The app uses Intrade virtual currency and a new “look and feel” and some new functionality that will be applied to the www.intrade.com platform soon (while retaining the current version of www.intrade.com as an option for those who may prefer it).
If you are interested in being a beta tester of the app or the new version of Intrade, please let us know.
Happy St Patrick’s day from all your friends on the Emerald Isle.
The 17th March is said to be that of St. Patrick's death and is a national holiday in Ireland. But as is typical of the Irish, it is a case of any excuse is good enough for a good party.
While for some St. Patrick's Day still has religious connotations, for most it is a day to “let your hair down” (if you still have the stuff) and go a little bit crazy or at least do something different.
But here is a bit to the worst trivia ever.
St Paddy himself was a big fan of blue and not green.
Perhaps the green theme for St Pat’s day stems from how many of us look after a couple or more Guinness, Bushmills, Baileys, Jameson, Irish Coffee, Smithwicks, Middleton, Tullamore Dew, Galway Hookers, and White Gypsy. That would be of course before a massive feed of bacon, corned beef and cabbage.
So no matter what you do on the great day that March 17th is, we really hope you have a good one. We will raise a glass to all our friends at least a couple of times before noon. As for the afternoon, our intentions will be good at least.
To provide additional transparency any member can request a personal account be established in their own name within the suite of segregated member funds accounts that Intrade maintains. As we incur a cost to provide this service to our members we passes on the cost only to members availing of this service.
This service enables you to receive on an individual Bank Statement in from a bank guaranteed by the Irish or Danish governments your balance.
Intrade Wants You to Find and Benefit from Arbitrage Opportunities
It is the season to hunt for risk minimizing profit opportunities on Intrade and on and across other prediction market platforms. We would like to incentivize you to find, highlight and remove these market anomalies.
Periodically arbitrage opportunities exist on Intrade and other prediction market platforms. Arbitrage trading is a risk minimizing strategy that by definition should be “no-gamble”.
To encourage you to profit from these irregularities we will make sure our fees are no obstacle. We are offering all members the ability to execute arbitrage trades entirely on Intrade at zero fees for those trades.
Additionally any member who can find and execute an arbitrage trade between Intrade and any other platform should submit proof after the trades are completed. Once reviewed if our fees have caused the return on your trades to be negative we will refund upto 100% of our fees on such trades. We would encourage other platforms to consider offering the same.
Sometimes people identify arbitrage opportunities but are not in a position to execute the relevant trades. We have created a new thread here (see T&C's) where such arbitrage trades may be logged.
Anyone who does find and highlight to the public such an opportunity and does not execute the relevant trades themselves will earn our thanks, plus a $20 trading credit (and will probably increase the predictive accuracy of the market) if the trades are executed by a trader. Markets that are bid to over 100 or offered at less than 100 for mutually exclusive events do not necessarily qualify for a trading credit.
Fee incentives will be posted to your account after request to firstname.lastname@example.org and submission of relevant supporting information.
We hope and expect that people will develop simple price reading and price comparison robots to search for these opportunities. If you are a developer but not a trader and you have such an application or would like to create one, please contact me on email@example.com as we may be able to help you get started with API assistance and support.
Terms and conditions will apply to this offer, but no sneaky ones. Please see our Forum for T&C's.
Traders please take note: All profit and loss risks associated with all trades including trades and traders that attempt to benefit from this offer reside with the trader absolutely and not Intrade. In the event that a trader suffers losses in pursuing an arbitrage strategy for any reason (such as but not limited to a market rule change, one contract in a group being voided or unwound, the platform becoming unavailable, rule changes or differences on Intrade or across platforms, inability to complete the hoped for arbitrage or any other reason whatsoever) Intrade will not entertain, accept or otherwise enter correspondence about any losses as the risk will reside absolutely with the trader.
Free Intrade Historical Market Data - Beta Testers Required/
Happy New Year to All.
We intend to soon offer on a trial basis certain historical market data free of charge as part of an initiative to improve the accessibility, transparency, and validation of prediction markets.
We hope in the near future that by making certain historical market data freely available (and foregoing a revenue stream) we will encourage further academic and business study and support of the prediction market phenomenon.
We will present data by category, event, market group, and individual market. No personal data will be made available. The initial reports that we will provide are closing prices and time and sales of each trade on a market. The data sets will be in a CSV format and will be refreshed daily.
We are looking for a limited number of people to Beta test our application and market data sets. Please contact us on firstname.lastname@example.org if you are interested in being a tester and getting access (T&C's will apply) to historical market data.
In business we all should prospect as if our life depends upon it, because often it does!
Having had many business relationships that seemed so promising and likely to be win-win we all know the feeling of dread when a good business prospect or worse partner won’t return calls.
I remember one time about 2 years ago when I was told by the CEO of a large NYSE listed financial services company that we had an agreement. I remember even better the personal disappointment and that of the team when it didn’t happen*.
It is at these moments we all ask ourselves “At what point do I simply give up?”
Winston Churchill in typical fashion answered this question better than most when he said "Never, never, never give up!"
That is my approach. Just because someone doesn’t “buy” or something doesn’t happen within the expected time does not mean that the opportunity is over. Sometimes you are not talking to the right person or underestimating the time required to achieve something of value.
I got my first job as a graduate after applying to the same investment bank 5 times within a month and not taking “no” for an answer. As an aside, I met my future wife on the first day I finally got a job there. Similarly, one of the best relationships Intrade has achieved is with a large media organization that happened after 2 years and over a dozen different approaches to different gatekeepers.
Thomas Edison when asked about the 700 hundred failures to create a long lasting light bulb is reported to have said “"I have not failed 700 times. I have not failed once. I have succeeded in proving that those 700 ways will not work. When I have eliminated the ways that will not work, I will find the way that will work."
Emulating an attitude like Edison or Churchill above will help you succeed. It most certainly has for us.
* Little did we know then that "no deal" was the ideal outcome for our future.
The FT Covers Intrade thanks to Carl, Intrade Exchange Operations Manager
Politics: Several ways to lose a deposit
By Huw Richards
Published: September 25 2009 01:59 | Last updated: September 25 2009 01:59
Governments that fear they may be mere months from oblivion must take comfort where they can. So a listing on Intrade, the Ireland-based predictions exchange, has to be counted good news – or at least as good as it gets – for Gordon Brown and colleagues.
Eighth on the list of the markets currently most favoured by Intrade’s predominantly American clientele – and shoehorned between the Democratic and Republican prospects in the forthcoming election for Governor of Virginia – was the one on the likelihood of a Labour victory come the forthcoming UK General Election.
Admittedly, one element in this is that Labour’s hopes now appear to have receded to a point that they offer the thoughtful trader a potentially lucrative long-shot with only a limited downside. A win on a predictions market pays out at 100. Intrade rated Labour’s chance of being largest party following the next election at 15.
Still, it represented a marginal improvement on a site whose traders have earned a formidable reputation for collective wisdom – predicting all 50 states in the tightly-contested US presidential election of 2004, and in 2008 missing only on two, whose outcome was so close that they took some days to resolve.
As the UK election looms, spread betting and prediction sites can expect a sharp rise in political business. Interest inevitably follows the electoral cycle, spiking at election time after long periods of quiet. This is one reason why politics tends to be an add-on for companies whose main business is in more consistently appealing fields.
Politics has won Intrade a lot of publicity, but its core markets are financial. In Britain, politics tends to be the concern of companies that otherwise focus on sport.
Wayne Lincoln, trading spokesman for Sporting Index, says: “It builds into very good business at election time and brings in customers who don’t usually bet on sport, except perhaps on the Boat Race.”
By far the largest market at present – Mr Lincoln puts it at 95 per cent of SI’s politics business – is the number of seats gained by each party at the next election.
There has been little good news for Gordon Brown in the way this market has progressed. When he became prime minister in July 2007, Labour and the Conservatives were nearly level. The initial “Brown bounce” took Labour almost 100 ahead at 330-336 against 234-240 for the Conservatives.
But by the end of the year, Labour was back to 267-273 against the Conservative 300-306 – and its position has steadily eroded since: “Whatever goes wrong, it seems to stick to Labour at the moment,” says Mr Lincoln.
Recently, Labour has been rading at 205-210 on Extra bet, compared with a Conservative spread of 354-359 and the Liberal Democrats at 50-53.
The range of markets will grow as the election approaches. Sporting Index expects to add a considerable number on issues such as the number of women MPs and the time of the first declaration on election night.
It also has a market on the identity of the next chancellor of the exchequer. Mr Lincoln explains: “We put that up when it seemed likely Alastair Darling might go.” With that now seeming unlikely this side of the general election, the market leader is George Osborne, the shadow chancellor, with his deputy Philip Hammond running second.
One bet that might seem equally popular is the identity of the next Labour leader, but there is as yet only limited interest. Chris Shillington of Extrabet says: “We offered a fixed-odds market on that a few months ago. It got us a fair bit of publicity and a lot more traffic on our politics markets in general, but not a single bet was laid on it.”
Anyone who still fancies Boris Johnson’s chances of being the next Tory premier can back their hunch on Intrade, which puts its probability at about 6.9 per cent. Carl Wolfenden, Exchange Operations Manager, says: “That was a market we put up at the request of a member and there have been 53 contracts traded, which isn’t bad.” Several of Intrade markets originate in such suggestions. Mr Wolfenden says: “One example was presidential endorsements last year, which created a lot of interest.”
If hardly on the scale of a US presidential election, a British poll represents useful business for Intrade, which traded more than 17,000 contracts on the 2005 General Election. Much depends on how close it looks – predictions sites thrive on close-run things. The British poll at the moment seems rather too predictable, as does Germany’s election this month, with Intrade rating incumbent Angela Merkel as 95 per cent likely to continue in the job.
Still, US politics continues to offer much to intrigue Intrade’s clients. One particularly strong market at present is on President Obama’s health reforms, with agreement to a Federal-run health plan before the end of this year reckoned at 20.5 per cent.
Intrade is currently running a survey from its homepage.
The survey may be accessed here (Please take the survey if you haven’t already).
We are making the results* of our survey transparent and public. We are doing this as we believe providing open access to this information is in the best interests of our members, our business, the industry, our competitors, supporters and even our rare ;-) symbiotic detractors.
Should you like to discuss or collaborate on this or related surveys please contact me directly at email@example.com.
1. How did you discover Intrade.com?
Friend or colleague
Search engine (e.g. Google, Yahoo!)
Other (please specify)
48% (Top thematic answers: College Professor, CNN, CNBC, HardBall with Chris Matthews, Larry Kudlow, Glen Beck, ABC 20/20, Politickr)
2. How would you feel if you could no longer use Intrade.com?
N/A - I no longer use Intrade.com
3. What would you likely use as an alternative if Intrade.com were no longer available?
I probably wouldn’t use an alternative
I would use an alternative
35% (Top thematic answers: Drudge Report, Iowa Electronic Markets, survey/public opinion poll data, more time on virtual currency markets, any other real money prediction market)
4. What is the primary benefit that you have received from Intrade.com?
Various responses from respondents
85% (Top thematic answers: Profit, insight, excitement, hedge, training, education for finance, “seeing the curve before it curves”)
No responses from respondents
5. Have you recommended Intrade.com to others? If Yes, why?
74% (Top thematic answers: A futures market on events rather than commodities, , risk managed way to trade futures, a great place to use your knowledge to make money, the best predictions market with a good history, as an opportunity to profit from your good judgment, futures trading on current events.)
6. What type of person do you think would benefit most from Intrade.com?
Various responses from respondents
79% (Top thematic answers: finance, trader, investor, speculators, politicians, media people, people with expert information, Corp. CEO's, managers, 'Joe 6 pack')
No responses from respondents
7. How can we improve Intrade.com to better meet your needs?
Various responses from respondents
83% (Top thematic answers: Improve liquidity somehow, Make depositing easier, a better user interface/upgrade your website, a central clearing counterparty, add sport markets, more local markets, make it easier to spread the Intrade word)
No responses from respondents
8. Would it be okay if we followed up by email to request a clarification to one or more of your responses?
We have just pushed a new report live this morning. You can access this report here or by clicking on the link from the homepage called “Market Data Reports – New”.
The first report here is called the “Contract Volatility” report and it shows the most volatile* markets during the last trading session.
We hope that this report allows you focus on markets that may offer good trading opportunities due to their volatile nature.
We will be adding more reports to this section soon. Please let me have your suggestions for any specific reports you would like to see.
*Volatility is defined as the absolute percentage change in closing prices from yesterday to the day before, i.e. the opening price for this trading session to opening price from the pervious opening session.
With so many businesses failing and risk being a pariah of biblical proportions what are some of the future implications and what can we do about it now?
Here is an example.
Say the business you started was to fail. You may feel that you would have been better off if you had stayed in an 8-till-5.30 job and took your 15 days holidays per year instead of giving every hour of every week to your own business.
There is a lot of risk aversion right now. People are saving. Taking too much risk is the stated cause of the mess we are in. But if we somehow criminalize the concept of risk taking where is the innovation and entrepreneurial spirit going to come from in the future?
Related Story from Washington Times "EDITORIAL: In defense of speculators"
Trillions have been asserted to be invested in getting us out of the recession, crisis or whatever you care to call it to-date. However to-date most of it hasn’t found its way out of bureaucratic processes. Even still, the CEO of GE, Jeffrey Inmelt, and others believe that "the crisis is over”.
Do you agree with him? Whether you do or don’t consider please…
June unemployment: Another half million added to the 14.5 million unemployed bringing the rate to 9.5%. This is expected to increase. There is a 70% chance that unemployment will be above 10.25%at year end. As a CEO of a company, we will be reluctant to resume hiring until growth commences.
Consumer Spending Reducing: Credit card companies are curbing consumer spending further as they are being stung by increased defaults and delinquencies. But consumers are adding to this be saving hard for the rainy day as evidenced by the recent saving statistics. With less people employed, spending will reduce further.
Individual States in Crisis: E.g. California defaulting on short term obligations. They can’t run current budget deficits. With taxes falling they are forced to cut spending (something the Irish government seem unbelievable slow to do) which will reduce consumer spending now and the foundation for growth in future as education spending is being cut.
Foreclosures Increasing: The rising number of foreclosed and abandoned homes and commercial property. There are about 2 million foreclosed or abandoned homes now.
So the crisis is over? Alas this seems wishful thinking to me at least.
We need to up-our-game. It is unlikely that the supportive winds of a global recovery will arrive for years and therefore we need to put in place now the foundation to have a big sail (think spinnaker) to catch the wind if and when it arrives.
Lets focus on education, innovation and competitiveness.
A recent report carried our by a Washington DC think tank ranks Ireland as 13th out of 40 for innovation and competitiveness. In some categories we did poorly, but overall we are in the top 15 of 40. In areas like corporate tax rates and foreign direct investment we are #1. The report focused on EU states and the US.
One of the many things concerning about the report is that Ireland only rank 18th in R&D and below places like China and the EU10 accession countries. This bodes badly for us in the future should our standing remain so low.
In the category of GDP per hour worked, Ireland exceeds the United State but in terms of I.T. investment and researchers per capita we are only at 75% approx. of the US levels. Again this is worrying.
While VC capital availability has become more troublesome from the last survey we are still 14th and in the top 10 for entrepreneurship.
With the ongoing rise of China, India and global competition Ireland, the EU and the US will need to up-its-game.
I know investment capital at the moment is as rare as hens that have teeth. People are maxed out with borrowings including our government but where we can, indeed where we must we should focus now on…
1. Education – the cornerstone. Lets focus on the science, technology, energy, climate and food. I think clean traceable organic food may be the next “black gold”. And Ireland can be a super producer of this currently under appreciated commodity.
2. Technical Rights to Succeed. We need all the facilitating links to make sure we catch the wind and contribute to it.
a. The right regulatory framework – I give us an arbitrary score of 7
b. An accommodative tax policy – mixed score here. R&D investment relief OK, cost of employing and VAT is crazy, corp tax rates great. Score 6.5
c. Technological infrastructure. We are dreadful in this area. We need to do more and fast. I live 21 miles from Dublin and cant get broadband.
3. Focus on some “wicked problems” where we have strengths. E.g. we can contribute significantly to solving our and others fossil fuel dependency. Ireland has masses of untapped wind and waver energy. While we may not have the capital base to do the entire R&D required we must invest in these areas. We have had success before. Same can be said again for good food and water.
In conclusion, we and others are on our knees at the moment but we must continue to invest in our long term. Increase our productive capacity by focusing on education in the first instance and removing the hurdles to innovation and competitiveness.
In Ireland we are innovative and entrepreneurial by nature but we must keep our morale strong. Yes things are bad and will get worse, but “this too shall pass”, and when it does our attitude is what will fuel our recovery.
Follow me on Twitter http://twitter.com/JDelaneyIntrade
The bailout-nation saga continued this week as the little-three carmakers from Detroit drove to Washington to plead for a $34 billion federal package to save themselves from bankruptcy and insolvency. Hot on their heels was a devastating report of 533,000 lost jobs in November. Actually, it’s a loss of 732,000 jobs, including downward revisions from the prior two months. Unemployment moved up to 6.7 percent from 6.5 percent, a number that’s going to get worse as the volume of discouraged workers continues to rise.
So here’s the painful choice for both Republicans and Democrats in Congress: Will the political class risk a Detroit-carmaker bankruptcy that might lead to catastrophic liquidation — including, realistically, a couple million car-related jobs — all while the recession deepens and job losses mount (1.2 million in just the past three months)?
It’s a tough choice — especially for Republicans, most of whom want to vote against bailout nation and stop big-government encroachment on our free-market economy. That’s the right theory. But are the economic risks simply too great to employ it?
Various polling surveys say bailout nation, and a federal rescue for autos in particular, is very unpopular. At least 60 percent are polling against a bailout. The TARP bailout of banks is increasingly unpopular.
Meanwhile, the pressure for more bailouts grows daily. The Avis rental-car company wants a bailout from TARP. A company called BlueFire Ethanol wants a bailout. The trade association for equipment-leasing companies wants a bailout. There’s no end to it. And if we keep going down this path we’ll make a mockery of free-market capitalism.
Where to draw the line? That’s the huge political question.
Coming back to Detroit, there may be a pragmatic solution, one that takes some of the apocalypse-now threat of major economic decline out of play. Senator Bob Corker and others have proposed a federal oversight board that would in effect become a bankruptcy court. Strict conditions would be imposed on the carmakers, especially regarding compensation — the single-biggest reason for Detroit’s decades-long decline.
Corker wants Detroit to have the exact same compensation levels as the Japanese transplants in the non-union Southern states. That means moving hourly labor costs down from roughly $70 to $48. It means reopening the UAW contracts that have created the huge pay-gap between Toyota and GM. It means putting an end to excessive pension and healthcare benefits.
According to Professor Mark Perry of the University of Michigan, GM healthcare benefits add $1,500 to the price of every vehicle, while pension costs add another $700 per car. That will have to end. The lucrative jobs bank that pays laid-off workers 95 percent of their compensation also will have to stop. And bondholders will have to be satisfied with a complete renegotiation of GM’s $62 billion in debt, including the union retiree healthcare fund that is under-funded by $30 billion.
There still will be considerable job losses for downsized Detroit carmakers. They’ll have to cut a huge chunk of their dealer networks. Domestic brands will have to be sharply reduced. But essentially, as would be the case under Chapter 11 bankruptcy, the federal government will provide short-term financing while Detroit goes through its radical restructuring. It looks like bankruptcy lite, and it will completely change the direction of the former Big Three.
It’s probably too much to ask, but tough federal action under the aegis of oversight-board enforcement also should relieve the CAFE fuel standards that have plagued U.S. automakers. At the very least, worldwide standards should be substituted for domestic ones. Making expensive small green cars is an unprofitable business.
Ironically, with oil and retail gasoline prices plunging, it’s not unreasonable to expect something of an auto-sales recovery. Gas prices have dropped all the way to $1.75 from over $4. This tax cut will help revive the whole economy, along with auto sales.
But if Washington can put this car-bailout business behind it, perhaps Congress can move on to the ultimate solution: restoring economic growth. President-elect Obama has been cagey about the details of his massive $700 billion infrastructure spending plan and whether he’ll raise taxes on successful earners. But this new New Deal, including Obama’s middle-class tax credits, will not create permanent economic growth incentives. What will? A genuine supply-side growth agenda to reduce tax rates across-the-board.
If the Republican party wants to put bailout nation to rest it should campaign for lower corporate, individual, and investment tax rates. It should make clear that the Democrats are the government-spending party while the Republicans are the tax-cutting party.
We will not bailout our way into prosperity. Nor will we spend our way into prosperity. Somebody has to stand up and yell: It’s time to cut tax rates on the supply-side. That will reinvigorate growth and infuse new spirit into a demoralized economy.
New economic stats on consumer spending and business durable goods investment show an economy that’s sinking fast across-the-board. Wall Street economist John Ryding expects a 4 percent drop in fourth quarter real GDP.
Of course, the Fed is pouring in new cash hand-over-fist. And plunging retail gas prices to about $1.85 per gallon nationally amounts to a huge consumer tax cut of perhaps $320 billion, according to Mark Perry of the University of Michigan. So we’ve moved from tight money and an energy tax hike a year ago, to easy money and an energy tax cut today. The former mix has generated a nasty credit crunch and a recession. But the new monetary/energy mix will generate recovery next year. I hope.
At a wonderful dinner last night I had a chance to talk to Nobel Prize winning economist Robert Mundell about all things economic. What is to be done? I asked him.
Mundell, you may remember, was a leading supply-sider in the Reagan revolution. He argued for low marginal tax rates to spur the economy and a stable dollar to eliminate inflation. Bob Mundell also is the father of the euro. He is plainly an incredibly brilliant and distinguished man.
The dinner was put together by the indefatigable hard-money analyst Judy Shelton, a pretty smart gal herself. Our spouses were there along with some friends.
So here’s Mundell’s latest take on a pro-recovery, fiscal-monetary, growth mix. First, he’d like to see a complete corporate tax holiday for one year. He then favors corporate tax reform that would drop the current top rate from 35 percent to 15 or 20 percent. He believes this would generate badly needed business investment and job-creation to fight recession.
Incidentally, in today’s durable-goods business-investment report for October, capital-goods shipments are falling at a 12 percent annual rate versus their third-quarter average. Orders are down 35 percent. (By the way, that third-quarter average was a negative number.)
So Mundell is clearly on to something. Business needs help. Without healthy business, there will be no significant new job creation or consumer spending power.
On money, Mundell had two interesting thoughts: First, the U.S. dollar and the Chinese yuan should basically be re-linked at roughly today’s exchange rate (about 6.8 yuan to the dollar). There should be no more Chinese currency appreciation. Incidentally, Mundell thinks the Chinese economy is actually in some trouble. And he’d know. Mundell travels to China about once every other month as a key advisor to the Bank of China.
Also on the currency front, Mundell would prefer a floor under the euro at roughly $1.25. That’s about where it is today. It’s also roughly the same as the original $1.18 euro initial public offering in 2000. So Mundell is pressing for dollar stability relative to Europe and China. And he believes that would be consistent with domestic price stability here at home.
Unfortunately, Fed head Ben Bernanke simply doesn’t think in these global currency terms. Mundell has no real problem with the Fed’s huge balance-sheet expansion to push new cash into the credit-crunched recessionary economy. He believes there is a huge demand for dollars at home and overseas, and that the Fed should be accommodating this.
But Mundell frets that Bernanke is too much of a Phillips-curve unemployment-rate targeter, and that he doesn’t understand the powerful influence of a sound currency policy.
Putting it all together, Mundell’s anti-recession program is a reduction of the high marginal tax rate on business to reignite growth along with a stable dollar to contain inflation.
We also got around to talking about Paul Volcker, who is a friend of Mundell’s. He’s also my former boss from 1975, back when I was a young staffer at the New York Fed and Paul Volcker was the bank’s new president. Volcker, of course, has been counseling Barack Obama during the financial crunch. And today, the president-elect appointed Volcker, the former Fed chair, to be the head of a new White House advisory board on the economy. This advisory board takes a page from Ronald Reagan, who set up PEPAB, the President’s Economic Policy Advisory Board, back in 1981. Members of that group included Milton Friedman, Art Laffer, Alan Greenspan, Arthur Burns, Herb Stein, and others. George Schultz was the first chairman. This group helped sustain Reagan’s supply-side policies during some difficult times in 1981-82.
Now, no one really knows what Paul Volcker really thinks about the myriad TARP financial-rescue packages being run by the Treasury, the Fed, and the FDIC. Nor do we know what Volcker thinks about the Fed’s ballooning balance sheet, or U.S. dollar policy for that matter. A lifelong Democrat, Volcker is properly credited with slaying inflation in the 1980s. But he is no supply-sider.
Presumably, however, the conservative-Keynesian Volcker, along with Tim Geithner, Larry Summers, and Christina Romer, will advise Obama not to hike taxes in the next two years.
But that’s a presumption. We don’t know who else will be on this Obama economic advisory board. Might they consider a stable dollar and a big corporate tax cut? Well, if Volcker listens to his friend Mundell, he’ll gain some important advice to be passed along to the new president-elect.
President George W. Bush came out fighting for free markets with a strong and stirring defense of American capitalism on the eve of the G-20 World Economic Conference. Stocks soared 550 points Thursday as Bush’s luncheon speech was played live on all the major cable networks. It was as though Mr. Bush was trying to leave an economic-primer to his successor-elect Barack Obama. Markets cheered because it’s the best thing they’ve heard in many weeks.
Here’s one of several great passages from Bush: “At its most basic level, capitalism offers people the freedom to choose where they work and what they do … the dignity that comes with profiting from their talent and hard work. … The free-market system also provides the incentives that lead to prosperity -- the incentive to work, to innovate, to save and invest wisely, and to create jobs for others.”
In other words, free-market capitalism is the best path to prosperity.
During a gloomy period of financial crisis, recession, big-government rescues, and ailing banks and industrial companies, Bush has provided a strong visionary dose of big-picture economic prosperity and optimism that can lead the U.S. and the rest of the world out of its economic doldrums.
Here’s another uplifting passage from Mr. Bush: “Free-market capitalism is far more than an economic theory. It is the engine of social mobility -- the highway to the American Dream. And it is what transformed America from a rugged frontier to the greatest economic power in history -- a nation that gave the world the steamboat and the airplane, the computer and the CAT scan, the Internet and the iPod.”
Capping all this off, Bush said, “The triumph of free-market capitalism has been proven across time, geography, culture, and faith. And it would be a terrible mistake to allow a few months of crisis to undermine 60 years of success.”
That reference to 60 years harkens back to the original post-WWII economic-rebuilding conference held in Bretton Woods, N.H., in July 1944. At that historic meeting, the U.S. and Britain led 170 delegates from around the world into a new era of free markets, free trade, and stable currencies. It was a conference of global coordination that broke down the isolationist and protectionist sentiments that upset the world order so badly during the prior 15 years.
Ultimately, the free-market system forged at Bretton Woods, which was in no small way predicated on economic prosperity, led to a triumph of Western values over Soviet state socialism. And it was President Reagan -- along with his friend, British Prime Minister Margaret Thatcher -- who applied the final blow to the now-defunct Soviet system with his rejuvenation of free-market capitalism.
So what George W. Bush seems to be saying is this: Do not discard that triumphal system just because we’ve had a rough year in the financial markets and the economy.
In a few weeks Barack Obama will inherit the mantle of the capitalist system. What will he do with this responsibility? That’s the question being asked everywhere.
Since the election, and up until President Bush’s important G-20 speech, stock markets sold off nearly 15 percent. Investors want to know if economic rewards will be encouraged or penalized. Will trade remain open and free? Will we maintain competitive businesses that can compete worldwide? Or will we resort to the protection of ailing or failed businesses?
Will the U.S. lurch toward the semi-socialism of Old Europe? Or will we stay with free-market capitalism? Will we expand the nanny-state economy? Or will we keep the door wide open to entrepreneurial spirit and gales of creative destruction?
Investors want to know which way President-elect Obama is going to go. Might he reach back to the Democratic pro-growth supply-side policies of John F. Kennedy’s tax cuts, free trade, and strong dollar? Will he opt for Bill Clinton’s free-trade and strong-dollar policies, or even his capital-gains tax cut? Or will he fall back to the hopeless government tinkering of Jimmy Carter or the welfare-statism of Lyndon Johnson?
I’m keeping an open mind on Mr. Obama during this post-election honeymoon period. After all, he stole the tax-cut issue from Sen. McCain during the election. And surely he knows the conservative red states that joined his campaign for change didn’t vote for a leftward lurch to socialism lite.
Mr. Obama has a huge opportunity and an outsized responsibility to mend and revive the economy. It may be too much to ask, but perhaps he will give President Bush’s marvelous speech a close read. There is much wisdom there. And there is no iron-clad reason why a Democrat can’t adopt the economic-growth model that has worked so well and so long for this country.
Remember that huge congressional swing-out two months ago over the Treasury's request for $700 billion to purchase at auction a bunch of toxic assets that no one wanted to buy? And remember John McCain's curious behavior, temporarily shutting down his campaign in order to fly to Washington and save the nation from financial collapse? (Some say that episode sunk Big Mac's campaign.)
Well today, Treasury man Paulson announced that there probably won't be any toxic asset purchases after all. Instead, he intends to forge ahead with more capital purchases to strengthen bank balance sheets and also, by the way, non-banks, which lend roughly 40 percent of total consumer credit. Think AMEX, GE Capital, maybe GMAC, and others.
Actually, Paulson has a good idea for a private capital injection into banks (and maybe non-bank lenders) that would then be matched by taxpayer capital. This was a good idea proposed a while back by Harvard economist and former Bush advisor Greg Mankiw. The more private capital the less the government-takeover threat and the healthier the banks will be.
But there's more from Paulson today. He talked at some length about Treasury assistance for securitized credit-card student-loan and auto-loan assets, and he said the Fed is designing a lending facility to meet liquidity needs for asset-backed securities and their sponsors. This securitized-loan business is a whole new avenue of rescue operations. And it surely opens the door to a lot of non-banks that are going to play in the Treasury's sandbox.
Mr. Paulson also said the Treasury is looking at FDIC chair Sheila Bair's multi-billion dollar loan-guarantee program for foreclosure mitigation. This really means Uncle Sam will wind up eating some significant losses while the interest and principal on shaky mortgage loans are written down.
Stocks were off big today — before, during, and after Paulson — closing down over 400. Tough to pin it on the Treasury man, however, since the plunge started in the early-morning well before he spoke.
Some folks think the stock market is stalking Obama, whose defining moment may be a GM bailout. Plus, investors are waiting for a new Treasury appointee who will shed light on Obama's tax and trade threats for 2009 as well as his UAW rescue mission that is so strongly favored by Speaker Pelosi and Senate Majority Leader Harry Reid. Policies protecting ailing industries would certainly set a France-like tone for the new administration.
Here's a stat from my friend, blogger Mark Perry: Total compensation per hour for the big-three carmakers is $73.20. That’s a 52 percent differential from Toyota's (Detroit South) $48 compensation (wages +health and retirement benefits). In fact, the oversized UAW-driven pay package for Detroit is 132 percent higher than that of the entire manufacturing sector of the U.S., which comes in at $31.59.
I don’t care how much money Congress throws at GM. With that kind of oversized comp-package they are not going to be competitive. It’s throwing bad money after a bad cause. What a way to start the new Obama era.
I would still argue that rescuing banks and consumer credit companies removes systemic risk from our lending system. But the only thing systemic about the GM bailout is the hegemony of the UAW. Or maybe I should be more cynical: Republican socialism followed by more Democratic socialism.
Voters seem to think he’s the Ronald Reagan tax-cutter of the 2008 election.
Wouldn’t it be the height of irony if Barack Obama wins this election as the Ronald Reagan tax-cutter? His tax plans are severely flawed and his campaign narrative to support them is all wrong. And yet a recent Rasmussen poll shows that 31 percent of voters believe Obama is the real tax cutter, while only 11 percent choose McCain.
Believe it or not, Obama seems to have swiped the tax-cut issue from the Republican party. How can this be?
Well, for almost two years Obama has talked about cutting taxes for 95 percent of the people. McCain has no such record. And even though McCain has launched a strong Joe the Plumber investor-class tax-cutting surge in the last days of the campaign, it may not be enough to significantly impact Tuesday’s voting results.
This is bad news since Obama has some pretty strange views on taxes. Just look at his recent explanation for the decline in third-quarter GDP. He calls it “a direct result of the Bush administration’s trickle-down, Wall Street first, Main Street last policies that John McCain has embraced for the last eight years and plans to continue for the next four.”
Is Obama really blaming the Bush tax cuts for this recession?
After the bursting of the tech bubble and the 9/11 attacks, George Bush lowered tax rates across-the-board for individuals and investors. For five years the stock market rallied without interruption -- the longest bull market without a correction in post-WWII history -- while the economy expanded for six years, a bit longer than the average post-war recovery cycle.
And Obama wants folks to believe that tax cuts caused this downturn? Not the credit shock? Not the Obama-supported government mandate to sell unaffordable homes to low-income people and the pressure on Fannie and Freddie to securitize these loans? Not the oil shock?
No self-respecting Keynesian would buy into this. Yet Obama was at it again in Monday’s Wall Street Journal, saying, “It’s not change to come up with a tax plan that doesn’t give a penny of relief to more than 100 million middle-class Americans.”
Regrettably, not even John McCain has contradicted this. But the facts speak otherwise.
For example, the nonpartisan Tax Foundation says the Bush tax cuts -- which McCain would maintain -- provided substantially more relief than middle-class Clinton-era tax rates: A single earner making $30,000 will pay $2,756 under 2008 Bush tax law compared with $3,157.50 under Clinton tax law (in 1999). That’s a larger Bush tax cut by 8.7 percent. A married couple earning $50,000 will pay $4,012 under Bush compared with $5,085 under Clinton. That’s a bigger Bush tax cut by 21 percent.
So the facts of a middle-class tax cut are far different from what Obama claims. Obama also says his tax rates will be below those of Ronald Reagan. Wrong. Obama will raise the top rate to 39.6 percent, whereas Reagan left taxpayers with only two brackets of 15 and 28 percent.
Incidentally, the income cap for Social Security and Medicare taxes was about $42,000 when Reagan left office, compared with $104,000 today and the threat that Obama will raise that cap significantly.
It’s also worth noting that the Reagan tax-reform bill of 1986 mistakenly allowed the capital-gains tax rate to move up to 28 percent from 20 percent. Many believe this was a significant factor in the stock market crash of 1987.
Similarly, Obama intends to raise the cap-gains tax rate from 15 to at least 20 percent. It’s a risky move. Of course, Obama says only rich people will pay the higher cap-gains rate. But the reality is that a cap-gains tax hike will raise the after-tax cost of all capital, which will depress the future value of all equity assets.
McCain has recently proposed a reduction in the capital-gains tax rate from 15 to 7.5 percent. With 100 million-plus investors out there, and nearly two of every three votes in national elections being made by shareholders, this is right on target. Last Friday, McCain told me in an interview that a “low capital-gains tax is probably the greatest incentive for investment that we have in America today.”
In the frenetic final hours of the campaign McCain is also talking up his corporate tax cut, which would be a tremendous boost to plunging stock prices since corporate profits are the mother’s milk of stocks. Indeed, McCain’s overall tax-cut plan is far more powerful than Obama’s when it comes to creating jobs and stimulating economic growth. But his marketing effort appears to be too little, too late.
These things do, however, have a way of balancing out: If Obama and the Democrats go on a tax-hiking spree to penalize successful earners and investors, they will pay for it dearly in 2010 and beyond.
What follows below is a transcript of my interview earlier this morning with Senator John McCain on the investor class and the stock market. Big Mac is talking tax cuts on capital gains, businesses, and individuals. There is no question that he is energized. Politically, he is still running even with Obama among investors. That is not good. Is there time for Senator McCain to break through and run up his margin with this crucial voting block?
Larry Kudlow: Let me go back to the first question, which you were beginning to answer. We've had this terrible stock market slump. Some say $3 trillion dollars worth of wealth have been lost by investors in the investor class. And I was asking, and I think you were answering, what is your plan to create some recovery in the stock market?
Senator McCain: Keep taxes low, cut spending, create jobs with alternative energy, including nuclear power plants, including drilling offshore, wind, tide, solar. Free us from our sending $700 billion or whatever it is across to countries that don't like us very much. Free up credit. Larry, I’ve been meeting with a lot of small businesspeople, and they're having great difficulty getting lines of credit. This is something we've got to free up. Now, we have given the banking, the banks and other institutions the kind of infusion they need. It's time they pass that on to small businesses who say they can hire. They've got business, but they just haven't got the line of credit.
But make sure that everybody knows that we're going to keep taxes low. We're not going to raise taxes. We're the creator of business and the engine of our economy and small business, Senator Obama's proposal would tax half of all small business income, some 16 million jobs in America would be at risk. And then you put on top of that, he will force his mandated health care plan on small businesses, their employees, and their children. It's not good for America.
Kudlow: Just on the credit piece that you mentioned a few moments ago, have you and your campaign been following the improvement in the Libor credit market in London and the commercial credit markets here in New York? It looks like the Treasury plan is beginning to work. That may be a positive sign. Do you follow those areas?
McCain: Yeah, I do, and I get updates all the time. One of the areas that I’m still very disappointed in, though, Larry, and you may not agree with me, we've got to go in and get these home mortgages bought and give people mortgages they can afford so they can stay in their home. Look, I’m in Ohio. Homes are being foreclosed everywhere. A lot of these people, it's their primary residence, could stay in their home if they had a new mortgage at the new value of their home, at payment levels they could afford. That is the slow -- one of the slowest parts. I think it's the slowest part right now. Keep people in their homes. If they can't realize the American dream and stay in their homes, then obviously, the rest of this equation is hard to complete.
Kudlow: Let me swing back to the investor side. There are about 100 million investors, according to the Federal Reserve survey. And interestingly, in recent national elections, they're a huge voting block, almost two of every three votes cast are cast by people that own stocks either directly or indirectly. And yet, sir, you very, very seldom mention investors on the campaign trail. Why is this?
McCain: Well, I try to talk about them more often. A lot of the people that come, frankly, are people that are having trouble staying in their homes, keeping their jobs, et cetera. But I think it goes back to all this business of Senator Obama's view of "fairness." When Charlie Gibson said, why would you want to raise capital gains taxes when you know it will decrease revenue? And he said in “fairness”. And he told Joe the Plumber -- Joe the Plumber got the message through better, what we've been trying to do this whole campaign. [Obama] wants to "spread the wealth around." That takes from the investor class. That takes money from one group of Americans and gives it to another. Now that signal has been very clear. And I think people ought to pay attention to it, because it's been tried before in other countries, and policies of other left, liberal administrations. It doesn't work, and it's bad for America. We want to encourage the investor class, and that means capital gains and dividend taxes are low.
Kudlow: You've just unveiled a new tax cut on capital gains. Can you tell us about that? Because in some sense, that's probably the most important investor class tax.
McCain: It's the most important in many respects, Larry, and we want it low and we want it lowered. Every time -- there's one tax that there's no argument about, that every time it's been lowered since Jack Kennedy, we have seen an increase in revenues. Now, why anybody would argue, as Senator Obama does, that we need to raise it, even if it's -- of course, the amount needed to raise it is varied with whatever poll he's taken, but the point is that we want to lower it and keep it low and encourage investment, especially now in America in these difficult times.
Kudlow: But Senator, what is -- the current law rate is 15%.
McCain: Yeah, yeah.
Kudlow: You're taking the cap gains rate down to what?
McCain: First down to 10%, I would like to see it, and gradually even make it lower. Look, why should we tax people's gains twice? Why should we tax them twice, okay? They make an investment, they should be able to get their returns on their investment. And capital gains is obviously -- low capital gains tax is probably the greatest incentive for investment that we have in America today. And so, look, I’ll be glad to listen to smart people like you, Larry, but the worst thing we can do is tell people we're going to raise it, and that, obviously, would chill investment in America, right?
Kudlow: Well, with your lower capital gains tax, which in a recent speech you said 7.5% for two years, are you surprised, though, that respected pollsters like Scott Rasmussen or Investors Business Daily are still showing you running neck and neck, even with Mr. Obama? Back in 2004, President Bush beat John Kerry by 11 percentage points among investors. Now, you've got a lower cap gains tax. Mr. Obama proposes to raise the cap gains tax from 15% to 20%. Except you're still running even in the polls. Can a Republican win running even among investors? And why don't you think your message on capital gains has resonated with a bigger margin among investors?
McCain: I'm not sure, except obviously, when he broke his word that he would take public financing if I also did, he signed a piece of paper, that obviously, he's had a huge money investment. Look, I’m a 7.5%, I’d like to keep it permanently at 7.5%. Right now, we need more investment in America and in the stock market and in businesses and investment than ever before in these difficult times. So, it's pretty clear that if we keep them low, we will provide another tool for encouraging investment. Look, we are -- I am so happy we are where we are. I see a level of enthusiasm out here in this campaign, Larry that is remarkable. I haven't seen this level of enthusiasm before. I'm very optimistic, and we're coming from behind. I'm the underdog. That's where we always like to be. But we are within margin, and I’m very happy where we are.
Kudlow: Another really important tax for the stock market investors, of course, is corporate profits. Profits are the mother's milk of stocks, as I have said from time to time. You've proposed to lower that from 35% to 25%. Senator Obama says the other day, that's merely another huge and permanent tax cut for corporations, including $4 billion dollars for the big oil companies, but it is no help for workers. Would you react to Mr. Obama's criticism of your corporate tax cut?
McCain: He doesn't get it. Corporate tax rates in America are the second highest in the world. Japan is only higher. Ireland has 11%. Business -- I like to call them business taxes, because that's what they really are, because they're businesses and they create jobs and they create employment. And when businesses can go anyplace in the world, where are they going to go? Look, I can name you Fred Smith of FedEx, Meg Whitman, other CEOs who will tell you, when they have a choice to go around the world and pay less in taxes where they can invest more and increase businesses and jobs, they're going to do that. Obviously, they want to stay in America. And they want to create jobs in America, and they will, but we want to give them the incentive to do so. And lowering the business tax, the corporate taxes, in my view, they should be lower than 25%. Why is it that we're the second highest in the world, when 20 or 30 years ago, we were amongst the lowest in the world? It's not an incentive to businesses and jobs in America. It shows, frankly, that Senator Obama just doesn't get it.
Kudlow: You said yesterday or the day before when you were in Miami, Florida, the Democratic Congress is going to remove tax incentives or tax preferences for 401(k) accounts. Of course, that is a huge investor issue. What did you mean by that? What is the plan that Democrats want to take away from 401(k)s?
McCain: Well, that's exactly what they're saying. And Barney Frank, who is powerful, chairman of a powerful committee in the House, said we're going to raise taxes and we're going to increase spending. That's exactly the wrong thing to do in the economic difficulties we have. How did we get into this ditch? We ran up a $10 trillion deficit on our kids and half a billion dollar debt to China. So, obviously, they want to take the 401(k)s and use that money to give that to the government to spend, rather than people, and I think that's very dangerous disincentives to savings, which is exactly the cause of one of our problems, as we all know.
Kudlow: Last one, Senator, and I appreciate your time very much. Americans have an innate sense of optimism and confidence about stocks and the economy. The Rasmussen poll shows 73% believe stocks will be much higher five years from now than they are today. Is there a way for you in the closing days of this campaign to appeal to the innate sense of optimism that Americans have? Is there a way for you to connect with the investor class?
McCain: Well, I hope we've connected with the investor class by them examining our plans as we come closer to the election. But I also have to tell you, Larry, the people who want to invest are Joe the Plumbers of this world who want to own their small business. They want to employ people, and they want to invest in their futures and in the stock market and make investments, 401(k)s, IRAs and others, so that they could ensure their retirement and their future. And Joe the Plumber was able to do something that we hadn't been able to do this whole campaign, and that is articulate the reason why he doesn't want to see his taxes raised so that he can use it to buy a business and create jobs and to take care of his and his family's future. That's what this campaign is boiling down to, and that's why we're getting closer and closer, my friend.
Kudlow: All right, Senator McCain, thank you ever so much for sharing your time. Good luck in the rest of the campaign, sir.
Today’s GDP report showed a small contraction of 0.3 percent. But stocks went up nearly 200 points anyway. Many observers believe the thirdquarter downturn was not a catastrophe, especially if you factor in hurricanes and the Boeing strike. On top of that the short-term tax rebates ran out in the third quarter, and that helped depress consumer spending, which did fall 3.1 percent.
However, inventories are quite low after three quarterly declines. And business capex shipments actually rose slightly in the three-month period ending in September. So there’s no collapse, at least yet, in business investment.
Most analysts expect a much worse drop in the fourth quarter, ranging between a 3 and 4 percent contraction. But they are not factoring in a roughly $200 billion annual drop in consumer energy expenses that will accrue from the collapse of oil and gasoline prices. This is going to be a big consumer booster.
Meanwhile, credit markets continue to defrost and commercial paper is now rising again, as is inter-bank lending. So the economic story may not be near as bad as the consensus thinks. Remember, of course, the Fed is pumping in cash at a huge rate. That’s going to help the whole story.
The dumbest thing I heard today on the economy was a statement from Sen. Obama. He says the decline in GDP is “a direct result of the Bush administration’s trickle down, Wall Street first, Main Street last policies that John McCain has embraced for the last eight years and plans to continue for the next four.”
Wait a minute. Did I miss something here? After the bursting of the tech bubble and the 9/11 attacks, George Bush lowered tax rates across-theboard for individuals and investors. The stock market rallied uninterruptedly for five years. The economy expanded from the end of 2001 to the end of 2007. Are we to really believe the Obama narrative that cutting tax rates is the cause of this downturn? Not the credit shock? Not the Obama-supported government mandate to sell unaffordable homes to low-income people and to pressure Fannie and Freddie to securitize these loans? And not the oil shock, as well?
It was really tax cuts that caused this recession?
John McCain is gaining traction on the tax issue as he aggressively makes the case that Obama the Redistributor will take your money and give it to someone else, while he, McCain, will create more economic opportunity by growing the pie for everyone.
Key polls — like Rasmussen, Gallup, Battleground, and IBD — show a narrowing of the race to 2 or 3 percentage points just in recent days. This is in part because Joe the Plumber has crystallized McCain’s campaign message to a pro-growth tax-cut recovery plan that reaches out to investors all across the country. Now the big question is whether McCain will stay on message and keep hammering these points home.
Two days ago in Ohio, McCain argued: “We will cut the capital-gains tax. And we will cut business taxes to help create jobs, and keep American businesses in America.” It’s the first time he referred explicitly to his capital-gains tax cut, which would take the investment rate to 7.5 percent from current law of 15 percent.
Against the backdrop of plunging stocks and deflating home prices, that means asset buyers would keep 92.5 cents of every additional dollar of profit from the purchase of underwater stocks, houses, or any other asset. Current law will let you keep 85 cents on the extra dollar. So McCain’s plan is a 9 percent incentive reward to invest and take risks.
Now contrast that with Obama’s capital-gains tax hike to a 20 percent marginal rate (at least). That means you keep 80 cents of the extra dollar of invested profit instead of today’s rate of 85 cents. In other words, that’s a 6 percent penalty compared with current law.
Adding up McCain’s 9 percent reward and Obama’s 6 percent penalty, we’re talking about a 15 percent swing in the after-tax cost of capital and reward for investment. Stocks have already fallen 40 percent from last October’s peak. So the 15 percent differential between the Obama and McCain plans makes a very big difference to the 100 million investors who comprise nearly two of every three votes in presidential elections.
Additionally, McCain would provide a $15,000 capital-loss tax deduction and would lower the tax rate on retired investors who redeem their 401(k)s or IRAs to a rock-bottom 10 percent. Plus, McCain would drop the corporate tax — a big boon to consumers who actually pay the tax — and would keep income-tax rates at present levels.
Obviously, there’s a very significant difference between the Democratic and Republican plans. If only Mac hammers this home in the final days of the election. Sure, folks have a strong dislike for redistribution. They prefer opportunity. They want to grow the pie larger. And they don’t want left-wing activist Supreme Court judges to take away even more of their economic rights. Hence McCain’s case grows even stronger — if he pounds away and makes it. But yesterday on CNBC John McCain never mentioned capital-gains or investors. That’s not the way to do it.
The latest IBD/TIPP poll shows a 46-46 toss-up among investors. That’s not good. What I’m saying here is that while the redistribution argument is working, it needs to be bolstered by a strong case to investors, who are usually the very base of the GOP.
The opportunity is there for Sen. McCain. But he must have a disciplined investor message in the remaining days.
Back in early 1981, when I went to Washington to work for President Reagan, one of the architects of supply-side economics, Columbia University’s Robert Mundell, visited my OMB budget-bureau office inside the White House complex. At the time we were suffering from double-digit inflation, sky-high interest rates, a long economic downturn, and a near 15-year bear market in stocks.
So I asked Prof. Mundell, who later won a Nobel Prize in economics, if President Reagan’s supply-side tax cuts would be sufficient to cure the economy. The professor answered that during periods of crisis, sometimes you have to be a supply-sider (tax rates), sometimes a monetarist (Fed money supply), and sometimes a Keynesian (federal deficits).
I’ve never forgotten that advice. Mundell was saying: Choose the best policies as put forth by the great economic philosophers without being too rigid.
Of course, John Maynard Keynes was a deficit spender during the Depression. Milton Friedman warned of printing too much or too little money. And Mundell, along with Art Laffer, Jack Kemp, and others, revived the importance of reducing high marginal tax rates to reward work, investment, and risk. The idea was to make each of these activities pay more after tax, and in the process boost asset values across-the-board. This incentive model of economic growth was used effectively by President John F. Kennedy and the great 1920s Treasury man, Andrew Mellon.
During the 1980s Reagan enacted Mundell’s three-legged approach. He slashed tax rates on the supply-side and was not afraid to run budget deficits in the Keynesian mold. At the same time, Reagan gave Paul Volcker carte blanche to practice the tough-minded monetarism that curbed excess money and vanquished inflation. This eclectic policy mix reignited economic growth, and it ushered in a three-decade prosperity boom that revived free-market capitalism.
Today, however, the economic naysayers are ignoring the advice of Prof. Mundell. Looking at our financial crisis, with its deflationary sweep from stock markets to home prices to energy, they want to lurch leftward to a big-government tax-and-spend regulatory approach. Instead, we need to put all three legs of the Mundell hypothesis in place. And we’re already two-thirds of the way there.
Treasury man Henry Paulson is using a $700 billion rescue package to prop up banks with new capital, purchase distressed assets, and backstop inter-bank lending. Keynesian deficits will finance it. But it’s working. While ankle biters on the left and right have dissed Paulson’s plan, important credit-market spreads have declined significantly in the last two weeks.
Fed head Ben Bernanke, meanwhile, is combating deflation with a Friedmanite monetarist approach -- the second leg of the Mundell mix. Over the past two months the Fed has doubled its balance sheet and spurred a major increase in the basic money supply in order to meet the enormous liquidity demands that always accompany deflation. The Fed should keep this up in the coming months until stocks, commodities, and credit show life-signs of recovery.
But what’s missing is Mundell’s third policy leg: supply-side tax cuts. And here we find the partisan debate of the closing days of the presidential and congressional elections.
Democrats want to tax the rich, redistribute the wealth, and spend our way out of the economic doldrums. It won’t work. Senators Barack Obama and Harry Reid, along with Speaker Nancy Pelosi, disdain supply-side tax incentives. But Sen. John McCain wants to reemploy them as a recovery tool. McCain is right, and now is the time for the Republican party to call for sweeping tax cuts that would reduce marginal rates by half for businesses, individuals, and investors. Yes, it would be bold. But no bolder than Reagan in the 1980s, Kennedy in the 1960s, or Mellon in the 1920s.
The corporate tax rate should be slashed from 35 percent to less than 25 percent, including capital-gains. (Corporations, let’s not forget, don’t pay taxes. Only individuals do, since business costs are passed along to consumers.) The top individual rate should similarly be lowered, with fewer income brackets to clutter up the tax code. And investment taxes on capital-gains and dividends should be cut from 15 percent to 7.5 percent to revive the dormant animal spirits of investors.
These tax cuts would mean all three legs of Robert Mundell’s pragmatic approach to policy are in place. Use the money supply to combat deflation (inflation is not the problem), employ deficits to rescue and stabilize the banking and credit system, and slash tax rates to reignite economic growth.
In effect, a successful rescue plan requires a drawdown of all the major economic schools of thought. Given the current economic emergency, we need all the help we can get. For a change, how about a little pragmatism in the policy mix? That just might do the trick.
There’s a huge multi-thousand word article in this mornings Wall Street Journal on Paul Volcker, the former Fed chairman who conquered inflation during the Reagan years and has become a key financial advisor to Sen. Obama. Articles like this fan the flames of speculation that Volcker could be Obama’s secretary of the Treasury, despite his 81-year-old senior citizen status. But Volcker is a vigorous 81 and I think he could handle the job.
Of course, Volcker has a great reputation as a deficit-cutter and a strong-dollar man. What’s more, as a long time financial advisor who was president of the New York Fed, undersecretary of the Treasury, and of course Fed chairman, Volcker’s money knowledge would gain bipartisan support to solve the financial crisis, which will surely spill over into next year. Volcker would attract bipartisan support because of his superb reputation. He is not a supply-sider, nor did he agree with the Reagan tax cuts in the 1980s while he was Fed chairman. But he did work well with the Gipper. Reagan’s supply-side tax cuts along with Volcker’s tight money to slay inflation produced a strong economic recovery and proved all naysayers wrong.
Volcker will unfortunately agree with Obama that the top tax rate can be raised. Not good. But he’s very good on tighter spending and King Dollar. And he does have vast knowledge of the intricacies of world credit markets.
I’m sure the Obama campaign is encouraging the Volcker speculation, since Mr. Volcker brings gravitas and experience to Obama.
The other likely candidate for Treasury under an Obama administration is Lawrence Summers, the proven protégé who was Treasury secretary during Clinton’s last year and before that undersecretary. Summers also would be a strong player, with wide knowledge of our financial problems. He’s also for a stable dollar. And noteworthy is his long-held criticism of Fannie and Freddie. Like Volcker, Summers would agree to lifting the top tax rate; he is no supply-sider. But also like Volcker, he is a moderate-to-conservative Democrat who would be well received by Wall Street and investors.
Are Stocks Ready to Blast Off?
For those like myself who believe the stock market is on the rebound, please go to “Calafia Beach Pundit”, a blog site run by the very smart freemarket supply-sider Scott Grannis. He has a blockbuster chart suggesting a huge rally in stocks.
It’s based on the fact that the two-year swaps spread in the bond market has fallen significantly and is closely related to stocks. His chart suggests the S&P 500 could rebound to 1,200. That would be roughly 20 percent above today’s level.
If Big Mac Wants to Distance Himself from Bush …
The Washington Post reports today that Sen. John McCain is out there on the campaign trail criticizing President Bush in order to deal with the Obama media attack linking Big Mac to W. Apparently McCain is criticizing Bush and Paulson as bailing out the banks rather than buying up underwater mortgages to help homeowners avoid foreclosure.
Okay, fine. I think Paulson’s three-cornered plan to recapitalize banks, buy up toxic assets, and guarantee short-term inter-bank loans in London and New York is the right policy. And since surfacing two weeks ago, the rescue plan is actually helping boost the stock market. But if McCain wants to go there on mortgages, then go there.
However, the senator could distance himself from President Bush in other ways that might resonate with the investor class — the important voting bloc that McCain needs to win by 10 points but is now running even. For example, until very recently the Bush dollar kept sinking. So why doesn’t McCain distance himself from Bush by supporting a King Dollar that will attract global investment for job creation, hold down inflation, and improve America’s standing around the world? Sen. McCain also could tout across-the-board pro-growth tax reform, such as Paul Ryan’s idea of 10 percent and 25 percent marginal tax rates.
Economic emergencies require strong medicine, and tax reform along with currency reform is consistent with McCain’s message that he will be a real Washington reformer. There’s also McCain’s plan to reform the corporate tax. In this case, McCain’s rate-slashing idea can be sold as a jobs and wages booster and as a tax-cut for ordinary consumers who pay most of the higher corporate tax that is passed along to them.
These would be very strong economic-recovery ideas that are separate and apart from the Bush policies and have a strong reform message.
Last night, on CNBC's "Kudlow & Company", I had an exclusive interview with Treasury Secretary Hank Paulson. The entire transcript follows:
Kudlow: A very special evening here. The man in the eye of the financial storm. Treasury Secretary Henry Paulson joins me live here in our nation’s capitol. Thank you very much for coming back.
It's a tough day. You know all about that. The market is down over 700 points. Your announcement was yesterday, but we still have the bumpy markets. Fear seems to rule. Volatility seems to rule. A lack of confidence everywhere. Let me ask you, sir. Are markets missing something with respect to your new plan? How do you comment on this, because it just doesn’t seem like there is a wave of confidence.
Paulson: Well, Larry, there's a lot going on right now and a lot going on in the markets. We knew that the financial markets and all the turmoil in the financial markets were going to have a significant impact on the real economy.
Today there was some evidence of that. The retail sales numbers came in at a disappointing level, but not a surprising level. So, I think what the markets are saying today is that they understand that we are going to have a difficult few months ahead of us. But what I would say is let us remember that we have a very resilient economy. Last quarter we grew at 2.8 percent.
The steps we’ve taken are absolutely the right steps. They are bold steps. They are strong steps to stabilize the financial markets and inject confidence into the banking system along with capital. When banks start lending to each other, feel comfortable dealing with each other, they will start lending to businesses and we’ll see this make a big difference in the economy.
Kudlow: Do we have to take a recession? Are we in a recession right now, sir?
Paulson: Well, Larry, what I'm saying is, we're clearly in a difficult period, and it clearly -- the financial turmoil and the very, very difficult time we've had where the credit markets have frozen up, and when loans weren't being made, weren't being made to small businesses, people -- it was hurting jobs, it was hurting confidence, and this has to have an impact. And it's having an impact. But by far the most important thing we can do here is stabilize the markets, stabilize the banking system, and I'm very confident that the moves we've done, taken, will do just that.
Kudlow: All right. I want to get into all those things. They are very important points. Let me begin - front - page stories in all the major papers today. When you unveiled on Monday your rescue package to the nation’s top bankers, apparently it was a somewhat contentious meeting. I want to ask you, first of all, are the major bankers with you? Are they on your team for the rescue package? Second of all, what was the biggest bone of contention in that meeting? What was it you had to sell them on?
Paulson: Well, Larry, let me begin by saying I don’t believe it was a very contentious meeting. I think it was a candid meeting. I think it was pretty extraordinary to get nine bankers running key institutions – institutions with 54 percent of the assets, 50 percent of the deposits in the United States of America -- and to get them to sign up for this plan.
What I said to them was – this is about the United States of America – it's about our economy – it's about our banking system and this is a program for healthy banks. This is not about failure. We want healthy banks to participate in this, because healthy banks need to be well capitalized. They need to be dealing with other healthy banks and with businesses. They need to be deploying their capital. This will be good for the country, it will be good for the system, and good for all of you.
Kudlow: How did you persuade my friend Richard Kovacevich, who runs Wells Fargo? He seems to be the most prominently mentioned. I wasn’t at the meeting and he didn’t talk to me, but from the news accounts, how did you talk him into coming on board?
Paulson: Well, I’ve got to say this. We talked to everyone and there are institutions that could survive just fine without more capital - they have adequate capital - but they need to be well capitalized. What we want to do is to come up with a program. Remember something else about this program. There is nothing punitive about this program. This is a program that said to all the investors that want to come into the banking system, that when the government comes in it is not coming in to squash private investment.
Kudlow: Private shareholders.
Paulson: Private shareholders. No, it is encouraging private shareholders to invest in these banks. So, this is about increasing confidence in the banks and about increasing confidence of the banks and the banking system so that they can be proactive in deploying their capital.
Kudlow: Did some of these bankers worry about management control exercised by the Treasury Department? I mean clearly there are limits to executive compensation. There are limits with respect to dividend payments. And there are generic issues -- will you exercise your warrants and will you exercise voting strength. In other words, is this nationalization? I think that's on the minds of a lot of people.
Paulson: Well anything but. Anything but and this is about taking the preventative action so we don’t need to do any more radical things. Let me just take the issues you mentioned one at a time. These are relatively small positions in ownership terms. These are passive investments. Management -- this is not anything like what you suggested.
In terms of executive compensation, there was broad agreement in that room that this is an important topic. No one spent time debating executive compensation. I explained what the law required and that we were going even further and that there wouldn’t be golden parachutes. If there were profits based upon financial information that turned about to be materially misleading, that compensation would be given back.
Kudlow: Both of which the country seems violently opposed to -- the political nature of the country right now is so much against that kind of thing.
Paulson: And also that we couldn’t have incentives that made compensation based upon excessive risktaking. All of those CEOs in that room understood it. As a matter of fact, when I outlined it, one of the CEOs said "Hank, why are we even spending time talking about this? Of course, we get it."
Again, these are investments that are good for the country and good for the banks. These are temporary investments to bolster confidence and to bring capital to the system. It will be deployed and the economy will pick up and these investments will be refunded.
Kudlow: Do you think that with the preferred stock and all the other aspects you just described -- really, you say passive investments, not active management control -- will that attract private shareholders and private capital, not just the shareholders today, but the potential shareholders tomorrow?
Paulson: Absolutely. I think where people have gotten confused is there have been situations where we’ve had to come in where there is a failure. That is a totally different proposition.
Kudlow: AIG. Fannie and Freddie.
Paulson: Yes -- that's failure. That’s where you have to come in. This is about attracting private capital and it was clear to the whole world that these preferred share investments are going to come in right alongside other senior preferred and not senior to them. And again, preferred doesn't vote with common shares. The warrants are for 50 percent of the value of the preferred shares. And again, the warrants are for non-voting common shares. So, this is about capital and protecting the American people by getting our financial system working the way it's supposed to work. So, we’re going to be able to create jobs. This is about people’s 401k plan. This is about loans to send their children to college and keeping our economy going. That's what it’s about.
Kudlow: So many people want to know. People stop me on the street -- callers on my Saturday radio show -- how can you get the bankers to deploy the government capital that you are injecting? For example, the yield on the preferred is 5 percent. Their cost on the preferred is 5 percent. Some of them have preferred stock that is 11 percent in yield. They have bonds outstanding that are 7, 8, 9, and 10 percent. What is to stop them from getting new government money at 5 percent and retiring the outstanding paper that is much more expensive, rather than deploying this new capital in the economy for the purposes you just described?
Paulson: Well, that's a key question, and let me say, even before that, the reason we set the terms where they were set, we didn't think this term should be set at what the market would demand in a crisis situation. That's why the government's coming in to begin with. We wanted the terms to be like what you would have in a normal situation.
Now, the way you get bankers to deploy the capital -- because they know it's their job to deploy the capital, making the loans which are so vital to our economy -- the way you get them to do that is they've got to have, first of all, plenty of capital; they've got to be well-capitalized. Secondly, they've got to be confident in the system. They've got to be confident that as the money flows between and among banks that they're confident in that and confident in the strength of the system.
Kudlow: Rather than pay down their own debt.
Paulson: They're not going to be paying down their own debt. The regulators understand that and they understand that.
Kudlow: Will you jawbone from time to time -- that's a bad word, jawbone -- will you be talking to them in consultation as you did on Monday, for example?
Paulson: I will clearly be doing that, but I will also say to you that they understand this, and regardless of whether we had government investments there, we would be jawboning and encouraging them to do the right thing. And I will say it will be a lot more effective if people aren’t afraid. This is about confidence and confidence in the financial system.
Kudlow: Mr. Paulson, let me just ask you another question that I hear a lot. People are relieved that you are guaranteeing, the FDIC that is, is guaranteeing the interbank lending. The LIBOR markets are frozen up. Some say the New York markets are frozen up for the short-term loan. That's a huge drag on the whole system. But, let me ask you this – when does this guarantee actually go into place? There is a 75 basis point cost that the banks have to pay. I assume there is some registration. LIBOR rates have slipped a little bit, sir, but not very much. When does this guarantee for the interbank loans really kick in?
Paulson: Larry, I think when you do something as quickly as we rolled this out, there may be some confusion in the marketplace. But, everyone has a guarantee for 30 days. So, there’s a 30-day guarantee.
Kudlow: Do people know this key point?
Paulson: They should, because the guarantee is there immediately. At the end of the 30 days they need to subscribe to this. There is a 75 basis point fee. Then, if they subscribe, the guarantee lasts through June of next year. The guarantee applies to the senior obligations coming due -- unsecured obligations -- and they can refund those with a maturity out to three years.
Kudlow: Talking about the freeze up in London and New York and elsewhere, with the benefit of hindsight, was it a mistake to let Lehman go under? Because a lot of people are saying it was precisely the drop off in Lehman, which was roughly in early to middle of September when suddenly LIBOR rates went up, the spread against U.S. Treasuries went up something like 300 basis points and the whole system seemed to go haywire. The whole system was like a computer that completely froze up and there was nothing anyone could do about it. Was the Lehman decision an error?
Paulson: Let me talk a little bit about the Lehman situation. Some of you could argue -- are we dealing with a symptom or are we dealing with a root cause? Because one thing I saw clearly this weekend when we met with central bankers and finance ministers from around the world. There was something very good that came out of that weekend, which was the way in which we all agreed to work together with a common set of policies and objectives. The thing that wasn’t as good was to understand the extent of the problem with financial companies and banks in country after country where they said they didn’t have a real problem, to suddenly then have a significant problem.
But let me get back to Lehman. First of all, Treasury didn't have any powers to do anything as it related to Lehman. We've been very clear. I’ve been very clear when I talked with Congress in July that we didn’t have the authorities to deal with a wind down of a non-bank financial institution. So we were very, very clear about that.
Kudlow: But in truth sir, weren’t you deeply involved in the wind down of Bear Stearns last winter?
Paulson: Yes, working with the Fed and the Fed could loan -- under 13-3 -- they could loan against securities. But there was a hole that needed to be filled in the case of Bear Stearns. There was a buyer, J.P. Morgan. and they could loan against securities.
We worked very hard on Lehman. We all knew about the problem with Lehman for a long time and Lehman tried to work through their problems. I think regulators knew that if there was not a solution before they announced their third quarter earnings, there was apt to be a problem. It turns out there wasn’t a buyer.
There was no hole to fill. There just was not a buyer for Lehman. And, the Federal Reserve didn't think they had the authorities to loan (under 13-3) against Lehman. And I certainly wasn’t urging that because, again, we had a system where we have authorities that were put in place a long time ago for a financial system that existed in a different world and there are broad authorities if a bank fails.
Kudlow: But in truth, when you go back and look at it, the stock market is down 25 percent since Lehman, which was really just a few weeks ago. It was an extraordinary event and, at the time, some people applauded you and said enough is enough we can't take out every bank. But in looking back on it, that seemed to be the trigger to all this recent mayhem.
Paulson: I would say, Larry, looking back there’s a lot that happened. What was going on with Lehman, there is no doubt that when you look at the over-the-counter derivative markets, when you look at the complexity of today's financial world, a failure of any big financial system creates a big issue.
I always look back, in addition to looking forward and deal with the facts presented to us. But I could not have been clearer in June and July, that we didn’t have the authorities. And, we certainly didn’t have them at the Treasury and I don’t believe the Fed had them. If there was a buyer for Lehman -- we had a foreign buyer that was interested -- but near the end their regulator wouldn't let them. So, there was no buyer. There was no hole to fill.
Kudlow: Let’s move on. When you made your statements yesterday regarding the unveiling of the new rescue program, here’s what you said and I will quote. "We regret having to take these actions. Today’s actions are not what we ever wanted to do." What did you mean by that?
Paulson: What I meant was, you know, we're from the United States of America. We believe in free markets. We expect our markets to work well. Government intervention is about failure of a regulatory regime, mistakes on a lot of people's parts, but to me this was much, much better than the alternative. And this was about preserving our free market system and preserving our banking system and stabilizing it for the American people. There’s going to be a good deal of work that needs to be done once we get through this period and a good deal of work to make sure we don’t get like this again.
Kudlow: Some people read your statement and they wondered out loud -- did you mean the changeover in policy from the Treasury purchases of toxic assets to the new capital injections?
Let me read you what you told the Senate Banking Committee -- this is just a couple of weeks old -- in a very difficult Congressional battle, which you eventually won. "There were some that said we should just go and stick capital in the banks. Put preferred stock -- stick capital in the banks. And what to do when you have failures, you know, that what happened in Japan and other spots. But we said the right way to do this is not going around and using guarantees and injecting capital. There have been various proposals to do that, but we want to use market mechanisms."
What was it that made you shift your emphasis away from the toxic asset purchase and towards the injections of capital?
Paulson: Larry, I'm glad you asked me that question. Let me begin by saying that what we were talking about was always capital. Going back over a year ago, I did everything I could to jawbone institutions to raise capital. No CEO ever got in trouble by having too much capital. The illiquid asset purchase is about capital and about price discovery and freeing up capital. We're going to do illiquid asset purchases and it’s going to be integrated very well with the program.
When we worked with Congress we knew we were going to have the ability to purchase preferred stocks if it was necessary. But that statement I made then was about putting in capital if we dealt with a situation like Fannie or Freddie or AIG or we had to move to prop up a failing institution.
Kudlow: But some people are saying that the movement of Europeans toward capital injection, the movement of the British toward capital injection, essentially forced you to play your hand. Is there any truth to that?
Paulson: I look at it differently here. You always need to look at the facts, then the facts before you determine what you do. What we’re doing is very different from what the British are doing. It was clear to me after spending time with the Europeans and what was happening there -- learning more about this situation, that the problem was bigger than we had hoped and that the right way to make a big impact quickly was by purchasing preferreds on the terms of which we did it. That would make the taxpayer money go the furthest. This was clearly an investment where we should get these funds back with a profit.
We moved quickly, but remember let's just talk about what we've done. In just twelve days after the legislation was passed, we had the nine institutions (voluntarily) with 50 percent of their deposits in the United States sign on for a program.
Kudlow: For $125 billion
Paulson: $125 billion
Kudlow: And you’re going to go for a second $125 billion
Paulson: And then we are going to go broadly to other financial institutions and we’ll be going to regional banks and smaller banks and community banks.
Kudlow: That leaves only $100 billion out of the authorization of $350 billion. Is that where the toxic asset purchase comes from?
Paulson: Remember, we have $700 billion.
Kudlow: But you have to go back to Congress for the remainder.
Paulson: For the next $100 billion, all the president has to do is notify. Then, to go beyond that, there is a notification process and Congress has the ability, obviously, to pass legislation to prevent it. In terms of the illiquid assets, this is a $250 billion purchase of preferred equities and it gets very different from what we were talking about when we were talking to Congress. This is a way in which to encourage shareholders to come in and not the way in which I answered the question where we were talking about injecting preferred on a punitive basis.
Kudlow: We talked earlier about the recession or the downturn and the difficult position with retail sales falling three straight months. We really have unprecedented commodity deflation, credit deflation, home deflation, and all the rest of it. When do you think realistically that new credit will flow to consumers, to businesses, to state and local governments? When do you think Americans can realistically expect that to happen?
Paulson: Larry, that is the important question and that, more than anything else, will make a difference in this economy. I've said we have a resilient country and a resilient economy and it can bounce back and this is about confidence. We're going to have a number of difficult months here. We’ve taken the actions that I believe are the right actions based upon the facts that we looked at this week. I think they are the right actions and I think they can make a difference and they can make a difference more quickly than many people recognize, but it’s going to be confidence.
Kudlow: Whoever wins in November -- we’re a few weeks away -- would you be willing to stay on for a few months to keep this process intact before you hand it over.
Paulson: Larry, I’m going to work day and night through January 22 and right after the election I’m available to work with the best transition you’ve ever seen -- with whoever the new Treasury Secretary is. We're out looking right now for permanent leaders of this TARP and we're looking to get someone that will be more than acceptable to the next president and his economic team. This is going to be a first-rate transition -- can guarantee you that.
Kudlow: Mr. Secretary Henry Paulson, we appreciate it ever so much
It certainly wasn't the big-bang across-the-board tax-reform and taxcut plan that I and others lobbied for. But John McCain's "Pension and Family Security Plan" unveiled today on the campaign trail does have some solid pro-growth nuggets. I’m calling it some good little stuff.
The most important pro-growth measure is a reduction in the capitalgains tax rate to 7.5 percent in 2009 and 2010. Although I wish it were permanent, at least it will reward investors who scoop up undervalued assets, including bargain-basement stocks and underwater homes. Two years is not a very wide window. But this could promote a faster recovery in asset prices and wealth creation.
Alongside the cap-gains cut, McCain is proposing to increase the amount of capital losses eligible for tax write-offs from $3,000 to $15,000 for tax years 2008 and 2009. It's an offset to ordinary income. And again, while it should be permanent, at least it will be helpful.
Also in his plan, withdrawals from tax-preferred retirement accounts will be taxed at the lowest rate (10 percent) for the first $50,000 withdrawn from these accounts. Tax rules forcing seniors to sell retirement-account stock holdings when they reach age 70.5 will be suspended. That’s good.
In effect, going into the final debate, McCain has a significant corporate tax cut and a modest capital-gains tax cut. He also wants to keep the Bush income-tax cuts in place. All of these measures are pro-growth.
I would have preferred a Paul Ryan modified flat tax with two brackets of 10 and 25 percent. In other words, a true across-the-board reduction in marginal tax rates as an economic recovery measure to connect with folks who are worried about recessionary losses for their jobs and home mortgages. Economic anxieties are big, and a big-bang tax-cut response would be optimal.
But cutting taxes for businesses, capital gains, and individuals does give McCain a lot of pro-growth meat on the bone for the big debate.
Now, if only McCain can succeed in selling these measures. Especially the corporate tax cut, which should be sold as a middle-class consumer tax cut inasmuch as corporations pass along their tax costs to consumers in the form of higher prices. This is the key to selling the corporate tax cut. McCain's senior advisors tell me he has been briefed on this language, but so far it hasn't materialized in the debates. Perhaps it will Wednesday night.
Really, the McCain tax contrast with Obama is not hard to make. In the last debate McCain referred to Obama's tax hikes as Herbert Hoover. I'd like to see Hoover reemerge tomorrow night.
Fear and panic have taken over the stock market, the banking system, and the economy. It is one of those moments in history when people feel helpless, frustrated, and bewildered about what’s going on and why it’s happening.
Stocks are being pummeled in ways we haven’t seen in nearly a century, both here and overseas. The Dow Jones is down nearly 20 percent this week, its second worst week since December 1914. The S&P 500 dropped over 20 percent in what looks to be the worst week in the history of that index (going back to 1928).
Behind all this, the credit system is completely frozen. Banks are now loathe even to lend to each other in the overnight markets that are so vital to the daily financing of American business. And the profits outlook is deteriorating badly, sparking fears that we may have a deep and prolonged recession.
And yet, much good may ultimately come of this terrifying correction.
I commend everyone to read the Wall Street Journal op-ed of Friday written by John Steele Gordon, an eminent financial historian. Gordon writes that there have been financial panics roughly every twenty years throughout American history. He goes all the way back to Hamilton, who orchestrated the first banking bailout in 1792. From this came a regular money-supply system, a credible U.S. government debt system, and something of a disciplined banking system.
Gordon hopes that out of the current crisis we get a better system of well-capitalized banks regulated by a more unified government supervisory apparatus. My view is that the panic will pass and long-run American prosperity will continue. This may seem Pollyannaish right now, but I have great confidence that our free-market economy will come out better, with a strong financial underpinning, when the storm finally ends.
Paradoxical as it may be, strong government actions to stabilize banking are necessary to preserve the free-market-economy system. No free-market economy can survive without stable banking and credit. Without readily available credit, entrepreneurs can’t put their new ideas into commercial practice. And without that vital innovation, economic growth suffers.
The trick now is to use government levers in smart and efficient ways. Banks need to be recapitalized without punishing current and future shareholders. Henry Paulson is working on this. More than likely, the Treasury man and the G-7 finance ministers are figuring out a plan that will temporarily guarantee all short-term interbank lending in the New York and London money markets.
Britain has done this for its High Street banks. But the American and European banks in London are not guaranteed. This is the message of the LIBOR market, which has seized up. As of Friday, the three-month LIBOR dollar rate and its spread against Treasury bills have again increased significantly. This, in turn, is dragging down stocks.
In New York, the market for commercial paper issued by banks also has faltered. In fact, financial commercial paper has dropped nearly $160 billion in recent weeks. That’s why the authorities have to step in with a short-term backstop. Other measures to relieve banks of their distressed assets, backstop money-market funds, and guarantee all banking deposits will have a positive effect over time, as Paul Volcker noted in the Journal this week.
Meanwhile, the Federal Reserve has essentially moved off its fed funds rate target and is instead focused on injecting huge quantities of new cash into the banking system. The most basic money supply controlled by the Fed is now growing at a 16 percent rate after being nearly flat for 18 months. In the last five weeks the Fed has injected nearly $700 billion through a variety of lending facilities. This is important. The demand for liquidity during this period of asset and credit deflation cries out for massive new cash supplies from the central bank.
Then there’s oil, which is almost forgotten in this panic. The $150 oil shock and elevated prices at the pump are what worsened the credit crunch and hastened the recession. But now oil is about $80 a barrel. When the dust finally clears, lower energy prices will be an important tax-cut, pro-recovery factor. Meanwhile, the exchange value of the U.S. dollar is up 16 percent in recent months. That’s an anti-inflationary sign of confidence.
And as John Steele Gordon writes, hopefully we have learned to stop forcing banks to give mortgages to un-creditworthy customers, and to stop encouraging Fannie and Freddie to package these bad loans.
I recall the despair that surrounded the S&L/junk-bond credit crunch twenty years ago. Nobody believed prosperity would return for a long time. Commentators on the left wrote about the decline of the U.S. economy and American power. Yet the 1990s witnessed a strong prosperity boom; the free-market model of capitalism triumphed and the socialist model in Russia and elsewhere collapsed.
Yes, the months ahead are going to be tough. But I remain optimistic that our free democracy and free-market economy will survive this crisis as well.
While the presidential candidates were debating in Nashville on Tuesday night the Asian stock markets were selling off by 10 percent. Earlier in the day the U.S. market plunged by 500 points. These were big-time drops, yet presidential debaters never talk about the stock market. Nashville was no exception.
Roughly $2 trillion in U.S. shareholder capital has been lost in the past 15 months. Stocks are down 20 percent over the last month alone. Those are nasty hits. Stock market people are very unhappy campers right now. And the bad-news financial statements for September are now either in the mail or on the kitchen table. But there were no references to investors either by McCain or Obama on Tuesday night. This is nuts.
The investor class is a huge voting bloc. Shareholders in recent national elections represented nearly two out of every three votes cast. And most surveys put the investor-class population at slightly over 100 million. This includes direct investment through brokerage accounts, although the vast majority of investor-class members own IRAs, 401(k)s, and defined-benefit plans, such as state and city pension funds.
So why aren’t the presidential contenders trying to connect to investors? More glaringly, why isn’t McCain?
After the debate I checked in with TechnoMetrica’s Raghavan Mayur, who puts out the respected IBD/TIPP poll. Mayur consistently ranks among the top pollsters in terms of accuracy, including his work on investor preferences. For September, Mayur’s data show McCain with a small 45-41 lead over Obama among investors. That’s roughly within the poll’s margin of error, and for McCain it isn’t enough.
Four years ago this September, George W. Bush had a 10-point lead over John Kerry among investors. In November Bush won investors by a 53-42 margin. By this measure, McCain is now way behind. And I suspect it may be a function of his reluctance to talk directly about investor taxes -- especially on capital gains and dividends.
The Bush tax cuts in this area were very popular among shareholders since they reduced the cost of capital and raised after-tax investment returns. Of course, McCain has pledged to maintain President Bush’s investor tax cuts at the current 15 percent rate, while Obama proposes to raise them to at least 20 percent. But McCain seldom talks specifically about cap-gains and dividends, and the polling numbers strongly suggest he’s not connecting with investors.
Obama constantly bashes businesses and successful high-end earners, and one would think investors would be totally turned off by this. But Mayer’s polls don’t confirm it. Why? Perhaps investors sense a lack of tax-cutting passion from Sen. McCain.
For example, during the debate, McCain did mention how he and Obama differ on tax policy. At one point McCain even compared Obama to Hoover. “My friends,” he said, “the last president to raise taxes during tough economic times was Herbert Hoover, and he practiced protectionism as well.” McCain later said, “I’ve got some news, Sen. Obama -- the news is bad. So let’s not raise anybody’s taxes.”
But McCain never got specific on capital-gains and dividends, and he failed to educate voters on just how important investment is to healthy job-creating businesses.
Ditto for McCain’s proposed corporate tax cut. The senator wants to slash the business tax rate from 35 to 25 percent. It’s an excellent plan. But McCain doesn’t explain how two-thirds of the benefits of a corporate tax cut go to the workforce through higher wages, with the rest then going to shareholders. He also doesn’t point out that ordinary folks actually pay the corporate tax, since firms pass this tax cost along in the form of higher prices. So McCain could, in fact, call a corporate tax cut a consumer tax cut. But he’s not doing this.
McCain also needs to put investors on red alert about Obama’s middle-class tax cut. The Illinois senator’s huge government-spending plans will overwhelm his ability to cut taxes for 95 percent of the people. In fact, McCain needs to remind voters that Bill Clinton made exactly the same promise as a candidate in 1992 before he broke it as president in 1993.
Time’s running out. The investor class vote -- which still looks up for grabs -- has simply got to be a McCain priority if he is to win in November. Rag Mayur doesn’t have his October polling results in yet, but he believes the race will be much tighter than mainstream pundits believe. Message to Sen. McCain: The investor vote could well tip the balance.
Another bad day for stocks, which seems to be a habit lately.
Fear is the big factor. Fear over the latest credit-crunch freeze-up in short-term lending markets. Fear over deepening recession. Fear over profits. Fear that Treasury-Fed bailouts — which grow larger by the minute — somehow won’t be enough. And fear that John McCain is going down in a three-house, Reid-Pelosi-Obama sweep that will raise taxes, embrace trade protectionism, end union secret ballots, and spend us into oblivion.
Amidst all this pessimism, permit me three silver linings: First, the strong dollar. Second, plunging energy prices that will generate an economy-wide tax-cut effect. And third, rapid money-supply growth after 18 months of flat money. In fact, on this last point — which is so important — it looks like the Fed has un-pegged its fed funds target rate and is instead focused on pouring cash into the liquidity-starved global banking system. Meanwhile, the Treasury purchase plan for toxic assets will get off the ground sooner, not later. And the Fed is now backstopping the commercial paper market.
Against the rising tide of pessimism I would argue that these positives are planting the mustard seeds that will grow into the next bull-market prosperity. Believe it or not. Now it is up to John McCain to make a pro-growth case in tonight’s debate. As one friend put it at lunch, the former Navy pilot must shoot to kill. This is his last dogfight. He must hunt, not be hunted.
Today’s Zogby and CBS polls have Big Mac down only three points — a bit of encouragement from a whole spate of much worse polling numbers.
John McCain needs a knock-out performance at Tuesday night's presidential debate if he is to keep his hopes alive.
Right now polls paint a dismal picture for Sen. McCain. Rasmussen shows Obama leading 52-44, Obama's highest level ever. (Moving above 50 percent is a key indicator.) The RealClearPolitics average has Obama up 6 points. Intrade shows Obama up by 34 points. It also could be that key states like Ohio and Florida are now up for grabs, while Obama could win in swing states like Virginia and North Carolina. McCain, of course, is moving out of Michigan.
The financial crisis and economic downturn clearly have buried Sen. McCain in recent weeks. Some of McCain's supporters think he can turn the page on the economy Tuesday night and instead attack Obama on character and qualifications. That doesn’t seem realistic.
The recession economy and the financial crunch are front and center. Folks are asking: Can I get a loan? Will I have a job? Can I keep my house? Unfortunately, Sen. McCain's message overemphasizes government spending cuts, almost to the exclusion of stimulative and expansive tax cuts. This just doesn’t seem like the right time for a government spending freeze, at least to the exclusion of other pro-growth policy levers. Sounds like too much root canal. More like Bob Dole than Ronald Reagan.
That's why McCain needs to stress that tax hikes of any kind would be a total disaster during this economic emergency, and that letting folks keep more of what they earn is a recovery prescription. He needs to emphasize the need for across-the-board tax cuts for individuals and businesses. Lower marginal tax rates will reward work, investment, and risk-taking. They also will put money in people's pockets as they keep more of what they earn.
McCain can point to Paul Ryan's modified flat tax with two brackets of 15 and 25 percent. That would be a great message. This is an economic emergency and it calls for strong medicine. This is not the time to take away tax cuts. It's a time to add them. And reducing marginal tax rates would add substantially to taxpayer benefits on a permanent basis with new incentive rewards.
McCain should next talk about a corporate tax cut from 35 to 25 percent as a means of boosting jobs and wages. He should note that study after study shows that roughly two-thirds of the benefit of a corporate tax cut goes to the workforce. A corporate tax cut also is pro-investment and will make this country more competitive. But the key point is that a lower corporate tax rate is a job-creator. McCain must explain that you can't have jobs without healthy businesses that are funded by investment.
McCain also should state that the Federal Reserve needs to keep expanding the money supply. Milton Friedman taught us many years ago that the monetary contraction of 1929-32 was a key cause of the Great Depression. So Big Mac should tell Ben Bernanke to stop targeting the federal funds rate and pump up the money supply even more. Right now credit deflation and recession are the problems -- not inflation.
From the beginning of 2007 to the middle of 2008 the monetary base controlled by the Fed has grown only 1.6 percent at an annual rate. The basic M1 money supply has been flat. This amounts to a long-run liquidity squeeze. The credit-crunched economy desperately needs cash. But the Fed is not providing it.
Over the past three months the central bank has stepped up a bit to a 4 to 5 percent growth rate. But that is still way too little in today's confidence-lacking banking environment. Everyone is hoarding cash rather than putting it to work. McCain should highlight this point.
He also should address all the Americans who might be worried about their bank accounts. He should propose that all deposits be guaranteed by the FDIC, at least temporarily. He might also suggest that G-7 central banks guarantee all inter-bank loans for regulated banks. (Hat tip to Wall Street economist John Ryding.)
He also should put Obama's tax hikes and trade protectionism in historical context. Under Herbert Hoover, taxes were raised, trade protectionism increased, and the money supply contracted. Sound familiar? Obama’s tax hikes and trade protectionism are Hooveresque.
Right now, McCain sounds austere when he addresses the economy. Tomorrow night he must sound expansionary for economic recovery. Tax cuts, free trade, and money growth -- those are the pillars of recovery. An across-the-board tax cut for individuals and businesses will boost jobs at home and our competitiveness worldwide. Free trade benefits both consumers and businesses. The Fed's money supply must keep expanding.
On the morning after Senate passage of the Treasury rescue bill stocks are down 200 points. So there is no silver bullet to our economic woes.
Now, the dollar is up strong, and gold is off $35. Those are positive signs that the Treasury bailout will improve the quality of U.S. credit. More and more over the past year, I have come to believe that gold and the greenback are more closely correlated with our credit problems than with inflation fears.
Turning back to the rescue package, tomorrow's House vote is likely to be close, but there are a lot of positive signs that enough Republicans and Democrats will move from the nay column to a yea vote. I think the odds favor passage in the House. And the Treasury will probably start its auctions to purchase toxic bank assets in a couple of weeks. This will add much needed liquidity to the financial system.
But there is another problem: We are almost surely in a recession. Some of the recent numbers suggest the economy may have fallen off a cliff in September.
The ISM manufacturing report took a nosedive. Car sales were particularly dismal -- worst in twenty years -- both for Detroit and foreign auto makers. Jobless claims look recessionary and tomorrow's nonfarm payrolls report could be down 100,000, according to the Wall Street consensus. Consumer spending for the first two months of the third quarter was 2.7 percent below the second quarter at an annual rate. The August report for business capex went negative. Non-financial corporate profits after tax are down close to 30 percent since their peak in late 2006. Profits are the mother's milk of stocks and business. So it's no surprise that the current bear market in shares is off nearly 30 percent since the cycle peak last October.
There are two broad reasons for the economic slump. One is, of course, the credit crunch, which seems to be biting hard. A recent survey by the National Small Business Association reported that 67 percent of small businesses said in August that they had been badly affected by the crunch. The number of small business using bank loans was at a fifteen-year low, and 32 percent said their loan terms were getting worse. The same with credit-card rates, according to 63 percent.
Let me add another cause of the recession: the oil shock, which began late last fall, and has deepened the credit crunch by draining cash from family and business budgets. Oil is trading around $94, which is a lot better than $150. But average gas prices at the pump nationwide are still around $3.65. And I don't think that story gets any better until prices drop toward $3.
I have felt that we've been in a mild jobs recession this year. But surging exports, strong farm and energy sectors, and an almost unbelievable 3 percent productivity trend may have been keeping us out of a full recession. And now it looks like the cycle is truly descending. And I think the recession fear is driving down stocks today, just as I think it helped stoke Monday's plunge. In other words, there's more here than just the bailout package.
I sure hope Sarah Palin talks at some length about drilling in tonight's debate with Sen. Joe Biden. Palin is an energy expert. And if she is unleashed she can score major points against her opponent, who has opposed every expansion of oil, gas, and nuclear down through the years.
Does anybody doubt that our over-regulated energy sector and high energy prices are linked? Can there be any doubt that recessionary times are in large part a function of our terrible energy policies? Even the tax-extenders in the Senate bailout bill voted on last night include a $40 billion tax increase on oil and gas companies. Nobody talked about it. I can hardly believe it. Could there be anything dumber? Tax energy more and you'll get less of it. Huh? Is this what we need? Whatever happened to drill, drill, drill?
And here's one: A new Rasmussen poll shows that Americans favor across-the-board tax cuts just as much as the financial rescue plan. Lower marginal tax rates should be put on the table as an antidote to the economic slump. Revive the animal spirits. Strengthen incentives to work, invest, and take new risks.
So the McCain-Palin ticket should be emphasizing across-the-board tax cuts. Sometimes Big Mac refers to Congressman Paul Ryan's idea of a modified flat tax with two low rates of 10 and 25 percent. That plus slashing the corporate tax would be a great economic recovery program, especially if combined with drill, drill, drill and King Dollar.
Gov. Palin has a great opportunity tonight to slam Sen. Biden on all these points. Even on spending cuts and the elimination of pork-barrel earmarks. Didn't both Obama and Biden vote for the farm bill -- a $300 billion package of pork -- during a period when the farm sector was absolutely booming from high commodity prices?
McCain didn't mention this in his debate with Obama last Friday, but I sure hope Sarah goes there tonight. Isn't the Obama-Biden ticket really too liberal for America? Aren't they tax-and-spenders? Aren't they totally beholden to the enviromaniacs? Isn't Sarah Palin the exact right person to make this case?
Sure, we're in a recession and a credit crunch and an oil shock. But there is a way out.
Pro-growth policies in all these areas will do the trick just as they have in past slumps. Bush cut taxes during the recession at the beginning of this decade. So did Reagan almost thirty years ago. So did Kennedy almost fifty years ago. There's a great opening for Gov. Palin. Let us hope she seizes it tonight.
The FDIC chairman is the bank system's ultimate backstop.
You know what? Hank Paulson may not be the most powerful financial person in the country right now. That honor goes to Sheila Bair, the chairman of the FDIC.
In recent weeks, Ms. Bair has held the banking system together, coordinating smooth takeovers of distressed banks in deals run and controlled by her agency. I wouldn’t exactly say she’s flying under the radar screen since these bank takeovers are front-page news. But without holding the center-stage attention that Paulson has, she has seamlessly closed and reopened IndyMac, Washington Mutual, and Wachovia.
IndyMac was in fact taken over by the FDIC, becoming the IndyMac Federal Bank, while WaMu was acquired by JPMorgan Chase and Wachovia by Citigroup. So far as I know, not a single depositor at these banks has lost money. This is huge. And it suggests to me that if the Congress is unable to craft a deal for Treasury purchases of toxic assets, the nation is still in good hands as a result of the good offices of the highly professional, credible, and trustworthy Federal Deposit Insurance Corporation, run very well by Ms. Bair.
Who is Sheila Bair? Forbes just ranked her the second-most powerful woman in the world, behind German chancellor Angela Merkel. Before coming to the FDIC, Ms. Bair was a professor at the University of Massachusetts. She has served at the Treasury Department, the New York Stock Exchange, and the Commodity Futures Trading Commission, and was chief counsel to former Senate majority leader Robert Dole. Just as important, she has written two children’s books, showing the kids good examples of money management.
And now she’s showing the whole nation good examples of money management on a grand scale.
An editorial in Tuesday’s Wall Street Journal, called “Preemptive Plumbing,” walked through the details of the Wachovia takeover by Citigroup. The FDIC will backstop close to $300 billion of Wachovia assets while Citigroup is on the hook for the first $42 billion in potential portfolio losses from Wachovia. And Citi will give the FDIC $12 billion in ownership of preferred stock and warrants. This open-bank transaction flows from the emergency powers written into the FDIC Improvement Act of 1991. Systemic risk to the financial system provides that authority.
But each of these takeovers reveals the real FDIC glue that’s holding our banking system together, even in the absence of Paulson’s big-bang, toxic-asset purchase plan.
I think the Paulson plan is still essential. It will unclog the banking system and reopen the door to Main Street loans that are necessary to grow the economy. And taxpayers will wind up turning a profit since they will own the assets purchased by the Treasury, the roughly 10 percent yield on those assets, and the profits from the eventual Treasury sale of the bonds. And all these revenues will be used to pay down the national debt. But if there is no Paulson plan, the FDIC can carry the ball alone -- certainly through year end and until a new government comes into power.
Incidentally, as the FDIC crafts its preemptive takeovers of distressed banks, doing so before the banks crash, it is in effect injecting public capital to bolster sagging private bank capital. Former Reagan FDIC commissioner William Isaac suggests the agency can put even more capital into banks through a net-worth certificate program used in the 1980s for the troubled savings bank industry.
In addition, both presidential candidates are supporting at least a doubling of the FDIC’s deposit insurance program for banks. And this provision will likely be added to a new Paulson plan coming up in a day or two.
Hopefully, if there is a plan-B vote on the Paulson program, it will include a suspension of the so-called mark-to-market “fair value” accounting of assets, and replace that either with a net-operating-loss (NOL) carry-back or carry-forward, or at least a five-to-seven year amortization of loan losses incurred by banks that are selling their distressed assets.
NOL is used in many heavy industries where current losses can be offset by past or future profits for both tax and accounting purposes in order to smooth the profit cycle. Without this accounting relief, banks selling loans to the Treasury at a deep discount will further impair their already weak capital positions if they have to immediately post the losses. Congressman Paul Ryan had this provision in the House version of the first Paulson plan, but it was apparently taken out by Barney Frank. Former FDIC man Bill Isaac also supports this.
Tuesday’s stock market comeback -- with the Dow up nearly 500 points following Monday’s unbelievable plunge -- suggests that investors believe the politicians will deliver some relief. But my message to the investor class is this: If Mr. Paulson strikes out again, Ms. Sheila Bair is the ultimate backstop.
The End of the U.S. Financial System as We Know It?
A number of Republican House members and staff, along with others who are plugged in, are telling me that Nancy Pelosi and the Democrats will come back with a new bill that includes all the left-wing stuff that was scrubbed from the bill that was defeated today in the House.
As this scenario goes, the House Democrats need 218 votes, and they have to pick up a number of black and Hispanic House members who jumped ship because the Wall Street provisions, in their view, were too benign. So things like the bankruptcy judges setting mortgage terms and rates, the ACORN slush-fund spending, the union proxy for corporate boards, stricter limits on executive compensation, and much larger equity ownership of selling banks through warrants will all find itself back in the new bill. Of course, this scenario will lose more Republican votes. But insiders tell me President Bush will take Secretary Paulson's advice and sign that kind of legislation.
Personally, if this scenario plays out, I would probably withdraw my support for the rescue mission and switch to plan B, which would center on the FDIC and its bank-recapitalization powers. The bank-ownership issue, in particular, could lead to heavy nationalization of America's financial system with a three-house Democratic sweep in November.
I'm not forecasting, because I don't know the next bill's content. And while McCain's polls are heading south, he could still win. But a three-house Dem sweep to implement some off the very onerous provisions being talked about could set up the end of the U.S. financial system as we know it.
I'm gonna wait and see. Obviously, the financial markets are in total collapse today. And the economic outlook is suffering.
My latest information on executive pay-caps and government ownership warrants — which are now being called "equity protection” — is that they would apply to bond sellers, not buyers. (My original warning is below). I guess that makes it only half as bad. But I must say, it still is bad.
Why should a successful bank — whether large, medium, or small — give up ownership and allow pay-caps for executives?
Even the big guys like BofA and JPMorgan Chase are still solid banks. So is Goldman and Morgan Stanley. And Wells Fargo. And many others.
Why should they agree to this? It just makes the plan unworkable. Sources tell me the Treasury is opposed. Stay tuned for more.
My earlier warning:
If the bailout bill allows executive pay-caps and government ownership warrants for all buying or selling institutions, I must withdraw my support for the bill.
There is no clear information yet on this crucial topic. CNBC is reporting that Sen. Chuck Schumer is telling people that pay-caps and ownership warrants will be included for all banks and others (Fidelity-type investment managers, KKR-type private-equity firms, etc.) that either buy or sell the toxic paper.
The Treasury Department does not want this simply because it knows it would be unworkable. In other words, giving up pay-caps and warrants would probably mean that only the most dire, down-in-the-mouth banks will sell, and they’ll sell the very worst imaginable paper. Meanwhile, no reputable institution is going to buy the paper if they have to give up ownership or compensation rules.
So it would be stupid for Congress to write this kind of thing into the bill. It would go beyond France into pure socialism. It would represent a huge first step into government interference everywhere. And it would sink New York way down the list of world financial centers. London and Hong Kong would pass us by in the blink of an eye.
I’m trying to get more information on this. But here’s a very key point: No House or Senate member in his or her right mind should vote for this bill without reading it. There’s no telling what’s in there.
The stock market is applauding the pre-announcement of a deal. The Dow’s up over 200 points. And credit-market risk spreads are narrowing a bit on the bailout hopes. But let me tell you, if the U.S. government is going to start to own all of our financial institutions, all these markets will sink like stones.
Almost unnoticed amidst the hoopla over Treasury man Paulson's RTC-like rescue announcement to buy toxic assets from banks and unclog the credit system to promote economic recovery — a plan I support — Sen. John McCain gave a thoughtful speech today before a chamber-of- commerce group in Green Bay, Wisconsin.
The senator will undoubtedly support Paulson's plan. But he hinted at some of his concerns about the proliferation of bailouts going on in Washington. McCain has his own idea for a mortgage and financial trust that would be part of the Treasury Department and help troubled institutions. But he jabbed at both the Fed and Treasury by calling for more consistent policies and actions. "We need to enhance regulatory clarity by holding the same financial activity to one regulatory standard," said McCain.
But the most interesting part of Big Mac's speech was his criticism of the Federal Reserve. And I'll quote it in full: "The Federal Reserve should get back to its core business of responsibly managing our money supply and inflation. It needs to get out of the business of bailouts. The Fed needs to return to protecting the purchasing power of the dollar. A strong dollar will reduce energy and food prices. It will stimulate sustainable economic growth and get this economy moving again."
This is very good stuff. The senator is saying a strong dollar will promote economic recovery through lower inflation and more consumer confidence. He is dead right. It's the first time I can recall him being this explicit about money.
Elsewhere in the speech McCain repeated his call to keep taxes low and to slash the corporate tax rate. He also renewed his free-trade call and talked about drilling for more energy supplies across the board. I can't help but think that the more Mr. McCain talks about a strong dollar and low taxes as an economic-recovery tonic the closer he will move to a November victory.
The decision by SEC Chairman Chris Cox to ban short selling is a terrible idea. It is an encroachment on free-market principles. In extreme, the absence of short sellers would inflate stock market upturns, probably into bubbles. Short sellers keep the market honest. I know many in the short- selling community and most of them really do their homework. They are skeptical about puff pieces on companies and they are properly cynical about corporate press releases.
Why Cox is doing this is hard to fathom. He is supposed to be a free- market disciple of Milton Friedman and Art Laffer. It would have been much simpler and much more constructive if Cox restored the so called up- tick rule, where short sellers only can play after a share price has ticked higher. Some academic study apparently informed Cox that the up-tick rule was unnecessary. But virtually everyone who operates in the stock market disagrees.
I'm okay with banning naked shorts, where the seller doesn't even have to take possession of the borrowed stock collateral before the sale. But a complete ban is just a terrible idea and sends all the wrong signals about government interference in the market. As much as I agree with Paulson's new RTC-type agency, which is what I call a smart regulatory move, I disagree with Cox's action, which is an incredibly stupid regulatory move.
We can fix this. If nothing else, that's the message I hope readers take away from this column. Of course, the "this" is the run on the world banking system. Stock markets have plunged globally, gold prices have shot up, and U.S. Treasury-bill rates have plummeted to 10 basis points, the lowest since the 1950s. We're witnessing a desperate flight to safety by investors. Folks are running away from financial assets and financial institutions simply because confidence has disappeared.
This week, Treasury secretary Hank Paulson said "no" to a government bailout of Lehman. Paulson and Ben Bernanke then took over AIG with an $85 billion bailout, with the Treasury issuing roughly $100 billion in new T-bills so the Fed has the cash to resuscitate AIG.
All this was necessary. A collapse of AIG would have been unfathomable -- it is simply too interconnected globally. But it turns out this rescue mission only elevated investor fears. Shareholders are asking: "Who's next?"
The bears are now raiding Morgan Stanley and Goldman Sachs, two national treasures. Meanwhile, the Reserve Fund -- an original money-market fund launched by Bruce Bent, a hard-nosed friend of mine who for decades has supported conservative political causes -- has seen its net asset value drop from $1 to $0.97. That's a shocker. And the reason? The fund's holdings of Lehman commercial paper were unsupported by letters of credit.
Money-market funds are supposed to be safe havens for mom and pop -- for Mary and Joe in McKeesport, PA. But everybody now wants T-bills and gold.
Well, it's time for some perspective. The world is not coming to an end. The stock market has tumbled, but it's still over 10,000. In late 2002 it was 7,500 and in mid-1982 it was 750. Are things really that bad?
With home prices falling, foreclosures and defaults are at the root cause of the run against all manner of mortgage-related bonds held by the banks. But as investment guru Don Luskin points out, foreclosures today are less than 3 percent. During the 1930s they were 50 percent. Or how about the unemployment rate? Today it's 6.1 percent. Back in 1982 it was near 11 percent and for most of the 1930s it was over 20 percent.
As the oil bubble pops the underlying inflation rate is somewhere between 2 and 3 percent -- quite unlike the double-digit hyperinflation of the 1970s. Home prices themselves have fallen between 10 and 20 percent, but they're still about 50 percent higher than at the start of the decade.
And there are constructive policy measures that can help fix the market's problems.
Investor Zachary Karabell writes persuasively in the Wall Street Journal that "mark-to-market accounting in the aftermath of the Enron scandal makes no sense at all." Many banks have taken huge losses on mortgage-backed securities and their derivatives because the SEC insists on mark-to-market. But Karabell asks: Why knock down these bond values, sometimes by as much as 100 percent, when the underlying home values embedded in the mortgages have only dropped 10 to 20 percent? And in the long run, the housing market will recover, as it always does.
Bad accounting rules like this are sinking the financial system. And why hasn't the SEC restored the up-tick rule to stem cascading share-price declines triggered by manic short-sellers? Short-sellers are an important part of the stock market, and they add liquidity at crucial junctures. But until July 2007, they could only short a stock after the share price rose, not while it was continuing to decline. The SEC also should restore the net-capital rule, which limits banks to a 12-to-1 leverage ratio governing their debt. Over-borrowing by Wall Street is what got many firms into deep trouble.
A gathering consensus also seems to be forming around a new version of the Resolution Trust Corporation, which effectively disposed of bad savings-and-loan assets in the early 1990s. A new RTC could purchase underwater assets that proliferate through the financial system and are clogging the credit and loan arteries of our banks.
We clearly are in an emergency moment. But the government should opt for smart regulatory action rather than broad-based interference that could stifle the free economy. On Thursday afternoon, as rumors spread that Paulson was talking President Bush into a new RTC, the stock market soared 400 points. That's what I call an endorsement.
The pessimists are now talking about the end of capitalism or a permanent decline of America. I don't believe that for one moment. Specific regulatory reforms can get us out of this fix. And most of all, policymakers must maintain the low-tax, low-inflation, open-trade formula that has propelled this nation's economy and produced so much prosperity for so long.
After The MySpace Election, The MySpace Cabinet Selection Process
Think about this a second.
In 1992, President-Elect Bill Clinton, our party's last President-Elect, set about the process of picking a cabinet and, to be honest, he made some great choices. However, it's hard to imagine, but in 1992, no one was blogging about their favorites, no one was watching the prediction markets, no one was emailing their friends, hell, cell phones were new and faxes came out of the machines on long rolls.
The campaign we just survived was indeed the first national election in the internet age, there is no argument about that, but just as the netroots had injected itself squarely in the middle of the political conversation in this country, so now too, will the most DC of processes be broken wide open.
We saw a hint of this with the VP selection process where, when it appeared the choice was coming down to Biden and Bayh, there was an outpouring of negative sentiment towards Bayh, enough so that when that notion made it to the mainstream press, it had to have an effect.
Like many things online, the task of keeping track of all that information can be a little bit difficult so today, we are launching the Cabinet NewsLadder. On this special-edition NewsLadder, you will find all of the stories, articles, posts and rumors (and, of course, we'd appreciate your linking up any we have missed.)
You can also comment on stories and candidates, vote articles and the candidates they espouse up and down and, in general, make your voice known. There is a special Twitter feed from the Cabinet NewsLadder and a daily email will go out.
The (Surprisingly) Long History of Political Stock Markets
We have witnessed unprecedented betting volume on the Intrade political markets. Perhaps more interesting has been the sharp price swings. Some have attributed these changes to a “rogue trader” who is seeking to slant prices away from their fundamentals. This charge could prove a serious concern in the ongoing debate to legalize these markets in the United States.
What is often forgotten in these discussions is that betting on elections is hardly a new concept. Election betting has occurred in the US since at least the 19th Century, and even earlier in England and Italy. In the US betting became centralized in organized markets outside of Wall Street in the early 1900s, and newspapers reported the current prices and even individual wagers on their front pages (see images above).
My co-author Paul Rhode and I have documented the existence of these markets and have analyzed the time series of prices and bet totals.
These markets provide several lessons for the present experience. First, the historical markets had a very strong forecasting record. In the fifteen presidential elections between 1884 and 1940, the underdog in mid-October won only once (in the closely fought 1916 election). This suggests giving credence to the current markets, despite the occasional price gyrations.
Second, volatile prices were common in the months leading up to the elections in the historical markets. At the same time, they tended to rapidly move in favor of the favorite in the last few weeks before the election (likely reflecting the diminished chance of an October surprise which would change the leadership in the contest). So the recent strong shift towards Obama in the political markets is nothing new.
Third, they show that these markets do more than simply mimic polls. This must be true since scientific polls simply did not exist during the existence of the historical markets.
And finally, they help support the case for legalizing these markets. It is sometimes argued that political futures markets might be subject to manipulation by political partisans which in turn might influence election outcomes. Although large sums of money were at stake in the historical presidential betting markets, I are not aware of any evidence that the political process was seriously corrupted by the presence of a wagering market. Many current concerns about the appropriateness of political prediction markets are not well founded in the historical record.
The global financial system has gone into meltdown as investors suddenly realize they have mispriced risk for too long. Now, however, they see risk everywhere as a large percentage of the world's debt instruments turn out to have been holograms of fraud.
I have to wonder if we are seeing the same mispricing of risk in the 2008.PRES.McCAIN and 2008.PRES.OBAMA markets.
Investors are giving McCain a mere 15.2% chance of winning this election. And even that seems generous compared to the electoral college polling.
Are Intrade markets, however, failing to price in the risk of voting fraud?
Both campaigns are now warning of fraud and, yet, the markets look priced to perfection. Just like the stock markets before they collapsed.
While Obama is, as the markets reflect, far ahead in all the polls, favorability ratings and enthusiasm levels, what exactly are the algorithms that will translate these numbers into a vote?
Part of the reason that financial investors, for example, mispriced risk was that trading desks used proprietary algorithmic trading models they claimed almost eliminated risk. It turns out those algorithms weren't so miraculously immune to risk, or fraud, after all. As those trading desk algorithms are proprietary, of course, investors will never know just what formula it was that wiped out their net worth.
But just as triple AAA rated Collateralized Debt Obligation suddenly became worth 9 cents on the dollar, can five votes become worth say just one vote with the proprietary software running the electronic voting machines? Or, as I like to call them - the Miracle 51% voting machine.
The past two elections in America have been marred by the suspicion of not quite fair elections thanks to these electronic voting machines that, for example, gave sometimes drastically different results from the exit polls. Conveniently, the final results were so close that it was hard to cry 'foul' without seeming a poor loser. While the exit polls, of course, may have been inaccurate, we will never know if the voting machines were, too, as they leave no record and there is no way to examine the proprietary software on which the voting machines operate.
Remarkably, these paperless voting machines are apparently still around in several states.
And in West Virginia, where Intrade is giving McCain a 75% chance of winning, there are already reports of votes for Obama 'flipping' to McCain.
Three Putnam County voters say electronic voting machines changed their votes from Democrats to Republicans when they cast early ballots last week. .
This is the second West Virginia county where voters have reported this problem. Last week, three voters in Jackson County told The Charleston Gazette their electronic vote for "Barack Obama" kept flipping to "John McCain".
In both counties, Republicans are responsible for overseeing elections. Both county clerks said the problem is isolated.
No case of a Republican vote flipping Democrat has yet been reported.
Aside from the electronic voting machines, there is the old fashioned variety of vote suppression.
In state after state, Republican operatives — the party's elite commandos of bare-knuckle politics — are wielding new federal legislation to systematically disenfranchise Democrats. If this year's race is as close as the past two elections, the GOP's nationwide campaign could be large enough to determine the presidency in November. "I don't think the Democrats get it," says John Boyd, a voting-rights attorney in Albuquerque who has taken on the Republican Party for impeding access to the ballot. "All these new rules and games are turning voting into an obstacle course that could flip the vote to the GOP in half a dozen states."
Voter fraud has been a big issue in recent US elections. In the 2004 and 2006 election cycles, Republicans alleged widespread voting fraud by Democrats. They are now doing it again with the 2008 election.
"I'm astounded that this issue is being trotted out again," Iglesias told TPMmuckraker. "Based on what I saw in 2004 and 2006, it's a scare tactic." In 2006, Iglesias was fired as U.S. attorney thanks partly to his reluctance to pursue voter-fraud cases as aggressively as DOJ wanted -- one of several U.S. attorneys fired for inappropriate political reasons, according to a recently released report by DOJ's Office of the Inspector General.
The owner of a firm that the California Republican Party hired to register tens of thousands of voters this year was arrested in Ontario over the weekend on suspicion of voter registration fraud...
State and local investigators allege that Mark Jacoby fraudulently registered himself to vote at a childhood California address where he no longer lives so he would appear to meet the legal requirement that all signature gatherers be eligible to vote in California. His firm, Young Political Majors, or YPM, collects petition signatures and registers voters in California and other states..
Jacoby's arrest by state investigators and the Ontario Police Department late Saturday came after dozens of voters said they were duped into registering as Republicans by people employed by YPM. The voters said YPM workers tricked them by saying they were signing a petition to toughen penalties against child molesters..
The firm was paid $7 to $12 for every Californian it registered as a member of the GOP.
Regardless of whether or not any of these cases of voting registration fraud translates into actual voting fraud, the one thing that is clear is that the integrity of the US voting system is becoming increasingly suspect.
And with so many charges of voting fraud out there, it would seem there is no smoke without fire.
I don't buy Republican suggestions that Obama would need to participate in all the fraud they allege is happening. What on earth would be the point? Usually it's the guy behind in the game that needs to cheat. And the US ain't Russia where 90% wins are deemed necessary.
Nor am I convinced, however, by Kennedy and Palast's theory that the election has already been stolen for McCain. Unlike 2000 or 2004, all the polls and markets are just so overwhelmingly indicating an Obama landslide. And the $150 million raised by the Obama campaign in September suggests millions of American voters have skin in this outcome - unlike 2004 when Kerry support was always lukewarm, for example.
No. The Kennedy-Palast scenario is just too difficult to do in 2008. Such a theft could only happen if the resulting win is plausible. There would just be way too much explaining to have to do.
Furthermore, even the giants of the Republican party and/or Conservativism are planning on voting for Obama:
Obama has in him—I think, despite his sometimes airy-fairy "We are the people we have been waiting for" silly rhetoric—the potential to be a good, perhaps even great leader. He is, it seems clear enough, what the historical moment seems to be calling for.
So, I wish him all the best. We are all in this together. Necessity is the mother of bipartisanship. And so, for the first time in my life, I'll be pulling the Democratic lever in November. As the saying goes, God save the United States of America.
"I firmly believe that at this point in America's history, we need a president that will not just continue, even with a new face and with the changes and with some maverick aspects, who will not just continue basically the policies that we have been following in recent years," Powell said..
"I think we need a transformational figure. I think we need a president who is a generational change and that's why I'm supporting Barack Obama, not out of any lack of respect or admiration for Sen. John McCain."
.... Powell went on to say of Governor Palin . . .
"I don't believe she's ready to be president of the United States."
Endorsements galore from Republican leaning newspapers are also inconvenient to the Kennedy-Palast scenario.
The Chicago Tribune in their first Democratic Presidential endorsement ever:
McCain failed in his most important executive decision. Give him credit for choosing a female running mate--but he passed up any number of supremely qualified Republican women who could have served. Having called Obama not ready to lead, McCain chose Alaska Gov. Sarah Palin. His campaign has tried to stage-manage Palin's exposure to the public. But it's clear she is not prepared to step in at a moment's notice and serve as president. McCain put his campaign before his country.
Then, out of nowhere, and without proper vetting, the impetuous McCain picked Alaska Gov. Sarah Palin as his running mate. She quickly proved grievously underequipped to step into the presidency should McCain, at 72 and with a history of health problems, die in office. More than any single factor, McCain's bad judgment in choosing the inarticulate, insular and ethically challenged Palin disqualifies him for the presidency.
The LA Times, which has not endorsed a Presidential candidate in decades:
Indeed, the presidential campaign has rendered McCain nearly unrecognizable. His selection of Sarah Palin as his running mate was, as a short-term political tactic, brilliant. It was also irresponsible, as Palin is the most unqualified vice presidential nominee of a major party in living memory. The decision calls into question just what kind of thinking -- if that's the appropriate word -- would drive the White House in a McCain presidency. Fortunately, the public has shown more discernment, and the early enthusiasm for Palin has given way to national ridicule of her candidacy and McCain's judgment.
Regardless, both sides are gearing up with massive legal teams - one to prevent certain voters from voting and the other to ensure certain voters can vote.
In Florida, Democratic lawyer Charles H. Lichtman has assembled almost 5,000 lawyers to monitor precincts, assist voters turned away at the polls and litigate any disputes that can't be resolved out of court.
"On Election Day, I will be managing the largest law firm in the country, albeit for one day,'' said Lichtman, 53, a Fort Lauderdale corporate lawyer and veteran of the five-week recount after the 2000 election when Florida eventually delivered the presidency to George W. Bush.
WITH his electoral prospects fading by the day, Senator John McCain has fallen out with his vice-presidential running mate about the direction of his White House campaign.
McCain has become alarmed about the fury unleashed by Sarah Palin, the moose-hunting "pitbull in lipstick", against Senator Barack Obama. Cries of "terrorist" and "kill him" have accompanied the tirades by the governor of Alaska against the Democratic nominee at Republican rallies.
The scenes from the Palin rallies remind me of that film, To Die For, in which a hot newscaster babe (played by Nicole Kidman) winks her way into the hearts of a group of young, impressionable teenagers who promptly do away with anyone standing in the way of her ambition. 'All she wanted was a little attention'.
Nicole Kidman won a Golden Globe for her performance, and Palin has won the devotion of many for her own A-list winkage. The backers of Palin's performance, however - the McCain campaign - are losing big time at the Intrade box office.
As the Palin mob reached a fever pitch, McCain crashed on Intrade's President 08 (Individual) from the mid to low thirties to 20.
Hoping to stop the bleeding of mainstream support, the McCain campaign have reportedly resorted to keeping the press away from this base at Palin's rallies. It may be too late, however, for judgement has been rendered far and wide in the beltway and in the polls.
But seriously, folks, I'm beginning to worry about the level of craziness on the Republican side, the over-the-top, stampede-the-crowd statements by everyone from McCain on down, the vehemence of the crowds that McCain and Palin are drawing with people shouting "Kill him" and "He's a terrorist" and "Off with his head."
The McCain campaign knows that Obama isn't a Muslim or a terrorist, but they're willing to help a certain kind of voter think he is. Just the way certain South Carolinians in 2000 were allowed to think that McCain's adopted daughter from Bangladesh was his illegitimate black child.
But words can have more serious consequences than lost votes and we've already had a glimpse of the Palin effect.
The Post's Dana Milbank reported that media representatives in Clearwater were greeted with taunts, thunder sticks and profanity. One Palin supporter shouted an epithet at an African-American soundman and said, "Sit down, boy." McCain may want to call off his pit bull before this war escalates.
There is still no doubting that Palin can powerfully move a Republican crowd. Her angry attacks on Obama stir supporters far more effectively than does McCain's more measured style. But she is now largely reduced to stumping in the rural Republican heartlands of America. She is a powerful tool in working up the party base, ensuring that they turn out on election day, but her crossover appeal has gone. Indeed, even Republican critics of Palin have been stamped on for questioning her. Several high-profile conservative writers - such as David Brooks in the New York Times and Kathleen Parker in the National Review - have poured scorn on her. Brooks even called her 'a fatal cancer on the Republican party'.
But the response among the base was instant and brutal. Parker received no fewer than 12,000 outraged emails, including some wishing she had been aborted, after writing that Palin should step down. There seems little doubt that Palin is still the darling of a huge section of red state America. But what works for the Republican base no longer works for the country as a whole
To cap it all off, the Dow has had its worst week since the Great Depression and "It's the economy, stupid" plays well in all but the reddest of states where 'culture' issues trump everything.
In the leading polls, Obama has a taken double digit lead across most. Obama and Biden's favorables have risen, while McCain and Palin's unfavorables have risen even more.
On Intrade, McCain sits below 23, while Obama rests comfortably above 77. Obama has also taken a commanding lead in the Intrade Electoral Vote Predictor map (O364, M174) with North Carolina, Florida and Ohio firmly blue and even Indiana turning blue.
McCain needs the mother of all October surprises if he has any chance of turning this thing around. We're only half way through the month . . .
A USA Today/Gallup poll finds 53% of Americans describing themselves as "angry" about the financial crisis that has gripped the nation the past two weeks. Fewer Americans, but still a substantial 41%, say the recent events have made them feel "afraid."
That's right, Americans are mad as hell and they aren't going to take it anymore.
And, of those 'afraid' of the financial crisis, women feel the most fear:
The poll does find that women (49%) are significantly more likely than men (32%) to say they have felt afraid as a result of the economic problems . . .
This is big, bad news for the McCain campaign which has decided to begin scaring these already freaked out security mom voters with stories of bigger scary things, like home grown terrorists from way back in the 1960's? Hockey mom Palin has made repeated claims this past weekend that Obama 'pals around with terrorists.' Unfortunately for these McCain team scare tactics, the Dow is actively terrorizing Americans' 401ks day in and day out for the past two weeks. Ayers, meanwhile, acts all too respectable and bespectacled at some university in Chicago. Either Ayers picks up a hand grenade soon, or I see McCain/Palin's latest fear tactics backfiring big time. For, while this Rovian strategy of freaking out the voting population has worked for eight years, the same voters McCain/Palin are trying to scare are far angrier than they are scared. And I suspect the blatant attempt to make their bad situation even more frightening will see these voters pay McCain back with an electoral kicking.
Over in the President 08 (Individual) markets, I warned a week ago that McCain would next see support at thirty if he passed through 40. Sure enough, after plummeting through 40, McCain slid through 30 momentarily before bouncing back on Sunday to about 35 which seems to be a bit of a ceiling for this apparent dead cat bounce.
A 30 point gap now sits between the two contracts: Obama 65; McCain 35.
The US government bailout of the banking system bill was the hottest contract of the past week. Traders remained bullish on the bailout passing the House until early Monday morning when the price collapsed a few hours before the bill failed to pass.
In banking failure markets, the hot money is on National City followed by Downey and Bank United. Shares in National City are down 92 percent in the past twelve months while BankUnited Financial is down 95%.
In celebrity implosion news, traders are giving OJ Simpson a whopping 77 percent chance of being found guilty of at least one of the charges in the Las Vegas robbery. The NFL Hall of Famer is charged with a dozen crimes, including kidnapping and armed robbery. If found guilty, he faces five years to life behind bars for the Sept. 13., 2007 incident.
An attorney for O.J. Simpson tried Monday to undermine the effect of an audio recording in which the former NFL star asks whether a cohort pulled out "the piece" in a hotel hallway right before a confrontation with memorabilia dealers.
Simpson associate turned prosecution witness Michael McClinton testified last week in the armed robbery trial that Simpson asked him to bring a weapon and "look menacing" at a confrontation over sports memorabilia at Palace Station Hotel & Casino.
And in a tape recording McClinton surreptitiously made after the incident, Simpson asks whether McClinton might have inadvertently allowed the weapon to be picked up by hotel security cameras. McClinton is heard on the tape saying that he "kept that thing in my pocket until we got inside that room."
Next up in market news, the McCain campaign's declining numbers.
I warned last week that were McCain to pass through support of 40, he could see 30 next.
Today McCain's price has dropped to 34.5, while Obama rocketed through his resistance at 58 to hold at just under 65.
Rabbits better be pulled out of hats soon or we could see some capitulation in the McCain contract! The biggest problem for McCain now is that many voters are already sending in their ballots while Obama is hot. A miraculous McCain comeback could be too late if it doesn't happen very, very soon.
Over at the Electoral Vote Predictor Map, I'm seeing more landslide blues for McCain. Punters give Obama 338 to McCain's 200.
After a bit of a tug of war, Florida has now turned blue. Ohio, as noted previously, has also turned blue. And even North Carolina turned blue - if only briefly before punters piled in on what they saw as a McCain bargain at under 50.
FLORIDA: Obama 49 - McCain 43 pre-debate; Obama 51 - McCain 43 post-debate; OHIO: Obama 49 - McCain 42 pre-debate; Obama 50 - McCain 42 post-debate; PENNSYLVANIA: Obama 49 - McCain 43 pre-debate; Obama 54 - McCain 39 post-debate Friday's presidential debate, Gov. Sarah Palin's sagging favorability and more voter confidence in Sen. Barack Obama's ability to handle the economy are propelling the Democrat to wider likely voter leads over Republican John McCain in Florida, Ohio and Pennsylvania, according to simultaneous Quinnipiac University Swing State polls released today.
No one has been elected President since 1960 without taking two of these three largest swing states in the Electoral College.
Quinnipiac goes on to quote Peter Brown, assistant director of the Quinnipiac University Polling Institute:
"It is difficult to find a modern competitive presidential race that has swung so dramatically, so quickly and so sharply this late in the campaign. In the last 20 days, Sen. Barack Obama has gone from seven points down to eight points up in Florida, while widening his leads to eight points in Ohio and 15 points in Pennsylvania."
"Sen. John McCain has his work cut out for him if he is to win the presidency and there does not appear to be a role model for such a comeback in the last half century."
On that note, there was much curiosity in the land of punditry as to why the McCain ticket would spend 24 hours in Iowa. According to the Intrade Electoral College Predictor map, he has only a 20% chance of taking the state's 7 electoral votes. Almost all the major polls place the state strongly with Obama as well.
Today the McCain campaign has moved on to Missouri where latest polls show his lead in the state narrowing. Regardless of the polls, traders on Intrade are telling McCain that he has nothing to worry about in the Show Me state where they are giving him a 68% chance of winning.
Finally, I got an email from Dr. Boyan Ivantchev, an economics adviser to the deputy prime minister and minister of foreign affairs of Bulgaria. He had this technical analysis of the President 08 (Individual) contract to offer:
Looking at the charts from intrade.com, you may see a leading sell off in Obama positions based on the Bearish Hanging Man appearing on the chart of 3Sept2008. That was before the Republicans convention started and the historically expected positive partisan support impact after the convention. My forecast in Bulgarian newspaper dnevnik.bg 14Sept2008/ for bottoming and consolidating of the position in oversold RSI zone for the period of 10-15Sept2008 plus Chaikin Volatility predicting the possibility of an uptrend for Obama once again proved leading in comparison to the fundamental data coming from the Gallup Poll Daily Tracking. As of today /29Sept2008/ the charts are telling me that we are close to breaking the resistance level of upper line of Bollinger bands and we are in heavy overbought zone of RSI. Election story ends on 4Nov2008 so it does not make me afraid to say that we can stay on heavily overbought zone up to the end of a game.
(I hold no positions in the contracts mentioned. )
Time reported on McCain's remarkable strategy in a piece titled, "Oh the drama! McCain in the Theater of the Absurd"
. . . an amazing week of political theater, starring the frenetic, operatic, borderline erratic McCain, the former fighter pilot who seems to have found his calling as a kamikaze politician. He might not win the election — another thing you missed this week was Barack Obama pulling ahead in the polls — but when it's over he's a shoo-in for a show on TNT. RuPaul doesn't know drama like McCain knows drama.
After much drama, John McCain, indeed, decided to show up at the first Presidential debate after all. Good thing he did because the pundits loved his performance:
John McCain was very lucky that he decided to show up for the first presidential debate in Oxford, Miss., Friday night. Because he gave one of his strongest debate performances ever.
While the pundits loved McCain, the markets were puking him up. McCain opened with a brutal sell off on Saturday and, by the end of this past weekend, he was down 10% where he found some support at 40. Obama had opened up a nearly 17 point price gap to below his upper resistance of 58. While McCain had recovered by Sunday evening to above 41, a few investors were actually flirting with Giuliani and Romney.
If McCain breaks through resistance at 40, watch out 30!
Not only had markets decided Obama won the debate, the voter had too. Polling of focus groups showed that the people that vote had declared by a wide margin that Obama had won the night. Even a Fox News focus group of undecided voters in Nevada had decided that McCain had lost the night. Frank Luntz conducted the focus group polling for Fox and the voters in the focus group said that after watching the debates they felt that Obama "... cared about the average person" and "he seemed to care about everyone in America."
After one of the worst fortnights in presidential campaign history, with his oscillations on the bailout and bizarre campaign suspension (except for all those ads and state organizations purring along), the fundamentals of McCain's campaign are not sound.
What struck me amid the usual post-debate bloviating by the punditrocracy and the ridiculous ritual of partisans telling the media what to write about how wonderfully well their guy did (Lewis Carroll would have had a field day), the desperation to stop the hemorrhaging by the McCain campaign was manifest. No one watching that debate could have believed McCain scored a convincing victory (for the record, this bloviating pundit thought the Republican nominee had his moments but Obama was solid enough to achieve a draw).
But the McCain campaign immediately inundated my inbox with e-mail bursting with snippets of quotes from various journalists, implying they had declared McCain the victor (even Henry Kissinger sided with his friend, John McCain!).
Regardless of what the media says, if McCain wants to show his investors some loving, he is going to have to do something very soon to get investors to dip back in. And, according to a report in the Times, "McCain camp prays for Palin wedding," Mac thinks a shot gun wedding between Sarah Palin's daughter and her lover will save his campaign:
In an election campaign notable for its surprises, Sarah Palin, the Republican vice- presidential candidate, may be about to spring a new one — the wedding of her pregnant teenage daughter to her ice-hockey-playing fiancé before the November 4 election.
Inside John McCain's campaign the expectation is growing that there will be apopularity boosting pre-election wedding in Alaska between Bristol Palin,17, and Levi Johnston, 18, her schoolmate and father of her baby. "It wouldbe fantastic," said a McCain insider. "You would have every TV camera there.
The entire country would be watching. It would shut down the race for a week."
This appears to be a legitimate story in the Times and I suppose in these Jerry Springer meets Pop Idol days, there could be some twisted logic to McCain's prayer of a Palin wedding. But I'm not convinced this will tempt investors back into McCain. Maybe the markets will prove me wrong.
Finally, on the electoral map today, Virginia, Ohio and Florida have gone blue. Obama takes 338 of the electoral vote predictor. Landslide.
Disclosure: I hold none of the securities mentioned.
John McCain's shock suspension of campaigning has drastically altered the fundamentals on the 2008 Presidential Election Winner (Individual) contract. The stunt is being met with wide spread selling off of McCain on Intrade, while traders simultaneously ploughed into Obama rocketing his price up to just under 57.
Obama has now opened up a nearly 13 point lead against his opponent.
McCain's move has been met with widespread disbelief in this morning's media.
Last we checked, the President of the United States was still George W. Bush, the Secretary of the Treasury was still Henry Paulson, the Chairman of the Federal Reserve was still Ben Bernanke, and Congress still had 533 members not running for President who are at least nominally competent to debate and pass legislation.
So count us as mystified by Senator John McCain's decision yesterday to suspend his campaign and call for a postponement in Friday's first Presidential debate so that he and Barack Obama can work out a consensus bill to stabilize the financial system. This is supposed to be evidence of leadership?
In an article titled, "John McCain's Decision to Suspend his campaign is bold - or bonkers," the New York Daily News had this to say:
Still, there's an old saying in politics: Think political, but never look political. Given McCain's timing, this seems more political than altruistic. "It looks like a desperate stunt," said another GOP political consultant who worked for a McCain primary opponent. "McCain could have bailed out of the debate a week ago if this was really about the merits."
On top of suspending campaigning, McCain also cancelled, at the last minute, an appearance on David Letterman. Letterman was outraged with the 'fishy' McCain campaign and wondered, "Are we suspending the campaign because there's an economic crisis or because the poll numbers are sliding?"
Is McCain experiencing a mere wave of panic selling? Can he rebound from 44? Time will tell, but so far traders don't seem to be buying McCain on this dip, nor is anyone taking profits yet on Obama.
A few more days should tell whether McCain's gamble will pay any dividends him, but so far traders have judged his move as 'bonkers,' not 'bold.'
Perhaps look for McCain to reverse this decision soon if he hopes to regain momentum.
Osama Capture Dec08 contract has tumbled by 50% in past two weeks and yet the word on the Hill is for an October surprise.
Twice in the past few weeks, US helicopters have crossed the border only to be turned back by gunfire from Pakistani troops. Scott Horton reports in Harpersthat Bush is hoping to deliver an "October surprise" for McCain.
What's up? There is one plausible explanation for the latest friction: the Bush Administration has given orders to go all out–helicopter gunships, air strikes, predator drones, and ground-based forces–through the end of the year in an attempt to apprehend or kill Osama bin Laden and other senior Al Qaeda leaders.
He goes on to argue:
The Bush Administration is hoping for an "October surprise" that will lift the tides of the Republican candidates just in time for Election Day. That explains why the extraordinary effort is undertaken now, and why the sensitivities of the U.S.-Pakistani relationship are being ignored.
Jeffrey Goldberg: Do you think al-Qaeda is planning an "October surprise," an attack on an American target, here or overseas, in order to influence the election?
Steve Coll: AQ leaders, maybe because they spend a lot of time trapped and bored in safehouses, seem to be obsessed with calendars. They like anniversaries and they pay attention to elections abroad. So I'm sure they have the American election in mind. My last well-sourced conversation is a few weeks dated, but last I checked the US intel system was very quiet in terms of "chatter" or other indicators of any attack in the U.S. What seems more likely are more attacks against US-affiliated targets in the Pak-Afghan region, coupled with media tape releases, similar to Osama's election-eve video of 2004. They like to be heard at big moments in American politics, and this campaign is certainly such a moment.
Every time I turn on the news I see something going down at the Afghan-Pakistan border, so I'm thinking the October 2008 Surprise might just be a big one - making Osama.Capture.Dec08 seem tempting at only 8.
Over at Intrade.net, might be worth launching a market on October surprises. No need to guess who would be helped by the capture or killing of Osama, but who would it help if Osama were to release a scary video in October? Or how about a"who will Osama endorse" contract?
Anyway, over in President 08 market action on Tuesday (September 23) McCain's price soared by just over 2 points, while Obama's price dropped by nearly 3 on the same morning. The two kissed briefly at 49 before McCain dropped back to under 47 and Obama rallied to 52. While the financial turmoil remains center stage, traders seem to be taking profits any time McCain gets above 47.
As the financial markets continue to react negatively to the Paulson bailout plan, Obama's numbers continue to hold steady. By a margin of 2-1 Americans (47-24), according to a CNN/Opinion Research Corporation Poll, blame Republicans over Democrats for the financial crisis that has swept the country.
While the economy may be swaying the President 08 market at this time, this might all change on Friday when the first of the presidential debates are held. By that time, some sort of bailout bill is meant to have passed into law. Furthermore, the first debate focuses on foreign policy where McCain holds an advantage. But will McCain's foreign policy advantage trump Obama's economics advantage?
If the financial markets are taking the bailout plan more positively by the end of the week, it could be a one two punch Friday for McCain. If not, he'll have to wait for an October surprise.
In Electoral College trading, Virginia is looking good for Obama. At least according to the latest polls that is. Two major polls are placing Virginia in Obama's electoral college camp. SurveyUSA puts the race at O51-M45; ABC News/Washington Post puts Virginia at O49-M46. Rasmussen, however, puts McCain ahead by two at M50-O48, though this is within the margin of error.
Regardless of the positive Virginia polls for Obama, the Intrade Vrginia electoral vote predictor is giving McCain a 53% chance to Obama's 45%. Punters are betting on history as Virginia went to the Republicans in 2000 and 2004 by about the same percentage popular vote.
Onto New Hampshire. Traders are NOT buying the latest poll from University of New Hampshire which gives McCain a 2 point lead, within the margin of error. Over on the Intrade electoral predictor map, Obama is well ahead O60-M42
One state where Intraders opinion diverges from the polls is North Carolina where punters are giving McCain a 75% chance of taking the state. In the latestRasmussen Report poll of the state McCain is ahead only within the margin of error. Bush took 59% of the popular vote here over Kerry in 2004.
Finally, one more thing that might influence the President 08 market, of course, is the price of oil. And, despite, September 22 being the biggest one day rally in the price of oil, over at Intrade.net, punters are only placing a 25% chance of oil at over 135 by Dec 31st.
Despite a brief rally for McCain's (47.6) contract post GOP convention, the primary Obama (51.2) bull market trend has apparently resumed on the President 2008 market.
Obama's price has surged in the past week or so as the US financial crisis turns into the 'worst since the Great Depression." In the same period, McCain's price has dropped back over 10 percent. After an explosive mid August to early September where his price rocketed from the mid 30's to the mid 60's, McCain's contract is tumbling. Is this a correction in the beginning of a bull market for him? Or the resumption of his previous bear market trend?
How unusual is this sort of price action at this point in the cycle? These market prices are mirrored in the polls. According to fivethirtyeight.com:
"Over the course of the past several days, there has been a rather dramatic shift in this election toward Barack Obama. Our trendline estimate, which is engineered to be fairly conservative, registers the swing as equaling roughly 4 points over the course of the past week.
Changes of this velocity are unusual outside of the convention periods and the debates, especially in close elections. It took John McCain about 60 days and tens of millions of advertising dollars to whittle Obama's lead down from roughly 5 points at its peak in early June, to the 1-point lead that Obama held heading into the conventions. Obama has swung the numbers that much in barely a week."
If McCain's price collapse accelerates, perhaps he could appeal to the Bush Administration to extend the short selling ban to his own contract? Such intervention is not totally impossible in this new post free market era. Alas, I doubt this will happen since McCain bizarrely threatened last week that if he were to become President, he would fire Christopher Cox, Chairman of the SEC. I don't think a short selling ban will come to McCain's rescue now.
Speaking of market interference, having seized control of vast swathes of the mortgage and insurance markets, the Republican administration has now introduced a trillion dollar bailout bill which comes with the added bonus of the biggest expansion of federal power over the financial markets since the Great Depression (there's that word again). Some analysts are comparing the Federal intervention in markets to the Soviet Union. Communism, schmommunism. Free market traders are loving it! Intrade contracts for end of year DJIA above 11250 jumped from 30 to 55 on the government bailout of the financial markets. Bets seem to be on that no stock price will ever be allowed to fall again. Price fixing didn't work for the Soviets - in the long run, but perhaps in the short term, traders may be taking the right bet.
The Intrade Recession 2008 contract has also plummeted. Despite mass layoffs, home foreclosures, rocketing inflation, punters place only a 12 percent chance of a recession in 2008. Considering that negative GDP growth for two successive quarters is required and that the government is responsible for reporting GDP growth, well then, in this Soviet-like day and age, punters are betting that the US government will continue to maintain that inflation is only 1.2% and, hence, GDP growth will remain 'robust.' The Soviet Union you might recall was also a 'fundamentally sound' economy - right up until the day it collapsed into a whole heap of nothing in 1989.
Following on the nationalization theme, I was speaking to a central banker from Venezuela. He told me that the US nationalization of the mortgage market was a good idea. I said, "Of course you think that. But when Venezuela does the same thing, like when you nationalized the oil industry, you are harangued by the United States." He laughed and responded, "That's just politics."
So, where next for the new found American lust for nationalization? I notice someone has started a contract over at Intrade.net on whether the US will nationalize the oil industry in order to finance the banking bailout! Punters are so far placing a 50% chance of that outcome.
With all these bailouts and nationalizations, I'm surprised nobody has started a US dollar contract on Intrade.net? What fate awaits the greenback?
Michael Seringhaus touches on an interesting point regarding media bias. In terms of politics, whatever long-term directional biases the media has, in the short run its "bias" is also towards more variance.
It should be clear to everyone that what is reported during campaigns is often fed to the media by the camps themselves. This doesn't just apply to facts and trial-balloons, but also arguments that are more editorial in nature. For one thing, this dynamic allows reporters to ingratiate themselves to the campaigns, who can rely on them periodically to push their respective talking points. In exchange, reporters get the occasional tip. The media can act like a double-agent in this respect, alternating directional bias from news-cycle to news-cycle, week to week.
Most importantly, this "variance" makes the contest seem closer and more exciting than it may be in reality, which encourages consumption of the news product. If you were watching the markets, this tendency manifested itself most obviously on the election night. Long after Intrade gave a 99% chance for an Obama victory, CNN announced him as the winner, predictably at 11pm EST on-the-dot.
Furthermore, it turns out that prediction market prices near 50% might inherently be more volatile. This is the argument of a new paper by Panos Ipeirotis and Nikolay Archak in which they introduce a model where prediction market volatility depends only on price and time to expiration, as summarized in the below chart. As a trader, I think I would rely more on historical volatility in most cases for a couple of reasons, but the model is intuitive and suggestive with respect to the "news product" idea.
For most people the election outcome will manifest itself most directly in the form of taxes. We can easily ascertain the general platforms of each candidate on this issue, but the specifics are intentionally left a little vague during the campaign season. Since they launched in February, the Intrade tax contracts help to cut through candidates' omissions, and provide a direct hedge to this pervasive risk. It's good to know who will win the election, but it's better to know how the result will affect you -- and be able to do something about it.
The tax contracts can be interpreted as revealing the probabilities of tax changes conditional on who wins the election. For example, currently they give a 61% chance of the top marginal rate for single filers going up in 2009. If we assume this would be impossible under McCain's veto power, since Obama's chances for the presidency are 84%, this implies a 73% percent chance of taxes being raised in 2009 if Obama wins. That is, P(tax hike GIVEN Obama win) = P(take hike AND Obama win) / P(Obama win). Once the election is over, the contracts will continue to reflect the likelihood of legislation passing and other fiscal developments that might spur policy.
Of course, these specific markets are still young enough that marginal buyers and sellers can have a significant influence on prices. Care must be taken with such interpretations, but these issues should be greatly mitigated in future instantiations once US regulations are modernized.
Contractability will always be a challenge though, that is, making sure the hedge actually hedges. We really only care about our effective rates, and the highest marginal rate is only part of that equation. The many specific credits in Obama's tax plan underline this challenge. (I thought his advisor Austan Goolsbee was a proponent of tax code simplicity?) Still, while there is basis risk in the contract design, the highest marginal rate is the most tractable proxy for effective rates, especially for who one imagines to be the typical Intrade investor.
Going forward, it's imperative that policy-makers do not view such markets with hostility. It's difficult enough to design a contract that hedges an event outside of anyone's control. We don't want to get into a situation where legislators are reacting to the design of contracts and frustrating their usefulness with unexpected changes. (Clearly contracts should refer to outcomes like tax rates, and not specific bills.) We have to continue to demonstrate the desirability of these markets both in terms of price discovery and hedging. Policy-makers should consider them to be helpful insofar as they: (1) are informative about the consequences of competing policies, as with Robin Hanson's "decision markets", and (2) ease log-jams through their hedging function that allows private interests to essentially meet each other half way.
To this end, it is encouraging to see Austan Goolsbee write things like this on the advantages of market predictions. It is even more encouraging to hear from Jason Furman, Obama's Economic Policy Director, that the most important question to Obama is, "What does Paul Volcker think?" But why do I get the feeling that is hyperbole offered to placate certain undecideds?
At this point in the election lead-up, many people probably find themselves focused on the differences between the various projections out there. While the forces of supply and demand sometimes influence Intrade prices in unexpected ways, markets have several advantages over other means of forecasting. None of what I'm going to say is news, but it bears repeating, especially in this environment where people are suspicious of market mechanisms.
First, non-market methods of predicting are vulnerable to over-optimization. If someone fiddles with a model and its weights, they are likely to produce something with an excellent track record in retrospect, but what worked best in the past might not work in the future. Markets can be influenced by well-funded traders, but are less vulnerable to the errors in judgment of isolated individuals.
Second, markets naturally take non-market projections as inputs. If a non-market methodology works well, markets will gradually incorporate its output. While the opposite is possible in theory, someone would need to decide what weights to assign the market and non-market components, which brings us back to the first point. Markets have the advantage of flexibly incorporating all available forecasts.
Many have noted that lack of transparency in asset pricing (not to mention models) played a large role in the credit crisis. Exchange-traded markets provide real-time price transparency, 24/7 in the case of Intrade. Historical price and volume data allow for additional analysis, including detection of when traders may be exercising market power. Non-market methods are likely to only provide a snapshot of their output, making systematic analysis by users difficult. This may also bias reports of success. If a non-market analysis beats the market, you can be sure you'll hear about it. The opposite is unlikely.
It may be that in the case of elections, poll-based models give markets a run for their money, but that is a specific domain with a relatively rich dataset. It bears noting again that markets provide incentives for uncovering new information, an activity that is quickly reaching maturation when it comes to elections.
Finally, you may not even care about trying to forecast a result you can't control, but markets allow you to control how you are affected by the result. Modernization of regulations in the US will lead to far greater liquidity for prediction markets, which will finally allow for meaningful political hedging. Ultimately, risk-sharing markets may even help to address issues with representative democracies such as the "special interest" problem.
That last bit may sound crazy as I write this in October 2008, but look, ultimately what we are talking about are proper incentives and information aggregation, the lack of which contributed massively to the failure of 20th century communism. If 20th century finance institutions became lacking in the same areas, do you fault "markets" in the abstract?
Intrade provides markets in several states where there will be elections for both President and for Senate. Polling data are available for both sets of contests, and analysis reveals a few anomalies where candidates with similar poll performance have significantly different Intrade prices.
Either Intraders have information that is not in the polls or there are profit opportunities available (disclosure: I do not hold a position in any of these markets).
Above is a table (made Sunday afternoon, November 2) of the last 13 states whose Senate races Real Clear Politics (RCP) put on their “Battle for the Senate” tab that have recent polling data page (Louisiana and Nebraska had insufficient polling data to generate an RCP average and were excluded). Aside from Alaska (obviously a special case since the Republican candidate for Senator was convicted and the prior polling data may have factored in a possibility that Sen. Stevens would be not guilty), there is a rough correspondence between the margin in the polls and the Intrade prices. But a few interesting points emerge that I offer for the purpose of debate, knowing of many possible problems (such as the lack of liquidity in certain contracts) that might also explain these findings.
Comparisons among Senate Prices
Even though the Republican candidate Norm Coleman leads in the RCP average, Intraders believe that Al Franken is roughly an even chance. But the race is clearly very close and the polling data are fairly skimpy, with the most recent poll, from the Star-Tribune, has Franken significantly ahead. The interesting observation for Intraders might be the comparison with Georgia, where Saxby Chambliss has a lead comparable to Coleman’s but trades at a significantly higher price.
The other interesting Senate observation is in the spread between the prices of the Democrats who are 5 point RCP favorites compared with the prices of a Republican with a similar edge. Challengers Kay Hagan in North Carolina and Jeff Merkley in Oregon both have leads roughly comparable to incumbent Republican Mitch McConnell in Kentucky. Yet both Democratic contracts trade a bit higher than the Republican contract.
Finally, Intraders believe that the polls for Roger Wicker in Mississippi seem to overstate his chances. Jeanne Shaheen in New Hampshire has a slightly smaller edge in the polls (against an incumbent) and trades five cents higher.
Comparisons among Presidential Prices
The states that stand out are North Carolina, Colorado and Virginia; in North Carolina the polling is virtually even (the last four polls were Obama +2, tied, Obama +2 and McCain +3), yet the Obama contract trades over 60 cents while in Colorado and Virginia Obama’s 5 point lead corresponds to prices in the mid 80s. In New Hampshire, Obama has a larger lead and a lower price. To put these prices into context, candidates with 5 point leads in the Senate (in Kentucky, North Carolina and Oregon) all sell below the Virginia Presidential contract.
Senate-Presidential Price Comparisons
Anomalies: In Colorado and New Mexico, Obama runs well behind Mark and Tom Udall in the polls, yet trades at a slightly higher price. In Mississippi, McCain and Wicker have similar polling results and presumably most voters for McCain will vote for Wicker. Yet McCain’s price remains significantly higher than Wicker’s.
Analysts of the 2008 election have repeatedly cited the Bradley effect as a reason to discount polling data in elections pitting white candidates against black candidates, arguing that some voters tell pollsters they would vote for a black candidate when they intend to vote for the white candidate. Yet analyzing the data, it appears that Obama shares are performing as well as (or perhaps outperforming) his RealClearPolitics (RCP) polling data, indicating that Intrade investors believe that the RCP polls understate Sen. Obama's margin of victory.
The Bradley effect refers to the California gubernatorial election of 1982, in which the black mayor of Los Angeles, Tom Bradley, lost an election he had been expected to win. In a number of other elections featuring black candidates versus white candidates, the black candidate appeared to fare worse on Election Day than expected (see here for anecdotes from elections from the 1980s through 2006). While there is still active debate about whether the Bradley effect may have disappeared as American social attitudes changed in recent years, the evidence from Intrade markets is clear: Intrade market participants completely discount the Bradley effect.
If Intrade investors believed in the Bradley effect we would expect to see the price of Obama shares below 50 when the polls were even, only rising above 50 when Sen. Obama had a lead in the polls greater than the expected Bradley effect. For example, if 2% of the voters told pollsters they would vote for Sen. Obama when in fact they were supporters of Sen. McCain, then Obama shares would trade at 50 only when he had a lead greater than 2% in the polls.
Since Sen. Obama has had a large lead in the RCP polls in recent weeks, it is difficult to know whether the price of Obama shares accurately reflects the polling data. But for a brief period in early September the polls were very close. On September 2, after Sen. McCain cancelled the first day of the Republican Convention, Sen. Obama led in the RCP polls by 6.4% and his Intrade shares were trading around 60 cents. Then, after the surprise announcement of Gov. Sarah Palin as VP and a reasonably successful convention, Sen. McCain started to rise in the polls.
Sen. McCain actually led in the RCP polls for a short period; he had a small lead from September 7 until Sen. Obama came back to even in the polls on September 17 (and Obama has maintained a lead ever since).
Sen. Obama's closing Intrade price was 57 on September 7 and his shares remained above 50 through September 10, despite Sen. McCain's small and growing lead in the RCP poll. Only when Sen. McCain's lead reached 2.5 points on September 11 did Obama prices drop below 50. When the RCP polls were tied on September 17, Obama shares closed at 48.9, but they rallied to 51.8 on September 19 as Obama gained a 1.9 point in the RCP poll.
In other words, Intrade traders clearly believe that the Bradley effect will not be a factor in the 2008 Presidential election. Prices of Obama contracts remained above 50 at a time when he was behind in the polls, indicating that Intrade traders believed that the polls actually underestimated Obama's likely election performance. When Sen. McCain's lead in the polls grew, the price of Obama shares briefly dropped below 50 but they quickly recovered with the evidence of improvement in the polling data.
Political scientists will spend the next decade analyzing the 2008 polling data and election returns for evidence of a Bradley effect but Intrade investors have already cast their vote.
Gov. Jennifer Granholm on the real reason the Big Three need help from the U.S. taxpayer:
"The reason why the autos are in this challenge is because of the meltdown in the financial market," said Michigan Gov. Jennifer Granholm. "They were on a restructuring path -- yes, they were challenged -- but this has utterly kicked them in the gut and is strangling them because they can't borrow money."
Me: Hmmm ...something is missing here. Can't quite place my finger on it. I think it rhymes with "shmunions."
This, from the VoxEU site: "Should Barack Obama worry about the Bradley effect? The much-discussed effect refers to observed discrepancies between voter opinion polls and election outcomes, in which African-American candidates receive a smaller vote share than would be predicted using opinion polls. In this column, I study US congressional and gubernatorial contests from 1998 to 2006 – black candidates on average receive a 2-3% lower share of the two-party vote than non-black candidates with similar numbers in the polls. If an effect of a similar size would appear in the current presidential race, then it would lower Obama’s probability of winning from 85% to 53%."
Obama and Coal: Send Americans 'Price Signals' on Energy
It could have been a classic presidential debate moment, John McCain turning to Barack Obama and saying, "Isn't it true that you want Americans to pay higher energy prices?" Right in the middle of an economic downturn, that's the last thing most of us want to do. But that is exactly what Obama wants us to do.
Here is what Obama told Iowa public television last year (courtesy of Little Green Footballs): "I think it is important to send some price signals to change behavior. It's not going to be painless. Power plants are going to have to adjust how they generate power. They will pass on those costs to consumers.... A lot of us who can afford it are going to pay more for a unit of electricity; over time the electricity bill goes back down as technology catches back up."
Me: See, Obama's little-discussed cap-and-trade plan would raise costs on businesses for using energy, like the entire coal industry—and they would then pass on those costs to you and me. Those "price signals" effectively are $100 billion a year in energy taxes, which would wipe out Obama's middle-class tax cut/credit.
Last night's election of Barack Obama was indeed a defining moment for America. First-time voters wept alongside moderate supporters. The great crescendo of Change, mounting so long, finally struck home, sweeping the GOP from the White House and the Senate as well. But looking back, this victory was hardly a surprise. Intrade’s investors called it long ago. And we can use this crowd wisdom to vet more than upcoming elections.
The election’s eventual outcome was clear to many. The Economist boldly went to press this week with a cover bearing Barack Obama’s photo (alone), beneath the headline '"It’s time". The polls have long shown Obama with a widening lead (though nail-biters admittedly agonized over a potential 'Bradley effect' that would snatch the apparent vote away from the minority candidate.) Most telling of all, a great sage predicted in this very space that Obama at 63 was "just free money."
A month ago, the Intrade prediction markets may not have shown 100% for Obama, but they did reflect a clear skew, enough to bolster the many pronouncements now proven correct. Anyone forced to call the election a month ago using only Intrade markets would have done so correctly. How else can we use this tool?
We can begin by attacking the myth of the two-sided story in the major media.
There are certain issues for which the truth is not a matter of opinion, and if a counterpoint is to be presented, it is rightly cast as a fringe or minority view. History will reveal, for instance, that opponents of global warming – those who believe human activity could not possibly impact our climate on a large scale – are simply wrong, their pseudoscience overwhelmed by the steady accumulation of reliable, falsifiable data. Why, then, has climate change so long been presented as a ‘debate’? When scientists overwhelmingly support a single hypothesis, and the issue in question is a scientific one, we are likely best to defer to their collective expertise. (Put differently, if we are willing to weigh seriously the scientific whims of the masses, why bother training scientists at all?) Yet the media tiptoes around such results, deeply pressured to present a balancing view – regardless who they must tap to voice it.
By carefully affording equal space to opposing views in this way, journalists create false dichotomies. By seeking to avoid bias, we unwittingly introduce it.
It happens quite often. For a time, evolution could hardly be mentioned without a respectful nod to those who believe it hogwash and have made it their mission to replace it with religious teaching in schools. The implication? That there are two sides; that all are not convinced; that experts are split down the middle and it’s up to you to decide.
Such pandering empowers the audience, who find themselves suddenly elevated from mere consumers of news to the swing voters in major issues of the day. But this is of course misleading. Dig a little and you will find there is, really, no debate. It’s not up to you.
Evolution is fact. Climate change is real. And when the media stretches to present opposing views in the name of balance, the result is sometimes to present as uncertain and up for grabs something that in no way actually is.
That said, this quest for balance comes from a good place – presenting both sides often yields the most fair and nuanced approach. I don’t think major media reform is in order. Systemic change toward one-sided reporting would not be a good thing. (Fox News, anyone?)
But Intrade can help. A prediction market can restore the weight of mass opinion, the wisdom of crowds. It can remind us that in a false dichotomy, opposing views do not enjoy equal support.
In this sense, Intrade is not just a means to stake claims on the future, and it is more than a valuable predictor of election returns.
It offers a valuable lens through which to consume news. If you’re lucky enough to find a market that tracks a false dichotomy, Intrade can be a great clarifier.
As we coast through the final days before Americans elect their next President, the future of the Republican Party in America – thanks mainly to Gov. Sarah Palin – is very much in question.
The chipper Alaska governor has, in just a few weeks, neatly highlighted a fundamental divide in GOP ranks. On the one hand, there are the small-government, old guard Conservatives who, though perhaps religious, nonetheless appreciate intellectual inquiry and a cohesive sentence. The late William F. Buckley, Jr. was the iconic example of this set. On the other hand, the G.O.P. has lately welcomed a swath of faith-charged heartlanders who cheer Fox News, reject ideas in general and vote with their crucifixes – especially on so-called ‘moral issues’ such as abortion and same sex marriage. (Example? Oh, any Ann Coulter fan should do.)
These complementary yet distinct subsets might not have mingled socially, but as a voting base they were very effective. Together, they placed and kept George W. Bush in office, buoyed the Iraq war, and endorsed the easy-credit, cheap-money economy that has now brought the nation to its knees.
But Gov. Sarah Palin has divided the party.
A few highlights: just this month, the Conservative magazine National Review ran a scathing indictment of Palin; shortly thereafter, Christopher Buckley (son of WFB) endorsed Obama and resigned from the magazine his father founded. Colin Powell, George Bush's former Secretary of State, came out to endorse Obama on Meet the Press with Tom Brokaw.
These high-profile ditchings are endemic of a deeper rift: between voters who tolerated an everyman veneer on their President in order to see pet policies pushed through, and those who would seemingly actually endorse a neophyte for high office.
At the time, Palin’s appointment probably seemed logical. After all, playing to a (low) common denominator has worked wonders for the Republicans in recent years. Bravado beats books. Faith trumps reason. Big words are scary and distancing – so give the people someone who talks like they do, gaffes and all. With universities and the mainstream media increasingly branded as big-L Liberal, Conservative candidates have veered toward outright anti-intellectualism to scoop up votes.
When McCain tapped Palin as his nominee for Vice President, he no doubt sought to mine the same vein of back-to-basics bedrock sentiment that had worked so well for George W. Bush. But anything in excess is a poison, and Sarah Palin has proven to be too much of a bad thing.
We need not revisit here her now-famous interviews, the stunning poetry of her ‘verbiage,’ or the countless op-eds from conservative writers rejecting her as inexperienced, inadequate, and an insult to the electorate. What matters is that a major component of the Republican Party finds Palin difficult to stomach, and the G.O.P. is hemorrhaging moderates at a time when it can least afford to do so.
If Obama wins next week, as the popular polls and the markets suggest (2008.PRES.OBAMA trading above 85), G.O.P. heavies must weigh seriously and carefully the role they want Sarah Palin to play going forward. Her supporters within the party may seek to propel her toward the next presidential nomination (if you think so, you can already invest in 2012.REP.NOM.PALIN).
But that would be a bad move. A candidate who drives staunch, old guard Republicans from the fold isn’t good for business – and with Palin as leader of the Republican Party, the inmates truly will run the asylum. With moderates long gone, the fraction of Americans that remain in Palin’s GOP will look ever more like marginalized extremists.
America is ready for an intellectually respectable leader – and poised, at last, to get one. As the Republican Party retreats to nurse the stunning double axe-wounds delivered by the Bush administration and the coming Obama landslide, they will no doubt think carefully before thrusting Sarah Palin to center stage once more.
Has the late unpleasantness got you down? Tired of seeing banks fail, investments dwindle and honest, otherwise sane people endorse a VP candidate better qualified for Romper Room than the White House?
The perfect solution is right in front of you. Use Intrade as a hedge.
Using money to offset real hardship is a time-honored trick. Insurance companies rely upon this approach to smooth over all manner of downers and upsets. So if you feel strongly about the election or the financial crisis, why not buy a little insurance of your own?
If you can imagine nothing worse than a McCain presidency, why, take a big position in 2008.PRES.McCAIN. If he wins, you'll curse the sun and moon, but you'll at least turn a big profit (he's currently trading at 18.6). And if he loses, you'll be so happy you won't miss the money.
Hope the economy pulls through? We all do. But if it doesn't, owning a little US.RECESSION.08 will help smooth the rough ride. What better way to counter your own personal recession than a little extra return when it hits?
It doesn't end there. Why not hedge against higher taxes on "Highest Marginal Single-Filer Fed Income Tax Rate to be Equal or Greater than 36% in 2009 Tax Year"? Boy, higher income taxes. That doesn't sound fun. But if it happens, an investment of $41.0 on 2009.INCOME.TAXRATE.>36% today will be worth $100.0. You could even invest just enough to cover a tax hike. No, really. Why not?
The possibilities are nearly endless. Say you hate Batman (who hates Batman?) and you can imagine nothing worse than The Dark Knight winning best picture. You’ll be glad you invested in BEST.PIC.DARKKNIGHT.
Live in the hurricane belt? I have a great pick for you, LANDFALL.08.FLORIDA. Current trading says there's just a 3.0% chance a Category 3 storm hits Florida this year, leaving a large financial upside to soften the blow if it does. There are other ways to profit from hurricanes, but believe me, you don’t want to do them.
Perhaps you're worried about bringing your fine art collection to market in the middle of this financial crisis. If so, you can hedge the risk that your Picasso's underperform at the auction podium with a short position in Intrade's MEI.MOSES.06JAN2009 fine art index futures.
In down times, we all need a little boost. Why not tie some financial upside to real-world events you dread? Intrade lets you do just that. A win could soften the blow with profit, and a loss – well, so what? The whole world is going your way.
Disclosure: I do not hold positions in any of the above markets.
Response to Congress' rejection of the proposed bailout plan on Monday has rocked the markets, both on Wall Street and Intrade. I'm not convinced that the bailout alone is dispositive in any of the major markets here (except, of course, those tracking the bailout itself).
First, its financial effects are routinely overstated. True, the Dow posted its largest single-day drop in history this week, at 777 points – but in fractional terms that's only 7%. The crash of 1929 amounted to a net drop of fewer than 200 points – but from its prior high of 381, the index lost nearly half its value. On Black Monday, October 19 1987, the Dow fell 22.7% in a single day (then quickly bounced back). Despite all the late unpleasantness, the Dow remains above the 'psychologically important' 10,000 mark we heard so much about after 9/11. Apparently it’s no longer so psychologically important.
Its political effects at first appear pronounced. Obama, trading nearly on par with McCain last week, has surged ahead by more than 27 points (McCain 36, Obama 63) in the clearest rally yet. I wonder though how much of that is tied to the bailout, and how much just reflects spillover of the frothing little cauldron of horrors that is McCain’s campaign of late.
Complicating factors are many. For starters, Sarah Palin has now embarrassed herself more thoroughly than any political candidate at any level of government that I have ever seen, meanwhile birthing the phrase "skewered by Katie Couric" – a sequence of words never before needed in English. Palin’s reappearance on CBS with McCain as chaperone further highlighted her status as an insult to an intelligent electorate. Are markets reacting to Palin?
Maybe - her chances to be withdrawn from the GOP ticket have nearly tripled in the past week, trading as high as 11.9 during today's session.
Or perhaps investors are still punishing McCain for his aborted effort to postpone the presidential debate. This gaffe had the dual effects of making McCain appear vastly overconfident – as though he would ride into Washington to personally set right those pesky financial troubles – and in the meantime rather sheepish, like an unprepared student looking for a doctor’s note in hopes of escaping the big debate.
(Max Keiser blogged about this earlier this week on these same pages.)
To me, the reason for Obama’s recent surge is far simpler. Despite his attempts to distance himself from the Bush administration, McCain still stands at the head of the GOP: the party under whose watch America entered a drawn out war and fuelled a consumer economy with cheap money and HELOCs. Skittish post-tech investors retreated to real estate. We witnessed a furious rise in housing prices, widespread adoption of exotic debt instruments to pay for overvalued properties, and the subsequent implosion of bad mortgages along with the blue-chip firms that traded them. All is not well, and the average voter won’t need any more reason than that.
Of course, it’s wrong to simply blame all this on one political party or another. Much of it is just the heave and flex of a market economy, albeit one lacking some needed regulation. But the fat years are past, and the recession – the same one we deferred with cheap loans since the tech crash and 9/11 – is finally coming due. That is true today, and will remain true long past Election Day.
So while the importance of recent market corrections may be overblown, public perception is paramount. The financial markets will absorb these overdue corrections and carry on – but growth-focused pundits will juxtapose numbers from last week, last month, or last year, and brand this still a massive crash. People will decry the collapse of America's financial markets and condemn any who brought us here.
The good news is the markets are basically sound. The bad news is, no one believes it. It is the simple vacillating impulse – things are bad, vote for the other guy – that will end up carrying the day on November 4th.
Assuming John McCain is declared the inner of Missouri’s electoral votes, Barack Obama will officially win 364-174 (or possibly 365-173 if Omaha’s 1 EV goes to Obama). If you were paying attention to Intrade, you knew that a month ago.
While Intrade did have Missouri and Indiana flipped, both were basically true toss-ups (a word much over-used by lazy people this season) and getting such incredibly close races right is more luck than anything else. Preliminary results show Indiana was decided by 0.96% and Missouri by 0.2%. North Carolina was the only other real toss-up, decided by 0.32%.
At no point during the 4 weeks preceding the election did Intrade’s state electoral markets have Obama winning outside the range of 353 to 375 electoral votes. Also, 49 to 51 states were called correctly every day of those last 4 weeks. Pretty good right?
Well, yes and sort of yes. Let’s take an even longer view. The markets were open for about two years, and they always had at least 41 states called correctly. In some sense, the bulk of the predictions are ‘easy.’ Oklahoma was going Republican (almost for sure). We all ‘knew’ that 2 years ago; the price of the ‘Republican wins Oklahoma’ contract was never below 85. Since a lot of states are like this, that’s how the rest get to be called ‘swing states.’ Here’s a graph of a daily view on how many of the 51 predictions Intraders were ultimately proven right on.
What’s interesting though is how this relatively stable situation can lead to great dynamism in the race. If we translate these predictions to electoral votes, we see that over 100 electoral votes were ‘in play.’
We also see that the Democrat was winning the Electoral College race in Intraders’ minds every day of the last sixteen months. So in some ways it shouldn’t be too surprising that my simulation, taking the dynamics of the state markets as input, came to a position of near certainty well in advance of the election when Obama’s lead became ‘insurmountable.’ Zooming in on the last four months, we see that the dynamics of the electoral markets were such that a McCain victory was all but inconceivable as of early October. This graph shows the simulated chance of Obama victory, as it evolved over the last four months.
Obama’s victory was not inevitable at all though. He nearly did lose. Around 45 days before the election, on the heels of the initial Palin effect, he was definitely in danger of losing. Then came the financial meltdown, McCain’s ‘response,’ and that was all she wrote.
The goals of the simulation model were to be responsive, predictive, and provide a ground-up check on the price of the national Obama & McCain contracts. It was responsive, showing wide dynamic range in immediate reaction to events. And it was predictive, correctly settling on Obama well in advance of the election. As a check on the national contracts, we see there was always something muting the response of the national traders. The national contract moved in a much narrower range in response to events, and the Obama contract never closed above 90. People kept feeling that SOMETHING was going to happen either in the campaign or in the vote-counting. Or maybe all the polls were wrong. Maybe their recent decades of solid performance meant nothing in this case for one reason or another.
The simulated chance of victory is again in blue, with the national-contracts-implied chance of Obama victory in pink.
Well, as is usually the case, this situation turned out to be not so radically unlike all other similar situations in the past. Analytics and modeling had a lot to say. Nate Silver won great acclaim for his ability to cut through the spin and assumptions of the various pollsters in order to come to a true consensus view of the race. Intraders should be equally commended, particularly those that participated in the state markets.
Last time I wrote, I declared that Obama had the election in the bag, according to Intraders participating in the state markets. Since then, Obama's strength has only solidified. For the last two weeks, Intraders have been saying Obama is the more likely candidate to win in states totalling 364 Electoral Votes.
Today, even if we give McCain every state where Intraders have Obama's chances below 80%, Obama still gets 273 votes and wins. In other words, let McCain keep every red state even if it is 51-49. Further, take FL (where Dems are currently trading at 63), MO (at 67), NV (73), NC (58), OH (61), and VA (78) away from Obama and give them to McCain and Obama still wins.
So according to Intrade's state markets there is basically no chance McCain can put together the Electoral Votes he needs to wim. Indeed, my simulation has consistently been putting McCain's chances at well under 1%.
At the time of my last column two weeks ago, the price on the Obama national contract was about 65, and it has since moved to about 85. From a certain perspective, 99%+ seems too high for the chance of almost anything that is two weeks in the future, and you suspect something must be inconsistent. From another perspective, the best a predictor can do is give you an answer with near certainty well in advance of the event. Intraders in the state markets have basically no doubt.
The action then, is in the question of how many electoral votes exactly will each candidate get. Intrade has a collection of markets for that as well, and through the simulation, we can get a good picture of what the state markets have to say on the question. A trader might look at the national price of 85 on 2008.PRES.OBAMA and figure the price of the Obama wins >270 Electoral Votes ought to be close to the same. Further, a trader might see that Obama is “expected” to win 364 Electoral Votes and suspect that the price of Obama winning > 360 Electoral Votes (or McCain winning > 170) ought to be around 50. Indeed, that is about where the Intrade markets on Electoral Vote counts are trading.
But the state markets have more to say than that. I simulate the joint dynamics of the state markets out to election day and produce a distribution of how many electoral votes each candidate ultimately may win. We can compare that distribution (in pink) vs. the Intrade Electoral Vote Count Markets (in blue), for the Democrat: And for the McCain, again my results from state markets in pink and Intrade's Elecotral College vote count markets for the Republican in blue: Fundamentally, the state markets are saying something different than the national markets and the electoral count markets. The state markets are actually implying a quite well-settled race at this point (not much can happen that will actually swing a lot of electoral votes). In the price of the national contracts and in the distribution implied by the electoral count markets, we see that Intraders still demand a significant risk premium for the suspicion that something big may yet happen.
In my last column, I said there is a >95% chance that if the next month goes more or less like the last three months, Intrade's electoral markets on Election Day will be predicting a victory for Barack Obama. Does Obama really have a >95% chance of actually winning the election?
He may not be far off.
Obama won the Democratic primary largely by working the rules of the contest. He needed delegates in that case, and his team put together a very targeted strategy to get them. Now, he needs electoral votes and he has done the same thing. While his lead in the popular vote is small to moderate, his lead in the Electoral College is actually dominant and very unlikely to be turned.
As of Monday afternoon, Intraders give Obama the edge in states carrying 338 electoral votes. He could lose 69 of those and still win. For example Intrade has FL, VA, OH, NV as the most vulnerable blue states right now.
They could all turn red and Obama still wins.
Intrade markets are historically 100% predictive in US elections when the prices are higher than 70 or lower than 30. If we take the states currently in that range, and add in Colorado, which is at 69 for Obama, we get 44 states that, given the level of volatility and the time left, are unlikely to turn. From those states, Obama controls 273 electoral votes to 163 for McCain (Karl Rove himself pointed this out today).
As Obama needs 269 to win, barring something radical, Obama has it in the bag.
And by the way: of the other 7 states, Obama leads in electoral votes 65-37.
Now, by something radical, I don't mean William Ayers. I mean something with a bigger effect on this race than the financial crisis. The recent past has actually been extremely volatile but has led to a relatively settled situation – I don't foresee a huge upswing in volatility between now and Nov 4th .
I have been using my simulation to jointly project Intrade's state electoral market prices forward to Election Day, then assuming Intrade would perfectly predict each state on Election Day. I have made an acknowledgment that there may be some fallibility in the markets when the price is between 30 and 70. In those cases, I now award the state with a probability matching the projected Election Day prices.
In bottom line terms, that will give the underdog a little more chance to win close states. Given the current landscape, that will help McCain more. Even so, I still see Obama having close to a 97% chance of victory.
Yet the individual market for Obama to win the presidency continues to trade around 65. Is there an arbitrage here? What is the real probability of Obama winning at this point? Let's look at other sources that claim to tell us this. Fivethirtyeight.com is a well-known site that works with polling data in a very detailed and sophisticated way. They assign an 87% chance to Obama victory. Election-Projection.net is a similar idea, and assigns a 96% chance. Independent oddsmakers give Obama a 74%-80% chance. If the future is more volatile or more correlated than the past, or if Intrade markets aren't well described by a Gaussian copula, my estimate of 97 may be a few points high, but I am fairly confident 65 is low.
Disclosure: I don't own any of the above securities.
Back in August, it was arguable who was winning the race for president. Unsatisfied with polls-based approaches for a variety of reasons, I turned to the Intrade markets. There are two metrics you can look at to see who traders think is winning at any given time. One is the relative prices of "Obama to win 2008 US Presidential Election" vs. "McCain to win 2008 US Presidential Election." The other is the number of electoral votes Obama and McCain are each expected to win.
Let's focus first on the overall chance of winning. If we look at the relative price metric over the past couple months, we see that Barack Obama has been winning consistently by on average 60/40 except for a brief period in mid-September. For convenience, I'll express the metric as Obama / (Obama + McCain). This is the pink line in figure 1.
In my previous column, I described a system for simulating the joint dynamics of the 51 electoral markets on Intrade forward to Election Day. One can extract from this, what is the probability of Intrade's state market prices on November 4th predicting an Obama electoral victory. That is the blue line in figure 1. In principle, the blue line and the pink line should be roughly the same if you accept the big assumption that the next month may be similar (in volatility and state-to-state correlation) to the last 3 months. As you can see, the simulation has much greater dynamic range than the simple "X to win 2008 US Presidential Election" contracts. The markets react sharply, and this metric reflects that without delay.
Is it credible to say that Obama has a >95% chance of winning the real-world election? He does have a very big lead and there’s not that much time left. But the overall Obama wins the election contract is trading below 70. I will address that in some detail in my next column, but what this really says is there may be significant trading opportunities between the national contracts, the state contracts, and the weekly options.
The other metric we can look at is the expected number of electoral votes for Obama (or McCain). In figure 2, in pink, we see the history of the Intrade electoral vote predictor for Obama, which assigns each state's votes depending on who's contract has the higher price that day. In figure 2, in blue, we see the mean of Obama's electoral votes from my simulation. Typically, these two lines are quite close, which is a good validation of the simulation. The gap is indicative of the predicted average net effect of states flipping from their current status between the measurement date and Election Day. Since the simulated mean is usually below the electoral vote predictor, Intrade's state market traders are implying Obama's lead is a little soft. But the reason the simulation still produces a predicted win for Obama >95% of the time going forward from today is that he does have a really formidable lead in the Intrade state markets.
There is a wealth of available information on the presidential race -- national and sate polls; poll aggregators like RCP; and meta-analysis like that being done at fivethirtyeight.com and others. And of course there are prediction markets. The Intrade markets on the presidential race (by party or individual) address the question of who is winning directly, but looking to them alone ignores all the information in the state-by-state market prices.And it is the state races, ultimately, that decide the winner.
Investigating the joint dynamics of these 51 individual state markets on Intrade gives a complimentary – and perhaps ultimately the clearest -- picture of how the race is going.
Fundamentally, the problem is similar to risk management of a portfolio. From the candidate's viewpoint, they have a portfolio of 51 binary pay-off assets with fixed weights as determined by each state’s number of electoral votes.
Each state race has a characteristic volatility. And critically, each state is correlated to every other state. These attributes can be empirically determined by Intrade’s historical state-by-state market prices.
Then, we can use the standard technique in portfolio management – to build up a picture of the portfolio dynamics by simulating (out to election day, in this case) correlated series of returns on each individual asset.
By repeating the simulation many times, we get a probability distribution of the expected outcomes. In each simulation, in each state, if the Republican price on Election Day is greater than the Democratic price, the electoral votes are awarded to the Republican, and vice versa.
I’ve run the simulation 5000 times, and found a very interesting distribution of where the electoral vote tally might end up – as implied by the Intrade markets.
As of Sunday September 21, even though national polls are coming in close to 50/50 and Intrade’s contract for Obama to win the Presidency is trading close to 50, Intrade's state-by-state traders implicitly believe Barack Obama has a 76.8% chance of winning at least 269 electoral votes and thus the presidency (I assume a 269-269 tie will be awarded to the Democrat by the new House of Representatives).
How does this fit in with the presidential market prices, which indicate a much closer race? That’s a good question, and I hope to hear some interesting suggestions. Here are some thoughts on:
Obama was winning 273 electoral votes on Intrade on September 21, and so we might expect that to imply a chance only slightly greater than 50% of victory.But Nevada (5 EV), Ohio (20 EV) and Virginia (13 EV) were all less than a 5 point lead for McCain while McCain's likeliest flip was Colorado (9 EV) at 56-44.Because Obama has a better chance of flipping some of the slim McCain leads than McCain does of flipping anything into his column, my simulation’s skewed toward increasing Obama’s total from 273.While 273 is the most likely outcome for Obama’s EV count, the mean was 283.
While conventional wisdom is that no Republican could win in this environment, none of the pre-convention polling data supports that conclusion. True, generic Democrats were beating generic Republicans by a large margin, but when the names were attached (Barack Obama and John McCain) the polls tightened to within a few points. The proof of this is the numerous almost countless stories during the summer asking why Obama's lead wasn't greater. The media then answered their own question and blamed it on "white blue-collar working class" voters convincing themselves Obama couldn't "close the deal" Unfortunately for John McCain, it appears he believed them even though there wasn't much evidence to support the claims that whites weren't going to vote for a black candidate. This may prove to be the first of many arguments that supports banning TV sets from campaign offices.
There has been a lot of hype about an anticipated "Bradley effect" also known as the "Wilder effect". The premise of these theories is that whites will tell pollsters they will vote for the black candidate, but in the voting booth, don't. Analysis of previous elections finds that this phenomenon was as high as 3.1 percent prior to 1996 but has been reduced to nearly insignificant now.
An analysis of the polls prior to the primary elections of 2008 showed no evidence whatsoever of a "Bradley effect" when compared to actual results. It should be readily apparent to any campaign analyst that a "Bradley effect" if existent, was not going to be a major factor with Barack Obama. The first sign of this was Iowa. Barack Obama won the Iowa Caucuses by significant margins. Iowa has a white population of nearly 95% and an African American population of nearly 2.5%. This media driven hype plays a big part in why McCain's campaign believes they still have a prayer and yet in State after State during the primary campaign, with the one exception of New Hampshire, Obama consistently ended up on election night +/- 2 points of where the polls had him. Even in New Hampshire, Obama received his predicted total but the large undecided number broke for Hillary Clinton. McCain enjoys no such undecided cushion.
So what does the summer polling tell us? Simply put, the polling, when analyzed by any metric, demonstrates that while a generic Republican should be in trouble, this Republican was different. This Republican could have won. In other words John McCain's narrative, war hero, statesman, straight-talking maverick, brought him 98% of the way back from the hole the generic Republican was in. What is killing John McCain's campaign is, frankly, John McCain's campaign.