Steve Forbes on the current Economic Crisis and Barack Obama

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I sat in today on a talk by Steve Forbes, Chair and CEO of Forbes Inc., Editor-in-Chief of Forbes Magazine and former Republican Presidential candidate, as he offered his view on the current economic crisis – how it came about and what should be done to lift the US economy out of the slump, plus what he thinks of Barack Obama and the task that lies ahead for him.

A few take-aways from the talk.

The disclaimer

He was quick to point out an adage passed on from his father, the founder of Forbes Inc., that set the stage for the rest of the talk:

You make more money selling economic advice than following it.

How the Economic crisis came about

In 2004 the US economy appeared to be slowing down and so to forestall this and to preserve previous gains, the initial response of the Federal Reserve under Alan Greenspan printed out more money. What resulted was the USD currency value dropped against the Euro, Yen and other world currencies, and its effects begun to be felt in the commodities market with prices of oil, steel, lumber etc., going up.

The excess cash found its way to the housing market since it was in the midst of a boom, prices were expected to go up year-on-year. This created a housing bubble. Lending standards went down since it didn’t really matter to banks whether folks paid interest or principal on loans – housing prices were going up. Negative amortization now becoming commonplace.

Government sponsored enterprises like Fannie Mae and Freddie Mac, seeking to redeem themselves from prior accounting scandals dogging them, became champions of affordable housing, creating a new sub-prime mortgage. Not a problem, most thought, since these were government protected. They underwrote $1.6 trillion in loans and received triple-A ratings. There was securitization of mortgages to spread the risk around.

In August 2007 the housing bubble burst. Banks seized up, loaded with bad securities. Business investments dropped for lack of accessible credit. Mark-to-market accounting caused assets to be marked down in value based on the current declining  market conditions. As a result, financial institutions incurred $700 billion in write-offs; these were book losses and not cash losses. This led to artificial insolvency of companies such as Merrill Lynch, which was eventually taken over by Bank of America.

So banks weren’t lending as much any more despite the liquidity since they knew it was too risky and could easily take a hit with the current market conditions. To make matters worse, the SEC repealed the rule on short-selling so traders didn’t have to wait for stock to go up before selling. Volatility went up. Case in point was Hartford Insurance whose stock value dropped from $65 in February 2008 to $5 in November 2008.

The US government was also inconsistent in its response by bailing out some financially troubled companies, like AIG, and letting others go broke, like Lehman Brothers.

The long and short of it: the crisis was as the result of a perfect storm – everything that could go wrong did; however, missteps by the Government in its initial response exacerbated the already dire situation, artificially creating the ‘disaster’ we now have.

What can be done to get the US economy back on track?

  1. Get rid of mark-to-market accounting – banks have the fear that lending could lead to oblivion since they may have to declare write-offs on bad loans. Perhaps the only unhappy campers would be accountants.
  2. Announce a strong and steady dollar – lack of faith in the dollar hurts risk-taking. It should be held steady in the good times and bad. For a stable currency – look to the price of gold.
  3. Housing still an impaired market – issue guarranteed bonds by the government. The government should buy troubled mortgages at a fixed rate 4.5-5% for housing prices to go back up. Have permanent fixed mortgage rates.
  4. Cut taxes – at 35% US has 2nd highest business tax globally. Ireland has a 12.5% business tax but collects more than the US does with all its complexities.

On Barack Obama

He inherits a tough economic situation. For now George Bush can still catch some flack for the crisis, but after a year it’s all him so he needs to act expeditiously.

Though Steve is a Conservative, he has a high regard for Obama, citing the recent meet he had with Conservative columnists Bill Kristol, George Will and others as a sign that he is open to listening to viable solutions and is not afraid to engage in a back-and-forth on substantive matters of policy. He maintains that although there will be a euphoria around him for a while, he thinks Obama is shrewd, intelligent and will probably be stronger than Bush, Clinton and Carter; about Ronald Reagan, well, that remains to be seen.

On the stimulus package: in and of itself, probably won’t be enough to jump-start the economy in the short-term. It may help lay a foundation for long term growth, along with such crucial projects such as modernizing the electricity grid and other infrastructure.

Other good stuff

Stocks tend to make a comeback when people are pessimistic so now is the time to get into the market. The next 10 years, historically, show that the market will do well. Negatives tend to be accentuated during a downturn.

The current slump is probably the worst since the early 80’s; not nearly as bad as the 30’s.

On trade deficits with China – consider the flow of capital not only commodities or single line items.