The Financial Crisis And You: Effects on the Election

Post columnist Sebastian Mallaby was online Friday, Oct. 17 at noon ET to take your questions and comments about how the current financial turmoil will impact the presidential and congressional races and the outcome of the election.

A transcript follows.

Sebastian Mallaby is a biweekly columnist for The Post, specializing in globalization, trade, investment trends, international development and economic policy. His column appears every other Monday. A member of the paper's editorial board from 1999-2007, Mallaby now directs the Center for Geoeconomic Studies at the Council on Foreign Relations.

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Arlington, Va.: From everything I've read on this horrible financial crisis, including news reports from a few years back, it looks like certain officials from the Clinton administration and several Democrats on Capitol Hill bear significant responsibility for putting bad policies into place and resisting calls for regulatory reform. We can't do anything about the Clinton officials, but we can do something about the Democrats still in Congress who resisted regulatory reform and protected Fannie Mae and Freddie Mac. Are there any grassroots efforts or any public interest groups forming to put a spotlight on the members of Congress and hold them accountable? Thank you.

Sebastian Mallaby: Hi, I'm not an expert on grass roots movements, but I think your account of who's responsible is only partly right. The Clinton Treasury shared the view that Fannie and Freddie were too big; people in Congress, mainly Dems but by no means only, were the ones who protected Fannie and Freddie, and even pushed them to lend more aggressively to people with dubious credit. I guess members such as Barney Frank are not about to lose their seats in this election, so I'm not sure what citizens' best method of pressuring them is.

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Washington, D.C.: Which was more fun, predicting economic destruction at the Economist or the WP?

Sebastian Mallaby: Both The Economist and the Washington Post are great places to work. Predicting economic destruction is less fun, but unfortunately it can be necessary.

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Harrisburg, Pa.: We've gone from the "it's the economy, stupid" to "it's this stupid economy." Has anyone correlated economic indicators with the polls? It seems when the market was crashing Obama gained in the polls. Once the market began rebounding, McCain rebounded. Is this anecdotal or can anyone find any statistical correlation?

Sebastian Mallaby: I think it's pretty well recognized that good economies favor the incumbent party and bad ones favor the challengers. Clinton won in 1992 partly by running on the economy and blaming the downturn, which actually had ended by the time of the election, on Bush the elder. He cruised to victory in 1996 because the economy was going great then. Gore was in the dog house until his climate change comeback because he managed to lose in 2000 despite a strong economy.

Of course, when you have the White House incumbent leaving office one could argue that blame for a bad economy could favor either side. I think McCain is suffering partly because he is from Bush's party and Obama has spent oodles on painting McCain as a continuation of Bush. But McCain might now be faring better if he was himself more fluent on the economy and had put together a better team of advisers. There was a revealing poll of academic economists published in The Economist recently. Not only did the vast majority of economists support Obama over McCain. Even Republican economists said that Obama's economic policies were superior.

When you consider that Obama's economic policies actually have considerable flaws--for example his populist anti-trade stuff--this is a remarkable indictment of McCain.

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Anonymous:"It's the economy, stupid" worked for Clinton, yet most of the elections over the past half century have been won by fear. We need to be protected from "wolves in the forest." Whether it is communists, murdering parolees, or terrorists, the Republicans have been there to remind us just before election day that we voters need their protection from these fears. Seeing how McCain improves as the market improves, how much might fear replace the economy? I see the robocalls and commercials reminding me that while Obama is not a terrorist, he just hangs up with a terrorist, and remember, Barak Hussein Obama is not really an Arab.

Sebastian Mallaby: You are right that people vote their fears. After 9/11, the fear was terrorism. Today, the fear is job loss, melting 401Ks, etc. This is why Obama is winning.

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Chicago: Hey Sebastian, I am curious about what you think the foreign policy implications are for the financial crisis. If we ever got to the point where foreigners balked at buying our debt, would the Iraq occupation have to come to a rapid close? Do you believe the financial version of MAD will allow us to borrow from the rest of the world for the foreseeable future?

Sebastian Mallaby: This is really great question. I have tried to think through the foreign policy implications of the financial crisis with some smart collaborators on a Council on Foreign Relations online Forum--see www.cfr.org/forum. Since that discussion was conducted, we've seen the Iceland episode play out: Even though Iceland is a NATO member, neither the US nor the IMF bailed that country out; instead it looks as though Russia will come to the rescue. What does Russia want in return? Maybe it wants Iceland to block Georgia's or Ukraine's entry into NATO? Anyone who's interested in that question should check on the "Featured Issue" on www.cfr.org/cgs.

You ask the question about US debt and power. Russia and China opposed the US operation in Iraq while financing it by buying US Treasury bonds and other US securities. Will this go on? For the moment, you can see that the dollar has recovered the value it lost in the first half of the year, so there's no real sign of money deserting US assets. But in the future, who knows? I'm inclined to think that foreigners bought US assets because they believed in the excellent regulation and transparency of US capital markets. After this bust, they may think again--assuming that there are better alternatives out there.

Anyone who really wants to learn about the interactions of US debt and power should check out the recent report by Brad Setser, which got a good write up recently from Steve Coll in the New Yorker. See www.cfr.org/publication/17074/sovereign_wealth_and_sovereign_power.html

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New Jersey: I have seen plenty of acknowledgments from all sides that "the system has failed," or "our economic landscape has changed forever."

Yet every effort seems to be directed at shocking the same old system back to life and "restoring confidence" in, yes, The System. Isn't this a contradiction?

I haven't any confidence in the system any more. There is blatant manipulation and insider trading going on. I feel I am being cheated whenever I make any sort of decision.

Is anyone (any politician or policy-maker) promising that The System itself will be changed significantly? In ways that will impede the ability of financial firms to control so much? Is that what the government stake will accomplish?

Sebastian Mallaby: You are right that there is a difference between crisis management--preventing a melt down--and fixing the system in the longer term. In the short term we just need to get money flowing through the system by having the central banks lend on very easy terms. But in the long term we want to discourage these pyramids of debt: lending will have to get more restrictive. There's no easy way out of this tension between long and short term.

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Washington, D.C.: Assuming Barack wins, how would you expect Paulson to transition with Jim Wolfensohn as Treasury Secretary, if Wolfensohn is actually displeased with his current work for the Clinton organization?

Sebastian Mallaby: Wolfensohn for Treasury secretary is a new one on me.... But having written a book about the guy, I guess I wouldn't exclude anything.

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Sugar Land, Tex.: Would you agree that Congressional Democrats and Republicans alike created dishonest accounting, legislated lower credit standards and hamstrung regulatory enforcement in order to stimulate consumer borrowing/spending in order to produce the economic expansion necessary to generate tax revenues that Congress needed to finance its addiction to spending.

And that Congressional actions and inaction created the environment for the first wealth meltdown, the dot-com securities market meltdown, and the current sub-prime mortgage market meltdown.

And that another wealth meltdown, is likely to occur as a result of Congress' failure to address the looming Medicare and Social Security crisis?

Sebastian Mallaby: There's some truth here. First, I certainly agree that the long term Medicare/Soc Sec cost has to be addressed, and that by building up those long term promises to folks without figuring out how to pay for them, the government is behaving like a family that took out a mortgage with a vicious reset on the interest rate that it could never pay for. Second, I think it's true that the government, including the Fed, was too tolerant of build ups of debt in the past. The dot-com bust encouraged the Fed to believe that it could clean up asset bubbles after they popped relatively painlessly. Well, it ain't painless this time.

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Princeton, N.J.: Fannie and Freddie were not the cause of the subprime mess. They didn't buy any subprimes until two years after the private banks went wild (think "New Century"). They never held a significant portion of their portfolio in those loans. The cause was lack of regulation and enforcement on the mortgage brokers and investment banks. This was due to conservative philosophy that the "free market" always is best, not the liberal philosophy that the poor and middle class deserve a fair shake.

Sebastian Mallaby: This is a serious assertion, but I don't fully agree with it. You are right that private mortgage lenders did most of the subprime stuff and also that they led the process, with Fannie and Freddie following. But it is still a fact that F and F bought hundreds of billions of dollars of subprime paper. And if you count subprime as including semi-bad stuff, you get to a number like $1 trillion of dubious loans, or one third of the bad paper that was created in the bubble. So we can debate how much F and F were responsible, but they certainly played a role. And many people say that they conferred a feeling of legitimacy on the sector. European banks felt okay about buying CDOs because Fannie and Freddie were buying them.

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Washington, D.C.: What IS the principal reason for the economic collapse? Is it fair to blame McCain for it?

Sebastian Mallaby: It's not fair to blame McCain. The collapse has its origins in loose monetary policy, and that was the Fed's fault. It was exacerbated by Fannie and Freddie, which McCain opposed. The trouble was also fueled by lax regulation of Wall Street, and I think both parties failed to lift a finger to change that. But although it is unfair to blame the crisis on McCain, it is nonetheless true that his responses to the crisis have been less measured than Obama's. One thing that infuriated me was when he demanded the resignation of the SEC chairman, Chris Cox. Trying to decapitate a government agency in the middle of a crisis is irresponsible.

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South Glastonbury, Conn.: I read today that the banks receiving MY money (which was supposed to be used to unfreeze the credit market) are going to hold/hoard the money, rather than putting it into the credit market.

Why is it no one of any political persuasion pushing to make bailout bucks contingent upon the recipient bank putting such monies in the lending market?

Sebastian Mallaby: Fair question, but the last thing we want is the government looking over banks' shoulders and telling them how much to lend and to whom. The British government is talking about that sort of oversight and I think it is a disaster. The point is that banks have plenty of incentive to lend, since interest rates for private borrowers are very high. When they judge it is safe to do so, the money will start flowing.

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Evanston, Ill.: If we are going into a sharp recession, why would the banks, even if recapitalized, start vigorous lending again? What's the risk that we get a bunch of Japanese-style zombie banks?

Sebastian Mallaby: I mentioned in my last answer that banks will eventually lend again because interest rates are very attractive. For example, I heard that you can earn more than 10 percent per year by lending to Morgan Stanley. So the extreme credit crunch that we've been experiencing for the past few weeks will subside if banks judge that other banks are not about to blow up. Beyond that, however, you are right that we are in a recession and so regular business lending will be more cautious than it was in the boom years, which now seem so distant.

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Anonymous: What do you think of the idea of the government paying money directly to lenders' homeowners equal to their negative equity instead of buying the mortgages outright? Methinks it would cost a lot less while infusing cash into lenders' coffers and hopefully spur a recovery in housing values as forclsoures decline.

Sebastian Mallaby: I'm sympathetic to the idea of helping home owners, and then letting that assistance trickle up to the banks that have lent to those same home owners. Politically, it would be nice to balance trickle down economics with a bit of trickle up economics. But the problem is practical. How would we judge the amount of negative equity, since house prices are hard to judge in this environment? Also, how would we answer the people who said this was an unfair reward to people who bought irresponsibly on no-doc loans? What about helping people who bought responsibly, or who did not buy at all because they did not want to overstretch? As I think through those questions, I come to favor fiscal stimulus-- a tax rebate for everyone. That would be fairer than just plugging the negative equity holes.

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washingtonpost.com: Sovereign Wealth and Sovereign Power - Council on Foreign Relations

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Princeton, NJ: You say (like everybody else), "I certainly agree that the long term Medicare/Soc Sec cost has to be addressed" I think these concerns have been overblown.

For SS, I am a mathematician and I believe we simply cannot make long term economic predictions. Remember "Surpluses as far as the eye can see"? Actually what is done are projections, i.e. IF A, B, and C happen, then D will happen with some probability. BUT A, B, and C depend on future events and are unknowable. This is why the SS projections when used as predictions are no better than reading the entrails of a goat.

As for health care, this is an easy problem at least for the medium term. It is one that has been solved by every other wealthy country. Other wealthy countries get much better health care as measured by all the basic public health statistics and they pay less than half the cost per patient. A more efficient system will at least put off the day when we have to make the really difficult decisions.

Sebastian Mallaby: On SS, surely you would agree that shaky projections about the future are better than no projections? In the absence of any projections at all, we couldn't plan anything. Besides, the SS actuaries have consistently reported, through good times and bad, that we face a looming problem.

On health, you are right that other countries do better. Last time I looked, the US spent 16 percent of GDP on health care while the OECD average was something like 11-12 percent, but the US had life expectancy that was no better. Some of that gap my reflect demographics--high immigration rate in the US, etc. But maybe half the gap reflects the staggering waste of the way we do health care in this country.

Politically, though, fixing health care is, uh, difficult.

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"And if you count subprime... : as including semi-bad stuff, you get to a number like $1 trillion of dubious loans, or one third of the bad paper that was created in the bubble."

Look, the most F & F spent on subprimes was in 2006 when under 15 percent of their investments were in subprimes. The Repubs want to put the blame on F & F because they believe the Dems were associated with them, and you have fallen for it. Same for CRA which was mainly against red-lining.

Sebastian Mallaby: The Sunday NYT a while back had a long investigative piece on this. A do not regard the NYT as part of the vast right wing conspiracy!

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Reston, Va.: A consumer base is needed in which personal debt is minimized. Incomes need to rise faster than inflation in order to enjoy true growth. The middle class bell curve we enjoyed in the '50s and '60s is gone.

The next global economic engine is probably China.

Sebastian Mallaby: Trouble is that if we want to minimize personal debt, we are going to go through a long period of doing something that we stopped doing a while back: saving. A higher household savings rate will mean lower demand and lower GDP growth, other things equal. This is part of the "great unwind" of excess debt that is going to have to happen in the financial sector too.

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Raleigh, N.C.: Good afternoon. Inside baseball question here. Given the partisan breakdown in the House on the bailout package (it was significantly stronger with Dems than GOPs), is there any evidence that Wall Street political donors are shifting money from House Republicans to either House Democrats or Senate Republicans? How might this play out in the medium term, with reapportionment coming up after 2010? It just seems that if the House Republicans lost the financial backing of the financial industry AND have a less-white electorate every cycle AND face gerrymandering and retirements, that it'll be a long, long time until there are 200 House Republicans again.

Sebastian Mallaby: I think industries like to contribute to the winning party, so that explains part of the swing to the Dems. Remember that after 1994 people talked of a permanent Republican majority in Congress. I think the cycles change faster than such predictions would suggest.

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Rockville, Md.: Hi Sebastian- I'd love to hear a candidate say we're going to stop taxing savings. Sure some parameters would have to be set, but eliminating the taxes on money you're able to save -- after paying taxes on it -- would be a great thing for me and the economy in general I think. I know I'm dreaming, but what's wrong with the idea? (Except the fact we can't afford it -- although that doesn't prevent other crazy ideas from being proposed/promised.)

Sebastian Mallaby: There's some merit in a consumption tax. The problem is that it tends to be regressive. The forces out there in the globalized economy are pushing toward greater inequality, so I think we should hesitate before embracing tax plans that reinforce that.

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Portland, Ore.: The religious non-profit I've worked for the last 10 years is suffering from the current financial crisis and is considering laying off staff. The real issue for me is health insurance. I have two chronic genetically-related conditions that cost approximately $35,000/year to treat. I currently gross $42,000/year. Fortunately I have very good employer-provided health insurance, but no private insurer in their right mind would take me if I'm laid off.

COBRA? There is no way I could pay $887/month for it while unemployed. I'm fairly certain that if I lose my job I will be bankrupt within one year, and perhaps dead from lack of medical treatment within two.

Is there anything I can do to prevent this from happening? (The Oregon Health Plan is currently not taking anyone, and the last time it did, it was through a lottery which very few won.) I've been thinking and researching for months but have not come up with any solution. Can you please tell me one?

Sebastian Mallaby: I wish I could answer this question better. Your case makes the point that the current system is broken. If Obama's plan is enacted, there would be the option of buying into a government insurance program, hopefully at an affordable rate.

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Sebastian Mallaby: Thanks for all the questions, folks. It's been fun discussing this stuff with you.

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