Reality intrudes upon politics

John McCain will spend the next six weeks or so hearing it said that he has admitted that he does not understand the economy and, while that's not quite what he said, I think it's fair to say that economics is not his strength. He is far more concerned with foreign policy and that is much more important in electing a President.

So is Obama the "economics" candidate? Hardly. Faced with the financial difficulties that came to the fore last week, he blamed the deregulation and encouragemet of greed in the past eight years. Now, I know that W., whatever his faults, did not invent greed so I have been searching these internets and asking my Obamaphilic friends - what deregulation do you have in mind? So far, the best answer I've got is a bipartisan repeal of certain lingering restrictions of the Glass-Steagall Act passed in 1999 and signed into law by Bill Clinton. What I have yet to hear is an explanation of how that law had anything to do with the present state of affairs.

Obama and, to a lesser extent McCain, wants to paint this as a catastrophe visited by the bad guys on the good guys; as a morality play to be resolved by an altar call. I don't think so.

I don't know that I completely understand the cause of this mess, but this is the best I can gather from wht I have read.

Deregulation of interest rates and financial instruments - not in the past eight years or even the past twenty - led to the rise of the subprime market. Lenders had the freedom to price loans to reflect the risk that they were assuming and this lead to a wider availability of credit. People who had not been able to get a mortgage in the past could now do so because lenders were able to price the loan to reflect the increased risk. Things that were unheard of when I last bought a house - no money down and no income verification loans - became common place.

This was not all bad. It allowed many more people to buy homes and the overwhelming majority of them have managed to make their payments.

The process seems to have been fueled by Freddie and Fannie who were willing buyers of these loans,spurred in part by political pressure to make home ownership more widely available.

In recent years, interest rates went incredibly low. Lenders could borrow cheap and lend at least a bit more dearly into the subprime market. Often borrowers were obtained through lower initial rates and originators fudging on their qualifications. Sometimes borrowers were fooled by this and sometimes they knowingly went along. Everyone believed that a growing economy and, most importantly, rising real estate prices would make it all good.

Except that it didn't, too much money flowed into housing inflating values beyond sustainable levels. Interest rates had to ultimately rise. Lenders could not offer refinancing at rates approximating the original ones. Borrowers who were in trouble could not unload their property and many chose to walk away - they had no skin in the game (they had paid nothing down) and did not wish to throw good money after bad.

Because some purchasers of this debt were highly overleveraged, the fact that 10-15% of this subprime paper went south had a devastating impact.

Much of this had nothing to do with government policy. It's far from clear that government superintendence of loan portfolios would have resulted in a better outcome without mandating a conservatism that would have resteicted home ownership. There may be policy improvements (that may include tightening of some and loosening of other regulations) that will help.

But a lot of what we are hearing has nothing to do with it. The crisis has little to do with CEO compensation. Improved disclosure requirements for mortgage loans may be a good idea but are not going to help the present emergency. Permitting bankruptcy judges to modify the terms of subprime loans will only interfere with disposing of securities backed by those loans. Potential purchasers will have a hard time essentially buying a bunch of loans that can be rewritten by the courts.

What does seem clear to me is that the resolution of this does not fit into the narrative of our political campaigns. It's not government vs the private sector. It turns on issues about which most people know little and are probably not very willing to attend to. I'm not sure that I like McCain's suspension of his campaign and postponement of the debate as a political move, but it does convey an important message. This stuff is too serious to become a political football. It must be dealt with in an incredibly short period of time and playing our our normal political games at the intensity with which we play them during presidential elections will probably hurt more than it helps.