We spend a lot of time worrying about the economy in the United States, especially as it relates to politics and policy. We’re facing very slow growth, well below the long-term trend, and certainly below what we’re capable of. At the same time, inflation is running well above normal (we reached a 5% annual rate in June).

Europe faces similar problems, although their policy response has been different from ours. The EU’s economic managers prefer to control inflation even if it means reduced industrial output. Here, we do it the other way around.

But while we’ve been reducing interest rates and generally doing everything we can to spur new credit formation and business activity, the exact opposite has been happening in Asia.

For the better part of a year, China and India have been raising policy interest rates and required bank-reserve ratios in a mad attempt to cool off their blazing economies. Just yesterday, India’s central bank raised its benchmark discount rate from 8.5% to 9%. The most comparable American and European rates are 2% and 4%, respectively.

This activity is starting to have an effect, especially in China, which has very effectively popped a domestic stock market bubble that peaked late last year. But the cure is causing its own problems.

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We were invited to attend a call with some very illustrious people this morning who are advising John McCain on economic policy: Martin Feldstein, Carly Fiorina, Meg Whitman, and John Taylor.

As a tech businessman it’s always a privilege for me to hear from these two ladies, and as a dilettante economist, it’s even more exciting to hear from Doctors Feldstein and Taylor.

The points that were emphasized on this brief call related to job-growth, energy policy, and government spending. It’s worth pointing out the substantive differences between McCain’s positions and Senator Obama’s.

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I’m often asked to speak in favor of lower Federal deficits. I’m not sure how clear I’ve been about this here, but I’ve long been very skeptical of the standard argument, found on both sides of the aisle, that fiscal discipline is a Good Thing.™

I realize that it takes some nerve to fly in the face of all the fine people on our side who say “It’s OUR money, not the government’s!” and “We’re saddling our grandchildren with debts they won’t be able to repay!”

But the first statement is only true insofar as the dollars that the government creates are technically liabilities incurred to the taxpayers. (That’s why it says “Federal Reserve Note” on the top of our paper money.) They can literally create as many dollars as they please.

The second statement is hogwash because government debt can be rolled over indefinitely, so long as people are willing to hold it.

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With the final passage of the Housing and Economic Recovery Act of 2008, we have officially embarked on the New New Deal. We’ve come to the end of a 30-year cycle of deregulation and are now moving into a period of expanded government involvement in the economy.

As Milton Friedman said, real change is actually quite rare, but when it does come, it generally activates whatever ideas happen to be lying around.

And all kinds of strange ones have been lying around, waiting for their turn in the sun.

Here’s one of them. It comes from Alan S. Blinder, a well-respected Princeton economist and former Federal Reserve Vice Chairman.

Blinder wants to spend your tax dollars to buy cars from low-income people.

Let’s work through this together…

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In the financial markets, last week was the wildest and most dramatic one since the Bear Stearns Companies collapsed last March. The subject was whether we would see a collapse of Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) that together own or guarantee $5.3 trillion in US home mortgages.

And by extension, the fear spread to the entire US financial sector. The popular imagination was captured by the failure and seizure of IndyMac, a California-based bank with large exposures to the Alt-A and subprime lending markets. This event was not insignificant. But it was dwarfed by the huge amounts of value that were subtracted from the stock prices of financial companies across the spectrum, and that came roaring back by midweek.

Let’s give credit where it’s due: Treasury Secretary Henry Paulson gets plaudits for stabilizing the situation. I’ll explain shortly.

But the emergent theme is that we’re moving decidedly toward much greater government control over the financial system. The very idea of free markets took a big hit last week.

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In our super-secret Contributor’s Conclave, we were discussing a certain Presidential candidate of notorious metrosexual proclivities, who had the bald effrontery to wear flip-flops with a blazer and slacks. And the question quite logically was asked: “This guy is supposed to bring culture and civility back to the White House?”

To the best of my knowledge, Obama has promised Hope and Change, rather than culture and civility.

Historically, culture and civility are found in stable, settled societies, and are marks of conservatism.

Hope and Change, on the other hand, are associated with revolution.

As of Sunday night, the US government, speaking through Treasury Secretary Henry Paulson, has committed to guarantee the value of securities issued by the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac.

That means that you, dear Taxpayer, are about to get into the housing business in a way you’ve probably never imagined and certainly didn’t choose.

So it’s worth asking a few questions about the business we’re all about to get into.

What does it mean to say that Freddie Mac is insolvent on a mark-to-market valuation basis? Exactly how much risk are the taxpayers going to be exposed to? Who owns the securities (or “agency debt”) issued by Fannie and Freddie, and how do they benefit from the bailout?

And most of all, what does it mean for people who want to buy houses in the future?

This update of a story that was originally written three days ago includes sections on market and Congressional reactions to the GSE bailout plan.

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As of Sunday night, the US government, speaking through Treasury Secretary Henry Paulson, has committed to guarantee the value of securities issued by the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac.

That means that you, dear Taxpayer, are about to get into the housing business in a way you’ve probably never imagined and certainly didn’t choose.

So it’s worth asking a few questions about the business we’re all about to get into.

What does it mean to say that Freddie Mac is insolvent on a mark-to-market valuation basis? Exactly how much risk are the taxpayers going to be exposed to? Who owns the securities (or “agency debt”) issued by Fannie and Freddie, and how do they benefit from the bailout?

And most of all, what does it mean for people who want to buy houses in the future?

This update of a story that was originally written three days ago includes sections on market and Congressional reactions to the GSE bailout plan.

Keep reading…

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Update: 9:40am EDT, 14Jul08: Overseas markets reacted well to the Paulson “we have a plan” statement. Asian markets ended lower on regional concerns while Euro markets are somewhat higher. The US stock market has opened up over 100 points, while the US Treasury market is only slightly lower. FNM and FRE stock were both up about 20% in pre-market trading, while their bonds, swaps, and CDS are all considerably tighter but not as tight as earlier this morning. Good initial reaction. We’ll see what the follow-through is. [End of update]

A lot of people heaved a big sigh of relief when the financial markets finally closed on Friday afternoon, including myself. It was one of those hair-raising weeks in which major financial institutions, not only systemically important but also widely deemed basically healthy, tottered and wobbled.

Of course I’m talking about Fannie Mae and Freddie Mac, the huge government-sponsored entities (GSEs) that together buy or back up nearly half of all the residential mortgages in the US.

It’s déjà vu all over again for Wall Streeters. This feels a lot like the weekend that the Bear Stearns Companies were put to death, back in mid-March.

And all through that wild weekend, officials at the New York Fed, the Federal Reserve and the Treasury Department worked frantically around the clock to resolve the situation before trading opened in Asian markets. That is, by Sunday evening, New York time.

Everyone expected that Treasury Secretary Henry Paulson would be burning up the phone lines this weekend too, and he did. A few moments ago, he issued this terse statement. It lays out an expectation for a range of actions by the Treasury Department and the Fed to ensure the continued smooth operation of Fannie and Freddie when the markets re-open for trading a few minutes from now.

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From an AP wire story, we hear that Senator Obama believes the US economy is in recession.

If you’re in business or you follow business, your response is likely to be “No [excrement], Sherlock.”

What frustrates me no end, however, are statements like these, which are being spun as His Highness’ “most definitive” statements yet on the economy:

“I have little doubt that we’ve moved into recession at this point, and the sooner we can get money into people’s pockets, the sooner that we can stabilize the housing market, and the sooner that we can send a message to the markets that we’re serious about creating an energy policy that will create greater energy efficiency over the next decade or so, I think the sooner we’re going to get our fundamentals right,” he said.

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Front and center this week have been the ill fortunes of Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) that together own trillions of dollars’ worth of US home mortgages.

At this point in time, there really is no reason to own the stock of either company. The Administration is said to be looking carefully at whether and how to do a government takeover of one or both. The grand 35-plus year experiment in semi-public support for US housing may be coming to an end.

But that’s far from the only problem in the mortgage/housing sector. In fact, it may be the easy problem. The hard problem is what to do about all the homeowners that are falling behind on their payments.

This is a time bomb that continues to tick away, and Congress has been working hard to pass a huge bailout bill (the Dodd-Frank Act). President Bush has vowed to veto it, but he’ll break that promise.

But what are the objectives (both political and economic) of this enormously costly legislation? Can it actually meet those objectives? And are they the right objectives in the first place?

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