Reflection on the Election II

Shortly after Congress voted the initial bailout package, John McCain proposed a plan whereby the government would buy up troubled residential mortgages to prevent widespread foreclosures and evictions. The details of McCain’s proposal were sketchy and the plan seemed to reflect an almost desperate attempt to respond to the crisis. The massive scale of the crisis and its swift emergence, caught most by surprise. Moreover, there was little agreement as to the correct remedy. But McCain's proposal was seriously flawed in at least two respects.

While the financial crisis continues to unfold, one lesson is clear. The seeds of this problem was governmental pressure on lenders to lower their lending standards, coupled with an accommodation by Fannie Mae and Freddie Mac, who bought many of these loans from the banks. The lenders and their investment bankers also spread the risk of these loans by bundling them into marketable securities. But the law of unintended consequences is always with us and what started out as an attempt to encourage home ownership to low-income borrowers, also produced a stream of easy money for real estate purchases. Moreover, due to the government's parallel efforts at suppressing interest rates, mortgage money was not only easy, but it was cheap as well as it provided the fuel for the massive real estate bubble which saw legions of normally sane investors turn into real estate speculators.

Barney Frank and his co-conspirators would have us believe that it was the excesses of Wall Street, aided and abetted by Republican de-regulation that caused the mess. Make no mistake about it, Wall Street is in business to make money. At the same time however, avoiding losses is an important part of that effort and the Street is usually very efficient at pricing risk. It could be argued that absent the government's meddling, the market would have self-corrected long before the sub-prime loans achieved plague status. McCain's proposal precluded any effort to accurately describe the underlying causes of the crisis, allowing the Democrats to lay the blame at the Republicans door.

As a result of the relaxed lending standards, borrowers who might have otherwise not qualified for a loan were provided mortgages, often for a higher percentage of the purchase price of the property. But when borrowers failed to meet their payments, concern was raised, not for the lender's losses, but rather the borrower who faced the loss of the property. This might be an acceptable social sentiment, but it makes no sense from an economic standpoint. The proposal to have the government purchase the troubled mortgage to "protect" the homeowner from eviction implies a back door entitlement program that most taxpayers would find unacceptable. This flies in the face of Republican free-market principles and invited questions of McCain's grasp of basic economics.

While this issue, by itself, did not decide the election, it is one of the issues that, emerging late in the campaign, worked to McCain’s ultimate detriment. The View will look at several similar issues in future posts. Within the continued irony that marked this campaign, McCain’s opponent remained virtually silent and emerged largely unscathed by the financial crisis, just as he did on so many counts.