Chalice

A Poisoned Chalice

By James Cumes, 30 June 2008

Obama has revelled – some might say arrogantly - in what has been a momentous victory. He is now the presumed Democratic Party nominee for President of the United States.

He has called it a historic moment, a moment of change, a moment for the United States to take a new direction.

In this, he seems to be right but the next four months and more especially the next four years may be historic in ways he may not yet have clearly identified.

The primaries showed convincingly that the first concern of the American people is the economy. This is likely to persist into the November elections. The average American voter may be woolly in his ideas of what precisely is wrong with his economy; and “expert” analysts who will try to explain what it is all about will only confuse him more. Those “expert” analyses will almost certainly continue to be distorted by “euphorisation” – a refusal to admit the realities – for some time yet.

However, time is already undermining the euphoria. The extreme and revolutionary action taken by the Fed and supported by the Secretary of the Treasury, together with stimulus packages and the like from the Bush Administration, has not resolved what has been variously known as “the sub-prime crisis”, the “credit crunch”, the bursting of the housing bubble and so on.

After months of effort and lavish outlays of not merely hundreds of billions but what may now be a trillion or more dollars by the Fed and others, the problems of the banking community, the financial system or whatever you may choose to call it remain doggedly in place.

Not only are the problems still there but they have grown ever more menacing. Almost certainly, the global credit crisis at mid-year in 2008 is entering – indeed, may already have entered - an even more turbulent phase than ever before.

In the last month, the cost of insuring against default on the bonds of Lehman Brothers, Merrill Lynch and other big banks and brokerages has surged, threatening to exceed the stress levels prior to the Bear Stearns debacle. Spreads on inter -bank Libor and Euribor rates in Europe stubbornly persist at or near record levels.

Credit default swaps (CDS) on Lehman debt have almost doubled from around 130 in late April to around 250 now, while Merrill debt has spiked to 196. Most analysts thought the tide had turned for such broker dealers after the Fed invoked an emergency clause in March so that they could borrow directly from its lending window.

However, the Fed may now be exhausting its potential. It has swapped almost $300bn of 10-year Treasuries for poorer quality collateral, and provided Term Auction Credit of $130bn. One senior financial-services practitioner commented that "The steep rise in swap spreads this [month] is ominous. The deterioration is in stark contrast to what investors have come to hope since March."

Lehman Brothers took write-downs of just $200m on its $6 .5bn portfolio of sub-prime debt in the first quarter even though a quarter of the securities had "junk" ratings, typically worth a fraction of face value.

European banks and non-bank financial institutions have been showing similar signs of weakness and distress. Moreover, the prospect is for the global finance industry to endure waves of defaults on credit cards, car loans and corporate loans. "We believe we're entering Phase II,” said a credit analyst of Dresdner Kleinwort. “The liquidity crisis has eased a little, but the real credit losses are accelerating. The worst is yet to come."

The surge in corporate bankruptcies has not yet been picked up by the usual indicators, which tend to lag the market, lulling investors into a false sense of security. However, the actual and potential losses can be calculated by financial specialists and assessments of the grim realities are spreading.

So far, extraordinary central-bank support, combined with widespread “euphorisation” has managed to sustain the markets – at least so as to avoid panic and total meltdown. However, we are now reaching the point at which the desperate rescue efforts are seen to have failed to maintain credit and other markets. The latter, after stabilising briefly, continue to show marked weakness.

The Plunge Protection Team has almost certainly been active and some soothing intervention in statistical analyses has probably helped to boost confidence or not shake it too rudely; but equity markets have still barely held their nominal value levels and most around the world are sharply down. Last week, the DOW fell to the brink of becoming a formal bear market. One correspondent told me recently: “From every which way I look at the markets, the rally of today is not going to survive the night! The equity markets are set up for a hard down. A real, extreme decline compared with what we are used to since the March lows.”

These issues were not prominent in the primary campaigns. They were not highlighted in the “Unity” demonstration by Barrack andHillary last week. One or other of them – together with the Republican nominee John McCain - have issued general assurances that they will create jobs, that they will help homeowners threatened with foreclosure and that they will tackle the problems of “off shoring” jobs and industries overseas.

But discussions of fundamental issues and of how to reform the financial system have been lacking. Almost invisible is the problem ofhow to handle what must now be seen as the almost inevitable, virtual meltdown of the system. That meltdown is now well on the way and can only intensify in the months to come.

We have seen little acknowledgement that such a collapse was always inherent in the financial system which evolved since the early 1980s and even more robustly in the last decade. The rolling thunder of the gathering financial storm will be even more foreboding from August when the Presidential election campaigns gather full momentum; and the lightning flashes will follow ever more closely on the thunder by the time the elections are held in early November.

By the time the successful candidate moves into the White House next January, financial devastation may already have swept through the American and global economy like a tornado.

What will the occupant of the White House then be able to do?

During Herbert Hoover’s successful campaign for the Presidency in 1928, signs of pending economic collapse were already visible but they were “euphorised” out of sight. He had been in office only nine months when the New York Stock Exchange crashed in October 1929. Hoover was energetic, highly competent and powerfully motivated. His advisers were probably as “expert” as anyone at that time.

Now we have an economic and financial crisis at least as terrifying as in 1929 and the occupant of the White House will probably again be energetic, competent and well motivated. He will have economic advisers of high repute; but it is likely that, whatever their competence, their imagination and their motivation, they will be unable to resolve the complex problems with which the collapse of the credit markets and the entire speculative financial-services industry has confronted them. This is all the more the case in that those potential advisers have been the very people who, by and large, have supported the policies and practices which have engineered the collapse and who, in recent months, have tried to engineer a rescue.

When a financial bubble bursts, the only realistic option may be to let it run its course and pick up the pieces as painlessly as we can afterwards. We now have a whole cluster of bubbles bursting more or less simultaneously. They all belong to a speculative system which was deeply and fundamentally flawed. No matter how brilliant an Obama or McCain Administration may be, it is unlikely to be able to redress the situation in the short space of a single four-year term. In 2012 we will still be living with the fallout from one of the greatest financial catastrophes of all time. The miseries will be domestic to the United States – and other countries – and they will also be global.

At that point a new Franklin Delano Roosevelt may be most desperately needed; and the situation is still likely to be such that the miseries will then be blamed not on the incumbent’s predecessors but on the incumbent himself – and his party.

After Hoover’s four-year term ended in 1932, the Republicans were out of office until 1969 except for Eisenhower’s two terms from 1953 to 1961. Even Eisenhower was elected more as a heroic World War Two general than as a Republican.

So it might prove to be for the party which provides the President starting next year. There is some suggestion that some Republican strategists might have contrived to support or at least not attack Obama too vigorously during the primaries because he is more vulnerable than Clinton. Those vulnerabilities might ensure the election of McCain as a highly respected war hero who has some of the qualifications – and appeal - of an Eisenhower.

If McCain is elected, he will drink from the poisoned chalice from which Obama and Clinton fought so hard to sip. After a nightmarish single term, McCain and the Republicans might then be out for perhaps most of the next twenty years.

If Obama manages to defeat McCain, his entire term will be spent trying to reduce the miseries of the American people and restore the strategic power and authority of the United States. In neither of these tasks is he likely to succeed except to prepare the way for his successor.

In this context, what might Hillary Clinton’s prospects be? Much will depend on how close her association is with Obama in office. If they are close, her political star might fall along with his. If she manages to keep him at arm’s length, then she might have some political future. However, her Democratic Party is likely to suffer the same fate as the Republican Party after the Great Crash and the Great Depression of the 1930s. They are likely to roam the political wilderness for years, perhaps decades, as the Republicans did between 1933 and 1969.

So her aspirations for the highest office might be seen to have ended with her courageous fight in the Democratic primaries of 2008.

As for Obama, one intriguing question is whether he should have waited to make his bid for the Presidency until 2012 or later.

At 47, he could have waited another ten or fifteen years before aspiring to the highest political office. He could have allowed Hillary or another Democrat to drink from the poisoned chalice in 2009; but he would then have had to live with a Democratic Party which might not have recovered until he was in his seventies.

Perhaps it was better that he should try now. If he becomes President in January 2009, he will be faced with a complex of problems similar to those which confronted Roosevelt before and – let’s not forget - during the Second World War and then in restructuring not only the American economy but in playing America’s full part in restructuring the global economy. All of this in the next few years will have to be tackled in ways even more challenging than before and after World War Two.

Perhaps he will meet and beat these challenges. There is just a chance that he will, with the assistance of spirited associates and advisers. Hillary Clinton has shown herself to be one of the most accomplished politicians – of any gender - of her time. She might help guide the United States through as rough a political, social, economic and strategic patch as her country has ever known. If she and Obama or, for that matter, McCain and his associates are able to restore their country to its former greatness that will be a legacy to rank with the finest achievements of the greatest American Administrations of the past.

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