Friday, March 28, 2008

McCain's Response to Meltdown Is “Dubious”

Senator McCain's approach to the credit crisis was today described by the LA Times as “dubious”. In Santa Ana, Orange County (home of Countrywide Financial and New Century Financial, failed leaders of the subprime fiasco), McCain called for minimal federal interference in financial markets and instead for (1) voluntary measures by banks to assist borrowers having trouble keeping up with payments and (2) a summit to discuss discouraging banks from writing down the value of distressed housing. The first proposal is already happening; the second is a shocker. Is McCain really serious about interfering with the markdown of bank real estate assets? The Japanese prolonged their recession by many years trying that trick.

Meanwhile, in Philadelphia and New York, Senators Clinton and Obama have advocated providing federal assistance to troubled mortgage holders and their communities, with Sen. Clinton's proposal the more aggressive. The two Democratic candidates question why federal aid has been used to preserve assets of wealthy investors in Bear Stearns while denying homeowners in foreclosure equivalent relief. Of the three main presidential candidates, Sen. Hillary Clinton is the most interventionist, both with regard to the Fed bailout of Bear Stearns (Sen. Obama has questions about it) and the desirability of further help to homeowners in default.

Congress is meanwhile not waiting for movement in or to the White House. It is going forward on two fronts:

1. Assembling Data on What Exactly Happened in the Bear Stearns Crisis and Bailout. As reported by Bloomberg yesterday, Senate Banking Committee Chairman Christopher Dodd has asked Fed Chairman Ben Bernanke, Bear Stearns CEO Alan Schwartz, JPMorgan CEO Jamie Dimon, SEC Chairman Christopher Cox and Treasury Secretary Hank Paulson to testify on the Bears Stearns bailout at hearings on April 3. In a separate action, the Senate Finance Committee has requested information about the Bear Stearns acquisition to JP Morgan Chase. Finance Committee Chairman Max Baucus , D-Mont., and ranking minority member Charles E. Grassley R-Iowa sent letters asking about federal assets involved and names of the negotiators, lawyers and accountants.

2. Preparing to Overhaul the Financial Regulatory System. Sen Chuck Schumer (D-NY) has outlined this imperative in an op-ed in today’s Wall Street Journal. Sen. Schumer is darn right – the overhaul is long overdue. The non-bank financial institutions have become a de facto part of the financial system that is being protected by the Federal Government. The scope of the orderly markets objective that led to the creation of the Federal Reserve in 1913 must be correspondingly expanded to include investment banks. We don't want a financial system in which institutions can take on risk with a “heads we win, tails you lose” option.

A unified federal oversight body with broad institutional coverage is needed to monitor market-wide leverage and risk. A market-oriented approach could charge players premiums for the extra risk they bring to the marketplace via higher leverage. A regulatory approach could control leverage via Basle II-type capital-adequacy requirements as are being planned for banks.