Since the middle of last year, the US Congressional Budget Office estimates that Americans have lost almost two trillion dollars from their retirement plans. Half of these losses have occurred in the past three months. A deep recession is almost inevitable, if one isn’t already underway, and there are growing rumours of something much worse. And yet, instead of turning into a debate over the origins of the crisis and a search for solutions, the last days of the presidential campaign seem fated to be filled with what President Clinton liked to call “the politics of personal destruction.” At the beginning of October, in a moment of unusual candour, a senior McCain strategist told the New York Daily News that negative campaigning was “a dangerous road, but we have no choice. If we keep talking about the economic crisis, we’re going to lose.”
The economy should get Obama elected, but it may also prove to be a Damocles sword once he is in office. The American taxpayer has already paid unprecedented amounts to rescue several banks from insolvency, and to get them lending again, but there is no reason to believe that the worst of the financial crisis is over. An unstable stock market has exacerbated the correction in the housing market and may result in a 14% drop in household wealth this quarter alone – the worst fall ever recorded. The financial impact this will have on ‘Main Street’ is frightening. In the 1990s home-equity loans accounted for about a quarter of annual personal consumption; that figure now stands at 36%. Also, the number of homeowners who rely on a mortgage has risen from about half in the 1980s to almost two-thirds today.
Beyond the immediate bailouts and rescue packages lie larger questions about the government’s role in overseeing the financial system. For two decades, regulation has been a bugbear for the sages of American finance. This is not likely to change overnight. In light of recent events, the New York Times reviewed former Federal Reserve Chairman Alan Greenspan’s record on regulation. It found him consistently against all but the mildest supervision of the financial instruments which had caused most of the current crisis. Time and again, Greenspan was willing to trust Wall Street to regulate itself. Even after the failure of the Long Term Capital Management hedge fund in 1998 – a crisis which required the now-paltry sum of 3.6 billion dollars, privately raised by banks that had too much vested in the fund’s future to allow it to fail – Greenspan played a central role in persuading congress to repeal the Glass-Steagall Act of 1933, which had insulated risks in the financial system by keeping commercial and investment banking separate.
Many believe that the repeal of Glass-Steagall laid the foundations for the US housing crisis. Once commercial lenders like Citigroup were able both to create mortgage-backed securities and to shape the markets which traded in them, there was a predictable surge of speculation. Much of it was driven by the appeal of Collateralized Debt Obligations (CDOs) which offered investors a steady stream of cash from the collected repayments of thousands of individual mortgages, on condition that they would also assume the risks associated with the loans. Like other financial derivatives, CDOs facilitated huge, leveraged bets in the global marketplace. (A derivative is a contract that transfers risk for an underlying asset from one party to another − in much the same way that an insurance policy offsets a homeowner’s risk of fire and theft by making the insurer liable for specific losses.) Credit default swaps – the formal name for the sleight-of-hand that transferred the downside of the housing bubble onto investors − allowed US banks to finance a real estate boom, while shielding themselves and, ultimately, the new borrowers from the impact of untoward ‘credit events’ like failure to repay extortionate adjustable loans. Since mortgages also generated lucrative fees, the lenders soon faced considerable pressures to sustain the high demand for new houses – hence the sharp increase of ‘subprime’ loans to people who could ill afford them. The resulting mess has been a perfect storm of the kind of unsupervised greed that Glass-Steagall had been set up to prevent. Bad as the collapse of the various speculative bubbles has been so far, there are real fears that further shocks are likely. (Fortune magazine says the current global market in credit default swaps is worth US$55 trillion – a figure that exceeds the world’s entire world GDP. Of course, this estimate is just a notional figure − the real estate collapse in the US has already shown that many derivatives’ underlying assets are worth a great deal less than their paper value.)
The political fallout from these crises has, to say the least, complicated the task of rescuing and re-regulating America’s financial system. This week’s editorial in the Economist summarises the situation well: “It will be a brave president who goes to Detroit and explains why the 45,000 well-paid folk at Morgan Stanley should get $10 billion of taxpayers money, but the 266,000 people at General Motors should not.”
These challenges would be enough to occupy the brightest US president for most of his first term. Placed within the context of the country’s current embattled foreign policy, its outdated infrastructure, failing education and health systems, they seem almost insurmountable. Every day of empty rhetoric and negative campaigning makes them more so. Robocalls about William Ayers, populist nonsense about putative tax hikes facing “Joe the Plumber,” and jibes about Obama’s “socialism” may be all the McCain camp have to deflect serious conversation from the economy, but the low road may end up costing the US an effective political response to its various economic crises. If American voters succumb to the old ploys yet again, they will have no one to blame but themselves.
