The first big challenge

While the next president is certainly going to inherit a host of problems from W., the mortgage crisis is kind of our first chance to see how the candidates react in “real-time.” They didn’t get to quietly focus group their approach to this problem over 6 months. More importantly, their campaigns were not selected by voters because of this problem (McCain and Obama are still standing in part because of their positions on Iraq vs. other members of their party, so of course those positions are popular).

So how are they doing? According to the NYT, Obama has the “best” plan for dealing with mortgages (see here)– bankruptcy reform. Lest we think the NYT is an Obama stumper, here is their endorsement of Hillary Clinton as their candidate. Lest we think this is just a fluke or happenstance, here is a brief analysis of why Obama’s plan is the best and why the plan proposed by each candidate follows directly from their political approach.

The Problem:

Economic issues are always extremely complicated manifestations of very simple underlying problems. The issue is always some kind of mismatch. Everybody wants something that nobody has or nobody wants something that everyone needs to do something with/be compensated for. The government doesn’t need to step in to correct the mismatch per se, it’s going to be re-balanced one way or another, but the government can influence which of the one or another ways the re-balancing occurs, and these ways have dramatically different social consequences. For example, mismatch in demand for and supply of food can be re-balanced by intelligent distribution schemes or by mass starvation.

The current crisis is based on two mismatches and one basic fact:

1. Lots of people have debts they can’t pay because they own homes on credit terms they can no longer afford.

2. Lots of banks depend on mortgages on their balance sheets to maintain good standing with their financial trading partners. That is, these mortgages help them fill certain requirements.

3. Banks are all tied together. Some banks are better than others, but in the market, even good banks rely on bad banks to make good on their basic promises. Transactions happen too fast to be done on any other basis than credit. I might buy something from you at 10am and sell it to someone else at 11am. I do this on the expectation that over the next day or two we can figure out who really owns what and get that to them. In other words, trades today are contingent on the traders being around tomorrow and for a few more days. So when some of the traders go under, lots of other traders are put in jeopardy.

These three things combine in a nasty way. Since people can’t afford their homes they must submit to foreclosure or declare bankruptcy. But if they do either of these things, their mortgage “ends,” it disappears. This means that the banks that hold these mortgages have to remove them from their asset listings, which means they may lose their good standing with other banks. So banks go under. But banks work together, so now lots of banks are in jeopardy.

There are many ways to address this problem. Each of the candidate’s offers their own. They are, not surprisingly, quite consistent with the philosophy of their candidacise:

John McCain: John McCain is running on the Reagan philosophy of “free markets” with limited government intervention. His proposal — let the private sector work it out. This policy can be criticized as having the typical pitfall of Reaganomics — it makes the less fortunate suffer. But this misses the point. Fair or not, this approach no longer makes sense. The globally inter-dependent economy of 2008, the one which developed in part because of the Reagan revolution, will not respond the way the Carter economy of 1980 might have. If banks aren’t discouraged from coupling, they will do more of it. Foreclosures on individuals with Fed bailouts for banks is precisely the outcome banks seek when they issue questionable debt — let the borrower pay consequences, but not us.

To follow this policy, then, is to make many citizens suffer and encourage another bubble on the same basis. This is the McCain presidency — more of what got us here. Four years of time that could be used to update our nation wasted proving to ourselves that update really is desperately needed (see my post here).

Hillary Clinton: Hillary Clinton is running on a “I’m going to fight for you” philosophy. The basic idea is that the world is a zero sum game of winners and losers, good and evil people, parties, constituents etc. Her goal is to make sure that when a crisis emerges we, Hillary supporters, get the “wins” and some other group takes the “losses.” In the caes of the mortgage crisis, home-owners should get the “wins” and “bad banks” should take the losses. She is not naive. She is not suggesting there will be a lot to win. Her point is about relative, not absolute, gains — whatever wins and losses are to be had, bad guys should lose more and win less than the good guys.

Her policy is thus impose restrictions on what potential good guys would have to pay or give up — limiting foreclosures and interest rates — and what potential bad guys could gain — freezing interest rates, cracking down on predatory lending. This policy mitigates the pain and unfairness of the current manifestation of the problem but does nothing to address the underlying cause. It treats the symptom rather than the disease and so shifts the problem elsewhere, we just don’t know exactly where. People still can’t pay their mortgages, and banks still need them on their balance sheets. If you force interest rates down low enough for people to pay or eliminate foreclosure for the long term, the banks holdings are still in jeopardy and the banking crisis is still upon us, though now without mass evictions.

This is not a crazy strategy. It shifts the burden of the crisis into the entire system. The American economy as a whole will take a hit instead of those home-owners specifically. Perhaps this is what we need and deserve, but it does nothing to prevent a future crisis operating in the same fashion.

Barack Obama: Obama’s candidacy is based on bringing people together to talk. He believes that by sharing reasons, information and concerns we can find workable solutions where there appear to be none. The key to executing such a strategy is to compel all parties to get at the core of their concerns, i.e., to get away from the bluster of their demands, what they think or feel they want, and get down to the real basis of their needs, what they cannot reasonably be expected to yield.

As is often the case, the needs of the parties are apparent in the core cause of the problem. People can’t afford their mortgages but banks need them to keep paying for them. Foreclosures are bad for everyone, then, but are the only alternative banks have if people cannot pay. Obama’s proposal addresses this specifically. By sending mortgages to bankruptcy court for re-negotiation, homeowners will be able to keep their homes and banks will receive some, though not all, of the money they were owed. Homeowners will give up other things — credit rating, perhaps other items bought on credit — but they keep their houses, they do not become homeless. Banks lose short term cash but get to keep the value of the mortgage on their balance sheet — the homeowner is still paying off the same principal.

Like so many of his policies, Barack’s plan is not radically different from Hillary’s in terms of immediate outcome. They both reduce foreclosures and the flow of payments to banks. The difference is in their influence on the longer term evolution of this problem and the economy as a whole. Hillary’s plan gives banks the incentive to game the system yet again. If interest rates are frozen and foreclosures temporarily not permitted, the markets have clear barriers around which to adapt new exploitative strategies. They can, for example, refuse to issue new mortgages unless they receive some kind of government kickback to make it worth their while.

Obama’s plan hits the issue at its core — the parties can work something out becaues they both need the same thing. They just have to give up some of the other things they want.