Financial Crisis Foresight

While we wait to see the latest version of the credit crisis bill, to which the Senate is adding "sweeteners" in hopes of attracting votes from the same Republican congressmen who helped wreck the economy in the first place, it's worth asking if either presidential candidate could have foreseen the financial mess we now find ourselves in. After all, one important quality we hope for in a president is whether he or she can anticipate big problems before they grow even bigger.

Turns out, one of the two running for president did exactly that -- he anticipated more than a year ago the exact kind of credit crisis that has now burst upon us.

Obama's warnings were largely ignored by the media at the time. But last week, star business reporter John Cassidy reminded us in a short piece ("Bailing Out") in the New Yorker's "Talk of the Town" section.

In September 2007, and again in March 2008, Obama was warning everyone who would listen about the very financial dogs that are now clawing at our financial door. As Cassidy writes:

For months, Obama had struggled to promote the sense — which was not altogether confirmed by the official statistics — that the economy was in real trouble. Back in March, in New York, he gave a thoughtful speech, tracing the sub-prime crisis to lax oversight, and calling for a major overhaul of regulatory policy. The serious newspapers reported the event, and that was that.

That "thoughtful speech" was delivered at Cooper's Union on March 27, 2008. The full text is archived here.

Within the text of that speech Obama references another one with similar warnings which he courageously delivered directly to an audience of Wall Street brokers on September 17, 2007. The full text is of that speech is here.

Anyone who is wondering if Barack Obama has what it takes to handle the credit crisis -- a crisis that will be with us years after Congress adjourns for this year -- should read both speeches.

Here is just a small taste:

[T]he American experiment has worked in large part because we guided the market's invisible hand with a higher principle. A free market was never meant to be a free license to take whatever you can get, however you can get it. That's why we've put in place rules of the road: to make competition fair and open, and honest. We've done this not to stifle but rather to advance prosperity and liberty.

As I said at Nasdaq last September [Sept. 17, 2007 text here], the core of our economic success is the fundamental truth that each American does better when all Americans do better; that the well-being of American business, its capital markets and its American people are aligned.

I think that all of us here today would acknowledge that we've lost some of that sense of shared prosperity. Now, this loss has not happened by accident. It's because of decisions made in board rooms, on trading floors and in Washington.

Under Republican and Democratic administrations, we've failed to guard against practices that all too often rewarded financial manipulation instead of productivity and sound business practice. We let the special interests put their thumbs on the economic scales. The result has been a distorted market that creates bubbles instead of steady, sustainable growth; a market that favors Wall Street over Main Street, but ends up hurting both.
* * *
Subprime lending started off as a good idea – helping Americans buy homes who couldn't previously afford to. Financial institutions created new financial instruments that could securitize these loans, slice them into finer and finer risk categories and spread them out among investors around the country and around the world.

In theory, this should have allowed mortgage lending to be less risky and more diversified. But as certain lenders and brokers began to see how much money could be made, they began to lower their standards. Some appraisers began inflating their estimates to get the deals done. Some borrowers started claiming income they didn't have just to qualify for the loans, and some were engaging in irresponsible speculation. But many borrowers were tricked into glossing over the fine print. And ratings agencies began rating bundles of different kinds of these loans as low-risk even though they were very high-risk.

Most everyone knew that some of these deals were just too good to be true, but all that money flowing in made it tempting to look the other way and ignore the unscrupulous practice of some bad actors

And yet, time and again we were warned this could happen. Ned Gramlich, the former Fed governor who sadly passed away two weeks ago, wrote an entire book predicting this very situation. Repeated calls for better disclosure and stronger oversight were met with millions in mortgage industry lobbying. Far too many continued to put their own short-term gain ahead of what they knew the long-term consequences would be when those rates exploded.

Those consequences are now clear: nearly 2.5 million homeowners could lose their homes. Millions more who had nothing to do with this could see the value of their own home decline – with some estimates projecting a cost of nearly $164 billion, primarily in lost home equity. The projected cost to investors is nearly $150 billion worldwide. And the impact on the housing market and wider economy has been so great that some economists are now predicting a possible recession – a prediction all of us hope does not come to pass.
* * *
In this modern, interconnected economy, there is no dividing line between Main Street and Wall Street. The decisions that are made in New York's high-rises and hedge funds matter and have consequences for millions of Americans across the country. And whether those Americans keep their homes or their jobs; whether they can spend with confidence and avoid falling into debt – that matters and has consequences for the entire market.

We all have a stake in each other's success. We all have a stake in ensuring that the market is efficient and transparent; that it inspires trust and confidence; that it rewards those who are truly successful instead of those who are just successful at gaming the system. Because if the last few months have taught us anything, it's that we can all suffer from the excesses of a few. Turning a blind eye to the cronyism in our midst can put us all in jeopardy. And we cannot accept that in the United States of America.

Obama then went on to detail his proposals for addressing the immediate problem as well as broader reforms needed to prevent its recurrence. We'll leave the rest for you to read.

In case you're wondering, in the upcoming issue of The New Yorker which is going on newsstands this week, Cassidy also takes a look at the way John McCain has addressed the very same financial crisis. He concludes:

If this is any indication of how a potential McCain Administration would handle a banking crisis, now may be the time to start buying gold and stashing cash under the mattress.