We should have no confidence in Dem Congress

Harvey Golub:

It's the day after a historic election and I can't help but worry. I'm one of those people who are pessimistic about the near- and medium-term prospects for our financial markets and our economy.

I'm not pessimistic about our country or our capitalist system: They are not the problem. I am pessimistic about whether our next president and the savants in Congress can deal with the massive economic issues we face.

Members of Congress, regardless of party affiliation or yesterday's results, will continue to meddle in matters beyond their knowledge. In doing so they will exacerbate our current economic downturn and delay the recovery of our financial markets.

In recent months, Congress has displayed a fundamental lack of understanding of how our economy and our financial markets actually work. Members believe they can say a bank is likely to become insolvent and that will not lead to a run on the bank, or say a major insurance company is in trouble and not have insurance stocks tank. They believe they can extend a $700 billion Troubled Asset Relief Program (TARP) beyond its charter and not have every institution under the sun try to get what they believe is cheap capital.

Most significantly, although Congress is a large cause of the collapse of the home-mortgage market (witness the folly of Fannie Mae and Freddie Mac), members believe the markets are too stupid to recognize Congress's culpability and will maintain confidence in Congress's ability to resolve the financial crisis.

To restore confidence in the markets, Congress needs to demonstrate that it understands the nature of the problem it is trying to solve. Moving from TARP and the legislation needed to attack the liquidity and credit problems, it is beginning to address the foreclosure problem by "helping people stay in their homes," and to increase economic activity by "stimulating the economy." This sort of language does not bode well for a swift recovery.

The most fundamental economic problem we face as a nation is overleveraging -- by our financial institutions, yes, but also by individual consumers and homeowners. In effect, we owe more than we can either repay or what is supported by the assets underlying our debt.

The recent rise in foreclosure rates is fundamentally related to falling home prices, rather than a change in peoples' ability to pay those mortgages. The bubble bursting was inevitable, and consequently those foreclosures were bound to occur at some point. Many people took out loans to buy homes without having the earnings necessary to support those loans. They believed that housing values would continue to rise at record rates. And now that the bubble's burst, under our bankruptcy system, they are able to walk away with relatively little inconvenience.

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The down side of leverage is unforgiving. One of the biggest mistakes financial institutions made was piling additional leverage on top of a highly leveraged real estate investment to begin with. Instruments that were supposed to add liquidity to the market did the opposite.

Don't look for Congress to take responsibility for the mess it made with Democrats in charge. With Democrats in control, they will bury their responsibility and attempt to shift the blame. It will be up to us to hold their feat to this fire.