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Press Release

    Two Economic Plans, Same Bad Idea

    03/28/2008

    Senator Barack Obama delivered a major speech yesterday in New York outlining his preferred policies for regulating financial markets.  Senator Obama called for “guiding the market's invisible hand with a higher principle,” and new regulations,” to ensure that we are not doomed to repeat a cycle of bubble and bust again and again.” 

    Obama is calling for returning to the failed polices of a previous era: government central planning of the economy. 

    In his speech, Obama called for the creation of an Orwellian sounding Financial Market Oversight Commission to advise the policymakers on systemic risks to our financial markets.  Yet there are already officials responsible for this type of work in several Congressional committees, the Department of Treasury, the Federal Reserve, the Securities Exchange Commission, and in the private sector.  It’s hard to see the purpose of creating another government body.

    Obama also stated that “financial institutions must do a better job at managing risks.“   If a corporation or investor mismanages risk, the market will sufficiently punish it, potentially putting the operation out of business.  Markets will always do a better job of determining an acceptable level of risk for individuals, investors, and markets than the government.  The current “crisis” is simply this risk management process in action—the market is repricing risk throughout the financial system.  In fact, there is a strong case to make that the past efforts to insulate financial institutions from bad decision-making—namely, the 1998 Fed-orchestrated bailout of Long Term Capital Management —led to the excessive hedge-fund leverage we see unwinding today.

    Senator Obama also called for an additional $30 billion stimulus package, including $10 billion for a new Foreclosure Prevention Fund.   This fund is designed to have the government assume the responsibilities for selling homes that are entering into foreclosure or have developed negative equity.   Senator Obama is proposing transferring responsibility of a loss from the individual to the taxpayer.

    What’s frightening is that Obama’s ideas seem reasonable when compared to his colleague, Senator Hillary Clinton, who recently declared she is also running to expand the Presidency into the ‘Commander in Chief of the economy.’ 

    Senator Clinton proposes having the Federal Housing Administration purchase ‘underwater mortgages,’ that is mortgages that are worth more than the current value of the home.  With the housing downturn, Moody’s projects the gap in underwater mortgages values at $1.9 trillion.  That is a tremendous amount of bad debt to make the government guarantee and the taxpayer accountable for.  Clinton believes that when the government auctions off this debt this program would be ‘self financing.’ 

    Clinton also proposes her own $30 billion stimulus program, a popular number these days, to give to states and cities.  The money would be used to buy foreclosed property.  Essentially, the federal government would underwrite state and local government communities entering the real estate and landlord business. 

    More troubling is her proposed "Main Street Test,"  which would apply to regulation of Wall Street.  The Main Street Test would require Wall Street to demonstrate to the government that new financial innovations "ultimately benefit America's working families."  Profitability and risk management utility should guide capital allocation, but Clinton would subject lenders to the vagaries of political calculation. 

    Government intervention, no matter how well intended, distorts efficient, productive markets.  The current housing crunch is no doubt unpleasant, but once the market adjusts to new realties and establishes a new equilibrium in pricing, we can get back to economic growth.   

    Taxpayers should not bailout imprudent investments for moral and practical reasons.  It is government intervention of the sort proposed by Senators Clinton and Obama that threatens to turn a short correction into a prolonged recession.