate to 39.6% is still well below the top rate from 1932 to 1986, a period that includes several Republican Presidents. Back then, Republicans did what they had to do to balance the budget. But that was before "Reagan proved deficits don't matter," as Dick Cheney puts it.

John McCain would like to be thought of as one of the great leaders of the Republican Party, but these leaders understood the importance of a fair and balanced tax policy:

President Theodore Roosevelt - December 3, 1906

The man of great wealth owes a peculiar obligation to the State, because he derives special advantages from the mere existence of government. Not only should he recognize this obligation in the way he leads his daily life and in the way he earns and spends his money, but it should also be recognized by the way in which he pays for the protection the State gives him.

President Dwight Eisenhower - October 17, 1960

In many countries of the free world private enterprise is greatly different from what we know here. In some, a few families are fabulously wealthy, contribute far less than they should in taxes, and are indifferent to the poverty of the great masses of the people. Broad purchasing power does not, therefore, exist, even for the domestic products of the nation. A country in this situation is fraught with continual instability.

Instead, John McCain is more likely to be remembered as a carbon-copy of George W. Bush and his failed "trickle down" economics policies. Not the legacy he had hoped for, I suspect.

Hand Me Down Economics

News that the Republican National Committee spent more than $150,000 on clothing and make-up for Gov. Sarah Palin and her family hit the media by storm yesterday, and for good reason.

Needless to say, this wasn't a trip to Wal-Mart. Palin spent the money in places where all well-dressed "Hockey Moms" go to shop. Stores like Saks Fifth Avenue (nearly $50,000) and Neiman Marcus ($75,000).

The explanation from spokesperson Tracey Schmitt of the McCain camp was priceless:

"With all of the important issues facing the country right now, it's remarkable that we're spending time talking about pantsuits and blouses. It was always the intent that the clothing go to a charitable purpose after the campaign."

Is this from the same campaign that's been going on and on about "Joe Six-Pack" and "Joe the Plumber?" Is this the same campaign that branded Obama an "elitist," and believes all real Americans live in small towns? Now all of a sudden they want to talk about "important issues?"

Well I have news for them: they don't have a Saks or Neiman Marcus in small town U.S.A., and many Americans don't spend $150,000 on clothes in their entire lifetime.

The notion that giving the clothes to charity somehow excuses such extravagant behavior shows just how disconnected the Republican Party is from those in need. It sounds a lot like Marie-Antoinette's "let them eat cake," but with designer clothes.

Maybe McCain's "trickle down" economics should be called "hand me down" economics.

Speaking of "elitists," whatever happened to the "respectable Republican cloth coat," Richard Nixon mentioned in the famous "Checkers" speech in 1952?

I'm not sure but I think Obama's wearing Nixon's old shoes.

The Obama Recession

It was clear in last week's debate that McCain continues to cling to Republican "trickle down" tax theories, and the false assumption that cutting taxes is good for the economy and raising taxes is bad for the economy.

McCain would like to cause voters to fear an "Obama Recession." This is a challenge to begin with, since it's obvious we are already in a recession. So, the McCain campaign is now forced to say that Obama's tax proposals will "deepen" our recession, with no explanation of how his plan to renew the Bush tax cuts when they expire in 2010 will change things.

The same claims were made when Bill Clinton ran for office in 1992. We were just coming out of a recession and the massive deficit was hurting our economy. In spite of lukewarm support from Democrats and staunch opposition from Republicans, Bill Clinton pushed through the Omnibus Budget Reconciliation Act of 1993, which passed Congress (without a single Republican vote) and was signed into law in August 1993.

In many respects it was similar to the Obama tax plan, and Republicans claimed we would immediately be thrust back into a recession, jobs would be lost, factories would close, etc. McCain's economic advisor and (former) campaign co-chair, Sen. Phil Gramm offered a dire warning: "The deficit four years from today will be higher than it is today, not lower."

Well, the architect of the financial chaos we face today, Phil "mental recession" Gramm, was wrong even back then. The budget deficit in 1992 was $312 billion. In the next few years, the budget deficit didn't increase. It went steadily down and actually produced the first budget surplus since 1969. In fact, we continued to have budget surpluses for four consecutive years (1998-2001).

Not surprisingly, Clinton's success in balancing the budget led to the longest period of economic growth since the National Bureau of Economic Research (NBER) started measuring recessions:

The NBER's Business Cycle Dating Committee has determined that a peak in business activity occurred in the U.S. economy in March 2001. A peak marks the end of an expansion and the beginning of a recession. The determination of a peak date in March is thus a determination that the expansion that began in March 1991 ended in March 2001 and a recession began. The expansion lasted exactly 10 years, the longest in the NBER's chronology.

This annoyed the Republican Party, to put it mildly. The NPER is a private, nonprofit, nonpartisan research organization founded in 1920. They are also the organization that determines whether the U.S. economy is "officially" in a recession.

So the Republican Party came up with the phrase "Clinton Recession," and even tried (unsuccessfully) to have the official dates changed before Bush had to stand for re-election in 2004. It's a shame they didn't spend less time thinking about how to "spin" history, and more time thinking about how to make lasting improvements in the economy.

In fairness, an argument can be made that President Bush didn't cause the 2001 recession, since he'd only been in office a couple of months when it started. At the same time, it certainly wasn't caused by tax reforms Clinton put in place eight years earlier. Fears of an "Obama Recession" are unfounded, and we have recent history that proves it.

So, the next time you hear someone complain about the "Clinton Recession," you can make a few bucks on a side bet.... because there wasn't one.

The Shadow Economy

If it seems like the U.S. government has no idea how to solve the current economic crisis, there's a reason: they don't. But there's an important reason for this.

I've written about the massive market in Credit Default Swaps (see Financial Weapons of Mass Destruction) and the total lack of regulation as a result of the Commodity Futures Modernization Act of 2000 . This was the disastrous piece of legislation that McCain's economic advisor and (former) campaign co-chair, Sen. Phil Gramm, tacked on to an appropriations bill at the last minute (see Financial Weapons of Mass Destruction - Part 2).

Think of Credit Default Swaps (CDSs) as "insurance" for bonds issued by corporations, municipalities, and others. Bond owners buy swaps to protect themselves in case a company defaults on its debt or bond. The seller of these swaps takes on the risk of default. But unlike traditional "insurance," financial institutions can insure a bond even if the company issuing the bond doesn't know it.

The result of this lack of regulation has been speculation, market manipulation, and highly leveraged growth in the CDS market. It's been called a "Shadow Economy," and it's now a $58 trillion market that no one (including the U.S government) truly understands.

For example, one credit analyst estimates that there are about $400 billion in CDSs associated with the bankruptcy of investment bank, Lehman Brothers. These CDSs will be auctioned later today at about 10 cents on the dollar, but won't be settled for a couple of weeks.

The resulting $360 billion loss will be spread out among sellers of the CDSs, including banks, insurance companies, and other companies. Eventually the loss to sellers of CDSs will be out in the open, at least for the Lehman bankruptcy. This may cause other firms who sold Lehman CDS's to go into default, and if it does, those who sold CDSs on these companies will suffer losses, and so on.

The problem is that no one (including the U.S. government) knows exactly who has sold CDSs and on which companies. The result is a "credit freeze." Banks won't loan to each other or to businesses that need funds to continue operations, resulting in severe damage to the world economy. Since financial losses due to CDS exposure is not included in the $700+ bailout plan, recent actions by the government have had little effect.

Would Treasury Secretary Hank Paulson have made the decision to not bail out Lehman Brothers had he known the extent of CDS exposure other companies have? We may never know, and that's the problem with the lack of regulation and transparency in financial markets.

We will eventually work our way through this, but the next time a presidential candidate boasts that they are a "deregulator," remind them that sometimes regulation isn't such a bad thing.

Financial Weapons of Mass Destruction - Part 2

I've written about the risks of financial chaos created by the $58 trillion market in Credit Default Swaps (CDS), and the role the Commodity Futures Modernization Act of 2000 (CFMA) in allowing them to go totally unregulated, severely damaging our economy (see Financial Weapons of Mass Destruction).

How this misguided piece of legislation became law is a story in itself, and points to the responsibility of our elected officials in this crisis. It's not just "Wall Street greed," it's also "Washington, D.C. stupidity." [Disclaimer: this applies to both political parties]

The Commodity Futures Modernization Act of 2000 was first introduced in both Houses of Congress (S.2697, H.R.4541) in June, 2000. At the time, cosponsor Sen. Phil Gramm proclaimed that the "bill eliminates the legal uncertainty that today hangs as an ominous cloud over the $7 trillion financial swaps markets."

In testimony on the bill before a joint Senate Committee (June 21, 2000), SEC Chairman Arthur Levitt commented:

I can appreciate that to some our securities laws may appear to be just more government regulation. But to study our securities laws is to discover the rich history of U.S. financial markets. Your predecessors did not write these laws in a vacuum. They enacted these statutes in response to significant problems that cried out for practical solutions.

History proves that these laws have worked for the securities markets. Not only our securities markets, but also our derivatives markets, such as the options markets, have thrived under this framework. To me, the question posed by this bill is whether the benefits of the securities laws that investors have come to expect should continue to apply to these markets. Unequivocally, the Commission’s answer to that question is yes.

To Gramm and the "deregulators," however, the answer was "No." They saw government regulation as an obstacle, not a benefit, and they wanted the obstacle removed.

The original bills were going nowhere, and they were becoming impatient. So, they were repackaged ((H.R.5660, S.3283) and reintroduced just before the Christmas 2000 recess. Thanks to Gramm, the bills were eventually tacked on to an appropriations bill (H.R. 4577), and the Commodity Futures Modernization Act of 2000 cleared Congress on December 17, 2000. It was signed into law a few days later. There was no debate on the floor, and it seems likely most Congressmen hadn't even read the 262-page bill.

SEC Chairman Arthur Levitt, who had served longer that any other SEC Chairman, announced his plans to retire (without completing his second term) on December 20, 2000. A new era of deregulation had begun.

So, the bill that mandated no regulation over a market that is now nearly four times the size of the entire U.S. stock market didn't come into being after careful deliberation. It was shoehorned into an appropriations bill that was passed hours before the end of the 106th Congress.

John McCain has called his economic advisor, Phil Gramm, "one of the smartest people in the world on the economy." As Gramm's role in causing the current economic meltdown becomes more obvious, I'd suggest McCain get his advice from someone else.

Financial Weapons of Mass Destruction

More than 5 years ago, Warren Buffett warned of the dangers of what he called "financial weapons of mass destruction" that could damage our entire economic system. Buffet was speaking of derivatives, such as futures, options and swaps. There's a reason he's called the "Oracle of Omaha" and renowned as the world's greatest investor.

As it turns out, one type of derivative, Credit Default Swaps (CDS) are especially toxic, and in a world where financial risks are magnified and government oversight is non-existent they have caused exactly the kind of economic crisis Buffett predicted.

According to Fortune magazine, CDS's "...played a critical role in the unfolding financial crisis.... by ostensibly providing 'insurance' on risky mortgage bonds, they encouraged and enabled reckless behavior during the housing bubble...."

In addition, "...terror at the potential for a financial Ebola virus radiating out from a failing institution and infecting dozens or hundreds of other companies - all linked to one another by CDS and other instruments - was a major reason that regulators stepped in to bail out Bear Stearns and buy out AIG, whose calamitous descent itself was triggered by losses on its CDS contracts."

Michael Greenberger, a University of Maryland law professor and former director of trading and markets at the Commodity Futures Trading Commission (CFTC) explains:

"If CDS had been taken out of play, companies would've said, 'I can't get this [risk] off my books. If they couldn't keep passing the risk down the line, those guys would've been stopped in their tracks. The ultimate assurance for issuing all this stuff was, 'It's insured.'"

In testimony before the Senate last month, SEC Chairman Chris Cox pointed to the dangers we face:

The failure of the Gramm-Leach-Bliley Act to give regulatory authority over investment bank holding companies to any agency of government was, based on the experience of the last several months, a costly mistake. There is another similar regulatory hole that must be immediately addressed to avoid similar consequences. The $58 trillion notional market in credit default swaps — double the amount outstanding in 2006 — is regulated by no one. Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market.

It's not encouraging to think that there's an even greater danger looming than the disaster created by the Gramm-Leach-Bliley Act. How can it be that a $58 trillion market (almost four times the value of the entire U.S. stock market) is not regulated? Who caused this? Is Chairman Cox simply making excuses after having "betrayed the public's trust," as John McCain has suggested?

I agree that Chairman Cox should be fired, but in fairness, the SEC can't regulate credit default swaps, nor can the Commodity Futures Trading Commission (CFTC). They are prohibited from doing so by a law.

The CDS market was never been well regulated, and attempts by the CFTC in the late 1990's to increase regulation were met with stiff opposition. More regulation was clearly needed for what was a very rapidly growing market. But even the possibility of increased regulation was too much for the "deregulators," who wanted absolutely no oversight whatsoever.

So the Commodity Futures Modernization Act of 2000 (CFMA) was born. It included numerous provisions, such as the infamous "Enron Loophole." The far more destructive impact, however, was that it eliminated any existing regulation over CDS's, and specifically banned regulation of CDS's by any federal agency.

Too bad the bill's cosponsor, Sen. Phil Gramm, didn't have Buffet's crystal ball before he claimed the CFMA "protects financial institutions from over-regulation ... and it guarantees that the United States will maintain its global dominance of financial markets."

Apparently, McCain's economic advisor and (former) campaign co-chair believed he was elected to "protect financial institutions from over-regulation."

And that's a big part of the problem.

The Politics of Blame

With the presidential election only a few weeks away, and our economy in a shambles, it's not surprising that fingers are pointing in all directions.

Republicans want to put the blame on the failure of Fannie Mae and Freddie Mac, and would like you to believe that John McCain led the charge to institute reforms that could have avoided all this.

I'll give McCain credit for advocating more oversight of Fannie/Freddie. The problems and abuses at Fannie/Freddie had been known for more than 20 years, and no action had been taken under either Democratic or Republican administrations. Sen. Chuck Hagel introduced the Federal Housing Enterprise Regulatory Reform Act of 2005 (S.190) on January 26, 2005. McCain didn't author the bill, but did sign on as cosponsor in May, 2006, after a damaging federal report on accounting practices at Fannie Mae was released. Better late than never.

But accounting wasn't at the heart of the problems at Fannie/Freddie, and they are only part of the cause of the financial crisis.

McCain's was quick to point a finger at the "greed that caused the crisis on Wall Street," and I agree with him. I'd be more impressed, however, if he acknowledged his own responsibility for the lack of oversight of our financial system.

In an article in Barron's (a Wall Street Journal Publication) last week, "A Memo Found in the Street", Barry Ritholtz points his finger back:

We on Wall Street feel somewhat compelled to take at least some responsibility. We used excessive leverage, failed to maintain adequate capital, engaged in reckless speculation, created new complex derivatives. We focused on short-term profits at the expense of sustainability. We not only undermined our own firms, we destabilized the financial sector and roiled the global economy, to boot. And we got huge bonuses.

But here's a news flash for you, D.C.: We could not have done it without you. We may be drunks, but you were our enablers: Your legislative, executive, and administrative decisions made possible all that we did. Our recklessness would not have reached its soaring heights but for your governmental incompetence.

Ritholtz provides a list that includes misguided policies at the Federal Reserve, relaxed guidelines at the SEC, and key pieces of legislation and regulatory change. His description of three key regulatory changes:

1999: The Financial Services Modernization Act (also known as Gramm-Leach-Bliley) repealed Glass-Steagall, a law that had separated the commercial-banking industry from Wall Street, and the two industries, plus insurance, came together again. Banks became bigger, clumsier, and hard to manage. Apparently, risk-management became all but impossible, even as banks had greater access to larger pools of capital.

2000: The Commodities Futures Modernization Act defined financial commodities such as "interest rates, currency prices, and stock indexes" as "excluded commodities." They could trade off the futures exchanges, with minimal oversight by the Commodity Futures Trading Commission. Neither the Securities and Exchange Commission, nor the Federal Reserve, nor any state insurance regulators had the ability to supervise or regulate the writing of credit-default swaps by hedge funds, investment banks or insurance companies.

2004: The SEC waived its leverage rules. Previously, broker/dealer net-capital rules limited firms to a maximum debt-to-net-capital ratio of 12 to 1. This 2004 exemption allowed them to exceed this leverage rule. Only five firms -- Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns and Morgan Stanley -- were granted this exemption; they promptly levered up 20, 30 and even 40 to 1.

I've written in the past about the role of deregulation (Fundamentally Unsound) in creating the turmoil in financial markets, the lack of SEC oversight, and the connection of Gramm-Leach-Bliley to the financial problems we face today. So the key role of McCain's economic advisor and (former) campaign co-chair, Sen. Phil Gramm, came as no surprise.

While I don't buy Ritholtz's excuse for Wall Street, he's right about one thing: this could not have happened without the support of those in Washington, D.C., including self-described "deregulator," John McCain and Phil "mental recession" Gramm.

Wall Street may be to blame, but I don't have to make a decision about Wall Street in a few weeks. I just have to decide who I believe should lead our country as President...and it isn't John McCain.


Next: More about the Commodities Futures Modernization Act of 2000 and "financial weapons of mass destructions."

Creation of a Lie

In the political arena, exaggerations and distortions are to be expected, I suppose. And perhaps given the urgency of the issues we face today it shouldn't come as a surprise that we're seeing more outright lying in this presidential race than we have in any election that I can recall.

Like many of you, I noticed the escalation in the "attack-ads" several weeks ago. I became especially concerned when former Bush advisor Karl Rove told FOX news

"McCain has gone in some of his ads -- similarly gone one step too far...and sort of attributing to Obama things that are, you know, beyond the '100 percent truth' test."

When the Master of Dirty Tricks says things have gone too far, it should tell you something. So an alarm went off when I saw a recent McCain ad.

Obviously embarrassed by McCain's insistence that the economy is "fundamentally strong," the McCain campaign released an ad claiming that Obama has said much the same thing, claiming Obama "attacked first," and even going so far as to say Obama is a "hypocrite."

The ad shows a clip of Obama saying "We’ve got the long-term fundamentals that will really make sure this economy grows.” Take a look and decide who's the hypocrite:



Now here's what Obama actually said:

"We don’t just need a plan for bankers and investors, we need a plan for autoworkers and teachers and small business owners. I have said it before and I’ll say it again: we need to pass, after this immediate crisis is over, an economic stimulus plan. Right now. For working families – a plan that will help folks cope with rising food and gas prices, that can save one million jobs by rebuilding our schools and our roads, and help states and cities avoid budget cuts and tax increases. A plan that would extend expiring unemployment benefits. For those Americans who have lost their jobs and have been working hard to find a new one, but haven’t found one yet. That’s part of the change we need.

"And then after this immediate problem, we’ve got the long-term fundamentals that will really make sure this economy grows."

Obama's statement that we'll have a sound economy after his changes are put in place is not at all the same as McCain's claim that we have one today. Just the opposite.

This is more than taking Obama's sentence out of context. The ad actually removes part of the sentence to change the meaning. As Karl Rove said, "one step too far."

It's ironic that in an age when so much information is readily accessible on the internet, we have distortions and so many ads that include blatant lies. Political "strategists" are counting on the fact that most people take ads on face value and form opinions based on 15 second sound bites.

Don't let them get away with it.