You don’t have to be a professional day trader to appreciate the seriousness of the current financial storm. Every day seems to bring a new development, whether a bankruptcy or government bailout, reflected in the 5% daily swings in equity prices. As if you don’t have enough to think about, bear in mind that the credit crisis is not only reshaping the US economy and its capital markets; it is also affecting the political landscape. Specifically, the economy has been catapulted into the spotlight of the presidential election, completely altering its tenor.
Accordingly, John McCain and Barak Obama have seized upon the publicity surrounding the economic storm as an opportunity to advance their respective platforms. Due to their propensity to speak in sound bites, however, it is difficult to distill their actual positions. Allow me to translate…
- Credit Crunch and Government Intervention: Within the arena of economic policy, of utmost importance is how the two candidates plan to resolve the ongoing credit crisis. Thus far, both have shied away from taking controversial positions and/or offering sweeping prescriptions. Instead, they have intoned populist sentiments by criticizing Wall Street and absolving American workers and homeowners of their collective responsibility. With regard to the bailout plan, both candidates have announced tentative support. Senator Mccain favors "an approach that would proactively resolve troubled financial institutions, enforce discipline on management and shareholders, and minimize the burden on the taxpayer." This seems to represent a slight reversal from an earlier proclamation, in which he argued that "The Federal Reserve should get back to its core business of responsibly managing our money supply and inflation. It needs to get out of the business of bailouts." Senator McCain is also working hard to overcome both a recent gaffe in which he claimed the economy is "fundamentally sound" as well as the belief among voters that the Republican party is responsible for the current crisis. Accordingly, he has (unsuccessfully) attempted to take on a leadership role in the government negotiations. Senator Obama, meanwhile, indicated that "We have to make sure that whatever plan our government comes up with works not just for Wall Street, but for Main Street." He has proposed an additional economic stimulus as well as increased regulation. [This will be explained in greater detail below]. Unfortunately, the Senate wasn’t consulted when the executive branch decided to save Bear Stearns, scuttle Lehman Brothers, and save AIG, so it’s impossible to know how either candidate would have voted if pressed for a decision. With regard to the government takeover of Fannie Mae and Freddie Mac (profiled in a related feature), both candidates again combined tentative support with fulminations about greed and corruption.
- How to Resolve the Financial Crisis: An excellent point-by-point comparison of the candidates’ respective plans to right the economy can be found here. To summarize, Mr. McCain would begin by firing Christopher Cox, Chairman of the SEC, despite its minimal role in the credit crisis. Next, he would move to prosecute corporate executives alleged to have willfully misled the public. As for the government’s role, he has proposed the creation of a unique government organization that would henceforth be charged with managing the "toxic" mortgage assets at the heart of the crisis. However, unlike Treasury Secretary Paulson’s plan, Mr. McCain would focus on troubled homeowners rather than the banks that lent to them. According to his chief economic advisor, "By starting with the homeowner and working up, you accomplish some of the [same] objectives of the financial-stabilization plans that we’ve seen come out of Congress." This would be followed by increased financial regulation (backtracking from an earlier position) and tax cuts to stimulate the economy. The cornerstone of Obama’s plan, meanwhile, is another economic stimulus package, perhaps to the tune of $150 Billion. In addition, some families would be eligible for tax rebates and penalty-free withdrawals from retirement accounts. Of course, there would also be an obligatory increase in financial regulation: "He’s talked about strengthening capital requirements on mortgage securities and derivatives, rigorously managing liquidity risk, and investigating ratings agencies and their potential conflicts of interest with companies they rate." Unfortunately, most commentators reckon that both candidates’ economic prescriptions are too watered-down to be effective. In all likelihood, we will have to wait until after the election for a plan that is both substantive and comprehensive.
- Economic Policy: Setting aside the credit crisis for a moment, let’s examine how both candidates plan to manage the economy once it regains its footing. To quote from an earlier article I wrote, "With his emphasis on consumer and worker rights, as well as in maximizing employment and wages instead of efficiency, Barack Obama is set to become the rule of his Party, rather than the exception. At the same time, his fair-trade brand of protectionism and his threats to limit unfair competition from abroad could reverse the trade deficit." In addition, Mr. Obama aims to attack the economic malaise by focusing on more "peripheral" economic issues, such as healthcare and energy. By reducing these burdens for middle-class Americans (combined with a tax cut), his aim is clearly to free up cash for consumption and investment in other sectors of the economy, namely in manufacturing and green technology. With regard to trade policy, Obama "favors trade agreements only when they raise labor and environmental standards with our trading partners." McCain, meanwhile, is vehemently pro-trade, and hasn’t offered any indication that he would reverse the course of trade liberalization that the country (and the world) has embarked on over the last decade. Otherwise, his economic policy (as well as his knowledge of economics) is admittedly thin, and is focused around comprehensive tax cuts and vague promises of matching cuts in spending. Unfortunately, he has yet to explain the mathematics of such a policy, leading one commentator to call it "one of the most fiscally irresponsible plans we’ve seen by a presidential candidate in a long time."
- Tax Policy: Thus far, I’ve spoken generally about both candidates’ proposed tax policies; let’s now drill into specifics. On paper, Senator McCain’s plan to cut taxes dwarfs that of his rival. He would begin by increasing the tax-deductibility of investment losses and lower the tax rate on capital gains to 7.5%, compared to a slight increase (though only for the wealthy) under Obama’s plan. Regarding income taxes, Mr. McCain would make all of President Bush’s tax cuts permanent, while Obama would raise taxes on the wealthy and lower them for everyone else. (A detailed comparison of their income tax plans can be found here.) The same holds true for estate taxes and corporate tax rates. Senator Obama would also reform the way in which private equity funds are taxed, by closing the so-called carried-interest loophole and subjecting the partners of such funds to normal tax treatment. The candidates have managed to agree on at least one aspect of tax policy: dividends. Swayed by the idea that lower taxes on dividends promote investment, Obama has quietly accepted one of the cornerstones of Republican tax policy. As for the fiscal impact of their respective tax policies: "Their specific non-health tax proposals would reduce tax revenues by $3.6 trillion (McCain) and $2.7 trillion (Obama) over the next 10 years, or approximately 10 and 7 percent of the revenues scheduled for collection under current law, respectively." So much for reducing the deficit.
- Role of Government/Regulation: In the words of one columnist: "The mega question — what is the role of the U.S. government in the nation’s economy? — isn’t just on the table, but at the center of the table." In this aspect, Mr. Obama probably has Mr. McCain beat, if only by virtue of his party affiliation. As hard as he tries, Mr. McCain simply cannot escape the fact that most Americans blame President Bush and the Republican party for the current economic crisis. While Senator Obama’s track record in this department is basically non-existent, he has nonetheless laid out a comprehensive plan to increase regulation and prevent this crisis from repeating it itself in the future." First, he said, any financial institution that can borrow from the government should be subject to stricter government oversight. Second, he would strengthen capital requirements and demand better disclosure of risks and obligations that firms hide off their balance sheets. Third, he would streamline regulatory agencies. Fourth, he would regulate institutions for what they do, not what they are. Fifth, he would crack down on market manipulation. And sixth, he would establish a process to identify systemic risks before they explode." McCain, meanwhile, has moved to distance himself from yet another dubious comment he uttered in September ("Im always for less regulation.") and has instead taken to echoing Obama’s insistence that Wall Street be subjected to greater government oversight. Aside from singling out the exorbitant compensation of CEOs, however, he has been scant on details. At the same time, McCain has pledged to vastly shrink the size of the government: "He wants to fundamentally alter the government’s role in the economy by deeply cutting non-defense spending, from discretionary programs to entitlements." Given the economic crisis and predictions of lower tax revenues, perhaps now might not be the most prudent time to push such an agenda.
- Attitude towards Speculation/Risk Taking: Both candidates have railed against the greed of Wall Street executives, as well as those pesky "speculators" who they accuse of fomenting the real estate bubble. According to Senator McCain, the "foundation of our economy…has been put at risk by the greed and mismanagement of Wall Street and Washington." Such incantations largely ring hollow, however, since it was recently revealed that at least 83 financial industry lobbyists double as advisors to his campaign. Obama was probably the earlier of the two to hone in on speculators, specifically within the context of the run-up in food and commodity prices that preceded the credit crisis. "Mr. Obama proposed preventing traders of American crude oil from routing transactions through offshore markets to evade American limits…and he called on the Federal Trade Commission and the Department of Justice to investigate market manipulation and oil futures." Given that the deleveraging of the last few months has also coincided with lower oil prices, Obama may be onto something.
- Corporate Friendliness: Generally speaking, both candidates have tried to convince voters of their skepticism towards big business, which is ironic considering that large corporations have been very generous in funding both campaigns. "Individuals associated with Merrill Lynch, which [recently] sold itself to Bank of America…have given his presidential campaign nearly $300,000, making them Mr. McCain’s largest contributor, collectively." Meanwhile, Obama has raised over $2 Million from individuals associated with hedge funds and private equity funds, despite his pledge to increase their collective tax burden. It looks like Mr. McCain will at least partially return the favor, given both his pledge to lower corporate tax rates and his recent appointment of former HP and eBAy executives as advisors to his campaign. With Mr. Obama, however, the return on investment is likely to be smaller, leading some commentators to quip that Wall Street workers would be better off investing in subprime mortgages than contributing to his campaign.
As a trader, what your are no doubt ultimately concerned with is how the election will affect capital markets. While predicting such (especially given the current atmosphere) with any shred of accuracy is nearly impossible, that won’t stop me from trying.
In a nutshell, the credit crisis has engendered the complete destruction of investor confidence. According to one expert, "The world capital markets are like a house of cards because of a lack of investor confidence, which in turn is caused by a lack of transparency. Sour mortgages weren’t the problem so much as the fact that no one, here or abroad, knew how much toxic stuff was on their books because it had been securitized into obscure financial instruments." The best (and perhaps the only) way to restore confidence is to create a sprawling global financial agreement that comprises all countries and all securities. Unfortunately, neither of the candidates seems to be even remotely cognizant of the need for such an agreement.
If and when capital markets do resume normal functioning, it seems unlikely that assets will appreciate at the frenetic pace that characterized the last two decades. Both candidates have repeatedly castigated "speculators," first for their role in fomenting the rise in oil prices, and most recently for their role in the financial crisis. In addition, the election of Senator Obama would result in higher taxes and greater oversight of hedge funds and private equity firms, both of which could crimp stock prices. Meanwhile, bond markets and forex markets will probably suffer regardless of who’s elected, as both candidates are generally regarded as fiscally irresponsible. "The deficit for the 2008 fiscal year, which ended Sept. 30, was $455 billion, or 3.2 percent of total economic output. Analysts say it could reach $1 trillion in 2009, or more than 7 percent of projected economic output…So far, both Mr. McCain and Mr. Obama have insisted they do not have to have to scale back their pre-crisis platforms." Both Treasury prices and the US Dollar could suffer if the government can’t find an efficient way to finance the growing national debt. In short, it’s going to be a bumpy ride regardless of what happens on election day.