Socialising risk, privatising rewards

If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole. Sen. John McCain, May 25, 2006

Sarah Heath was just a little girl of eight when Joe Biden (D-Delaware) for the first time, slid himself into one of the many rich soft leather seats that furnish the United States Senate. Thirty-six years later, Sarah Heath is now married to Todd Palin, has five children, is a proud hockey mum, ran a small town and now, as Governor, runs the largest state in the union.

Sen. Biden, the consummate Washington insider, is still glued to the same leather chair.

It’s judicious to study Friday’s Vice Presidential debate and look behind the cute comments of the Democratic candidate for Vice President and understand why the Republican candidate kept her powder dry.

When asked about the financial disaster by the moderator Ms Gwen Ifill, Senator Joe Biden was quick to apportion blame to the Bush Administration: “… it's evidence of the fact that the economic policies of the last eight years have been the worst economic policies we've ever had. As a consequence, you've seen what's happened on Wall Street”.

He droned on blaming President George W. Bush for policies of “excessive deregulation”.

The Governor of Alaska, in reply, softly mentioned that it was Sen. John McCain who three years ago warned the Senate about an out of control Fannie Mae. A Fannie Mae that needed more oversight. She didn’t labour the point. Even though it’s a very valid point to labour. I am confident that her running mate, Sen. John McCain, over the next month, through television advertisements will remind the American public of this. And of Sen. Barack Obama’s undignified role in this crisis.

Sen. McCain’s task will be difficult given the media is doing its utmost to show how politically correct it can be, by not discomforting the first black candidate for the highest office in the United States with any unsavoury questions. Even if such questions unearth evidence of conduct that one would not expect in a Presidential candidate.

In the lead up to Friday’s vote in the House, some representatives on Capitol Hill would have the proverbial working stiff believe that Wall Street’s difficulty is a lack of capital. So they (both Democrats and Republicans) agreed in principle to spoon out hundreds of billions in taxpayer funds to allay those concerns. Others, mainly Democrats, claim the issue is not so much a lack of capital, but rather a lack of “trust”.

Robert B. Reich, the pint sized Secretary of Labor in President Bill Clinton’s administration is one of the more vocal advocates arguing that rebuilding trust on Wall Street is Job #1.

In between writing op-eds and advising a community organiser from Illinois, Reich laments that the most ambitious intrusion of government into the market in living memory - bailouts and nationalisations - will not help Wall Street one jot. The Street's fundamental problem isn't lack of capital. It's lack of trust, he proffers. And without trust, Wall Street suits might as well undo their Ermenegildo Zegna ties and mothball their Hermes hand bags.

Financial markets trade in pledges: that assets have a certain value that financial statements are accurate, that a loan carries a defined risk, and that such risk is reflected in the anticipated return on that investment. Crucially, when a counter party asks for a withdrawal, the funds to realise that withdrawal actually exist. Once a car is out of petrol it doesn’t work. The same goes for investors when they stop trusting the promises made to them. The markets stop functioning.