Thursday, May 29, 2008

Lessons From the Housing Bubble

By Donald Wessel

The Wall Street Journal

May 29, 2008

Before we replace angst about housing, mortgages and credit markets with anxiety about rising oil prices, consider what we've learned in the past several months. We had a housing bubble; that's now obvious. But how did it happen? Why was its bursting so painful? Without answers, we can't hope to reduce chances of a repeat.

Boil it down to the three R's: rocket scientists, regulators, and ratings agencies.
The rocket scientists are the wizards of Wall Street who invented securities that supposedly dispersed risk widely but actually created much more leverage than proved wise.

There is a good case that the savings-and-loan mess of the 1980s was made in Washington, the inevitable result of government deposit insurance that led to tails-you-lose, heads-I-win banking. The current mess was made on Wall Street.

A bubble so large also required aggressive mortgage originators, imprudent home buyers and myopic investors. But it wouldn't have been as bad if not for the paper factories that sliced up individual subprime mortgages and assembled the pieces into securities, each with its own acronym, that were deemed safer than the underlying loans. They behaved as if they were taking a little poison and diluting it in a big reservoir; instead, they poisoned the entire water supply.
A lot of risk wasn't dispersed, as we now know. It ended up in banks like Citigroup and UBS. To the extent it was dispersed, that posed a different problem.

"The idea of risk dispersion is nice in theory, but in practice it depends on who it gets dispersed to," says Peter Fisher, a former Federal Reserve Bank of New York official now at money manager BlackRock Inc. "It turned out we weren't dispersing it to strong hands who could hold it through the volatility. Rather, we were dispersing it to weak hands who couldn't hold it, and ended up adding to the volatility."

The cost of delinquency, default and falling house prices often was passed to entities (some linked to brand-name banks) that lacked the financial strength to weather a storm. As the entities couldn't bear the burden for long, they had to sell mortgage-linked securities into a hostile, illiquid market, pushing down already depressed prices.

In a modern capitalist system, regulators provide guardrails to keep markets from driving the economy off a cliff. The regulators failed. Whether regulators should or could have restrained innovation on Wall Street or prohibited business deals between consenting, sophisticated adults is a tough question.
But regulators failed to protect unsophisticated consumers from mortgage loans that they simply couldn't afford or didn't understand; they're now fixing that. And regulators misunderstood the risks that banks were taking and failed to stop lenders from lowering standards too far in their frenzy to attract business; fixing that will be tougher.

Among their many failings, the regulators allowed lenders to make a fundamental mistake: To lend not against the borrower's cash flow and income, but instead to lend against the seemingly inexorable increase in the value of the collateral. Mortgages were made to people who couldn't afford the payments because the lender (or investor) figured that if the borrower defaulted, the house would always be worth more than the loan.

"It is the hallmark of a credit bubble when lenders think that because collateral is going up in price they can ignore the borrower's ability to pay," says BlackRock's Mr. Fisher. "Collateral should only be a backstop." When lenders forget that, regulators must step in. "Lenders need someone to prevent them from competing their way to the bottom," he says. Let's put those words on a laminated card and hand it to every banking supervisor.

Then there are the rating agencies, mainly Moody's and Standard & Poor's. "Credit-rating agencies assigned high ratings to complex structured subprime debt based on inadequate historical data and, in some cases, flawed models," the Financial Stability Forum, a collection of regulators and central bankers, said in an April report. "As investors realized this, they lost confidence in ratings of securitized products more generally."

The flaws of rating agencies are a mélange of conflicts of interest, misleading grading systems that classified complex securities as if they were much like simple corporate bonds and a backward-looking approach that proved particularly useless. They were the enablers. They are atoning and changing their ways, as they should. Their business model will change; government oversight will be strengthened.

But investors who relied on the rating agencies -- particularly supposedly sophisticated pension funds and other institutions -- are at fault, too. Rating firms became a crutch for investors who simply didn't want to spend the time and money required to be prudent investors at a time when low interest rates had everyone reaching for higher returns without contemplating the higher risks.

A little "back to basics" in banking and investing would go a substantial way toward avoiding a repeat of the Panic of '08.

Monday, May 26, 2008

Commodity Prices Soar, But Are They A Bubble?

By Justin Lahart

The Wall Street Journal

May 26, 2008

After being buffeted by the dot-com, housing and credit bubbles -- not to mention the Chinese stock-market bubble -- there is a readiness by people on Wall Street and elsewhere to ascribe the term "bubble" to all sorts of things. But when it comes to commodities like crude oil and corn, that may be off the mark.

A bubble, says "The New Palgrave Dictionary of Economics," "refers to asset prices that exceed an asset's fundamental value because current owners believe they can resell the asset at an even higher price."

But figuring out whether a commodity exceeds its fundamental value is difficult: Because there is no income stream, there is no equivalent to the price-to-earnings ratios that people use to value stocks.

Prices, to be sure, are soaring -- crude oil fetched $132.19 a barrel in New York on Friday, up 103% from $64.97 a year earlier. Yet crude has posted similarly massive increases a number of times in the past three decades. Most notably, in the spring of 1980, as gasoline lines lengthened, the price of crude oil was 150% above the year-before level.

That price spike was caused mainly by a production cutback by the Organization of Petroleum Exporting Countries -- coupled with the fact that consumers had few alternatives. But over time, the high prices spurred conservation by consumers and increased exploration and production in non-OPEC countries. Oil prices collapsed.

The episode is a textbook example of the huge price swings that can occur when supply and demand are relatively inelastic in the short run, but not in the long run, says Harvard economist Greg Mankiw, who cited it in an economics textbook he wrote.

Mr. Mankiw, like many others, thinks that increasing demand from China and other developing countries is behind much of the rise in oil prices.

High prices are sparking some conservation efforts -- on his blog, he has noted that some people are switching to mass transit, buying bicycles and, in the case of one Tennessee farmer, switching from tractor to mule.

"But it takes years for people to fully adapt," Mr. Mankiw says.

In the meantime, the response of oil producers to rising oil prices seems more sluggish than ever, leading worries that crude production has peaked.

The Paris-based International Energy Agency, which is conducting a comprehensive study of the world's top oil fields, is preparing to revise its oil-supply forecast downward.

For other commodities, supply and demand change more quickly in response to higher prices.

Some of the biggest recent price drops have occurred in commodities like wheat and cotton, which are renewable and have potential substitutes, says Howard Simons, a strategist at Chicago-based Bianco Research.

By contrast, oil and natural gas aren't renewable, aren't recyclable and don't have easy substitutes. Corn is renewable, but because much of the corn crop is getting diverted toward making ethanol, its prices are rising as well.

So it is far from clear that the first part of the bubble definition -- prices in excess of their fundamental value -- is in place. But the second part -- that people are buying in anticipation of selling at a higher price -- certainly is.

Speculation has long played a role in the commodities markets, but in recent years it has become much larger.

The traditional role of the commodity-futures markets was to allow players such as farmers and oil refiners to hedge against unexpected price swings. Now, more institutional investors are wading into commodity markets to invest, rather than hedge.

In February, the board of the California Public Employees' Retirement System, or Calpers, the largest pension fund in the U.S., authorized putting as much as 3% of its $240 billion portfolio in commodities. Hedge-fund manager Michael Masters told a U.S. Senate committee last week that institutional investors "are one of, if not the primary, factors affecting commodities prices today."

But Bianco Research's Mr. Simons say that because the final buyers of commodities are consumers rather than investors, the role of speculation is limited. "Commodities, unlike financial assets, cannot take on hope values very much," he says. "At some point, the price gets to the point where the buyer walks away."

In commodity markets, what is traded aren't physical commodities but contracts that are essentially bets on where prices will go, Harvard's Mr. Mankiw says. The final effect of the bets is limited unless they encourage speculation in the commodity itself -- encouraging, say, a coffee broker to warehouse coffee in hopes of getting a higher price later.

And that is what is happening, according to Mr. Mankiw's Harvard colleague Jeffrey Frankel, who says such speculative behavior is due to the sharp reduction in interest rates by the U.S. Federal Reserve. Low rates encourage commodity stockpiling, he says, by making it less attractive to sell commodities and put the proceeds into bonds and other debt instruments.

Critics of Mr. Frankel's theory say the expected rise in commodity inventories hasn't shown up. Mr. Frankel has acknowledged that, but also notes that perhaps oil producers are leaving those inventories in the ground. That could be one reason why the Saudi king rebuffed U.S. President George W. Bush's request for increased oil production earlier this month.

That would be a reckless game to play, because it could lead to the types of shifts that caused energy prices to drop precipitously in the 1980s, inflicting heavy damage on the Saudi and other OPEC economies. Indeed, the combination of a change in consumer behavior and an economic slowdown that is showing signs of spreading beyond the U.S. may already augur just the kind of sharp drop in prices that occurred back then. But if that happens, it won't be because oil prices were in a bubble; it will just be because that is the way commodity markets work.

Thursday, May 22, 2008

Today's Food Crisis Isn't a Blip

By Paul E. Roberts

U S A Today

May 22, 2008

For anyone wondering where food prices are really headed, the news that Beijing has begun buying up farmland in Africa and South America offers a troubling hint. When China began acquiring oil fields in the 1990s, it signaled both the end of China's self-sufficiency in oil and the start of a competition between China and other big oil importers that helped push crude prices to their current record levels. That the world's most populous nation now seeks to lock up pieces of foreign food production not only confirms that China has reached the end of food self-sufficiency as well, but suggests that Western hopes for a quick end to today's food-price crisis could be overly optimistic.

According to conventional wisdom, our food crunch is a temporary glitch. Because grain shortages are being caused by many factors — new demand by biofuel refineries, drought in Australia, among others — the pain can't last. Eventually, drought will abate. Biofuels programs will be reined in. Most important, farmers will plant more acres and boost global supplies, just as they always have during shortages. Food may never again be dirt cheap, but by next year, prices for key crops will swing back to a more moderate line. Right?

It's a comforting picture, to be sure. But as Beijing's real-estate spree suggests, food prices are being driven by deeper, more fundamental factors that won't be so easily resolved.

Food demand soaring

Consider how quickly food demand is accelerating. We've all heard how the developing world is rich enough to eat more meat. But the real story here isn't that
global meat consumption will more than double by 2050; it's that each pound of extra meat will require, on average, at least 6 more pounds of livestock feed, meaning we'll need to substantially boost our grain output. And that's a problem, because even as demand soars, traditional methods for increasing supply are losing their punch.

No longer can farmers boost grain output simply by plowing up more land: Most of the world's readily farmable acres are already in crops, and what remains is performing other useful functions. In fact, the world is actively losing farmland — to
erosion, overgrazing and development. Even in the USA, the inexorable spread of suburbs, malls and golf courses costs us nearly 2 acres of farmland for each birth or new immigrant.
Granted, the world has coped with land scarcity before. When India ran short in the 1960s and
famine loomed, so-called Green Revolution technologies — higher-yield crops, synthetic fertilizers and massive irrigation — let farmers grow more bushels from the same acres. This time around, even as farmers gain powerful new technologies, they'll also be facing new constraints that will make a second Green Revolution harder to pull off.

For example, a farm built on cheap oil suffers when crude prices quadruple. But the larger problem might be the soaring price for natural gas, the main ingredient for synthetic fertilizer. The University of Manitoba's
Vaclav Smil calculates that 40% of the world's calories are now produced with synthetic nitrogenous fertilizers. The idea that we must get through the next 50 years, and feed 4 billion more people, with fertilizers two to three times above today's prices, is more than a little breathtaking.

Expensive fertilizer is just the start. To grow a ton of grain, you need up to a thousand tons of water, which means our grain farmers must somehow find as much as a trillion extra tons of water — and this from a planet already seriously overdrawn on its water accounts.

A drain on water, too

one-sixth of the population of China and India are fed using amounts of water that can't be sustained. Some nations have even resorted to importing grain and soybeans rather than grow it themselves to save water. But this stopgap approach can't help hold off inevitable shortages: According to the International Water Management Institute, future farmers will need 17% more water than the world now has available. Just as nations compete for oil, China's move into foreign farms suggests competition for water isn't far off, either.
Lastly, there's climate. Even conservative scenarios suggest that in places such as Africa, where food output is already suffering, climatic shifts could make key crops, say wheat,
impossible to grow. But the real story might be the damage done to grain powerhouses such as the USA and Europe, where an anticipated jump in "extreme weather events" could hurt crop yields and erode our power to export just as basket cases are most in need of our grain.

These are, of course, only scenarios based on current trends. Science could yet provide the tools to restore some of our superabundance. But given the new limits farmers face, those breakthroughs will need to be more miraculous than anything we've seen.

If we're serious about avoiding a repeat of today's food crisis, we'll need to significantly boost research in areas such as crop science, water conservation and natural fertilizers. Just as important, we'll need to recognize today's food crisis for what it is — not some once-in-a-lifetime perfect storm, but an early, and fairly tame, warning of the challenges ahead.

Paul E. Roberts is the author of the new book The End of Food.

Democrats and Our Enemies

By Joseph Lieberman
The Wall Street Journal
May 21, 2008
How did the Democratic Party get here? How did the party of Franklin Roosevelt, Harry Truman and John F. Kennedy drift so far from the foreign policy and national security principles and policies that were at the core of its identity and its purpose?

Beginning in the 1940s, the Democratic Party was forced to confront two of the most dangerous enemies our nation has ever faced: Nazi Germany and the Soviet Union. In response, Democrats under Roosevelt, Truman and Kennedy forged and conducted a foreign policy that was principled, internationalist, strong and successful.

This was the Democratic Party that I grew up in – a party that was unhesitatingly and proudly pro-American, a party that was unafraid to make moral judgments about the world beyond our borders. It was a party that understood that either the American people stood united with free nations and freedom fighters against the forces of totalitarianism, or that we would fall divided.

This was the Democratic Party of Harry Truman, who pledged that "it must be the policy of the United States to support free peoples who are resisting attempted subjugation by armed minorities or by outside pressures."

And this was the Democratic Party of John F. Kennedy, who promised in his inaugural address that the United States would "pay any price, bear any burden, meet any hardship, support any friend, oppose any foe, to assure the survival and the success of freedom."

This worldview began to come apart in the late 1960s, around the war in Vietnam. In its place, a very different view of the world took root in the Democratic Party. Rather than seeing the Cold War as an ideological contest between the free nations of the West and the repressive regimes of the communist world, this rival political philosophy saw America as the aggressor – a morally bankrupt, imperialist power whose militarism and "inordinate fear of communism" represented the real threat to world peace.

It argued that the Soviets and their allies were our enemies not because they were inspired by a totalitarian ideology fundamentally hostile to our way of life, or because they nursed ambitions of global conquest. Rather, the Soviets were our enemy because we had provoked them, because we threatened them, and because we failed to sit down and accord them the respect they deserved. In other words, the Cold War was mostly America's fault.

Of course that leftward lurch by the Democrats did not go unchallenged. Democratic Cold Warriors like Scoop Jackson fought against the tide. But despite their principled efforts, the Democratic Party through the 1970s and 1980s became prisoner to a foreign policy philosophy that was, in most respects, the antithesis of what Democrats had stood for under Roosevelt, Truman and Kennedy.

Then, beginning in the 1980s, a new effort began on the part of some of us in the Democratic Party to reverse these developments, and reclaim our party's lost tradition of principle and strength in the world. Our band of so-called New Democrats was successful sooner than we imagined possible when, in 1992, Bill Clinton and Al Gore were elected. In the Balkans, for example, as President Clinton and his advisers slowly but surely came to recognize that American intervention, and only American intervention, could stop Slobodan Milosevic and his campaign of ethnic slaughter, Democratic attitudes about the use of military force in pursuit of our values and our security began to change.

This happy development continued into the 2000 campaign, when the Democratic candidate – Vice President Gore – championed a freedom-focused foreign policy, confident of America's moral responsibilities in the world, and unafraid to use our military power. He pledged to increase the defense budget by $50 billion more than his Republican opponent – and, to the dismay of the Democratic left, made sure that the party's platform endorsed a national missile defense.

By contrast, in 2000, Gov. George W. Bush promised a "humble foreign policy" and criticized our peacekeeping operations in the Balkans.

Today, less than a decade later, the parties have completely switched positions. The reversal began, like so much else in our time, on September 11, 2001. The attack on America by Islamist terrorists shook President Bush from the foreign policy course he was on. He saw September 11 for what it was: a direct ideological and military attack on us and our way of life. If the Democratic Party had stayed where it was in 2000, America could have confronted the terrorists with unity and strength in the years after 9/11.

Instead a debate soon began within the Democratic Party about how to respond to Mr. Bush. I felt strongly that Democrats should embrace the basic framework the president had advanced for the war on terror as our own, because it was our own. But that was not the choice most Democratic leaders made. When total victory did not come quickly in Iraq, the old voices of partisanship and peace at any price saw an opportunity to reassert themselves. By considering centrism to be collaboration with the enemy – not bin Laden, but Mr. Bush – activists have successfully pulled the Democratic Party further to the left than it has been at any point in the last 20 years.

Far too many Democratic leaders have kowtowed to these opinions rather than challenging them. That unfortunately includes Barack Obama, who, contrary to his rhetorical invocations of bipartisan change, has not been willing to stand up to his party's left wing on a single significant national security or international economic issue in this campaign.

In this, Sen. Obama stands in stark contrast to John McCain, who has shown the political courage throughout his career to do what he thinks is right – regardless of its popularity in his party or outside it.
John also understands something else that too many Democrats seem to have become confused about lately – the difference between America's friends and America's enemies.

There are of course times when it makes sense to engage in tough diplomacy with hostile governments. Yet what Mr. Obama has proposed is not selective engagement, but a blanket policy of meeting personally as president, without preconditions, in his first year in office, with the leaders of the most vicious, anti-American regimes on the planet.

Mr. Obama has said that in proposing this, he is following in the footsteps of Reagan and JFK. But Kennedy never met with Castro, and Reagan never met with Khomeini. And can anyone imagine Presidents Kennedy or Reagan sitting down unconditionally with Ahmadinejad or Chavez? I certainly cannot.
If a president ever embraced our worst enemies in this way, he would strengthen them and undermine our most steadfast allies.

A great Democratic secretary of state, Dean Acheson, once warned "no people in history have ever survived, who thought they could protect their freedom by making themselves inoffensive to their enemies." This is a lesson that today's Democratic Party leaders need to relearn.

Mr. Lieberman is an Independent Democratic senator from Connecticut. This article is adapted from a speech he gave May 18 at a dinner hosted by Commentary magazine.

Wednesday, May 21, 2008

Energy and the Executive

By Pete Du Pont

The Wall Street Journal

May 19, 2008

This election is notable in many ways. For the first time since 1952, neither the president nor the vice president will be his party's presidential nominee. For the first time since 1960, a sitting U.S. senator will be elected president. And for the first time ever, if the Democrats win, the next president will be female or black.

We are also at a fork in the policy road, for any of the three major candidates would lead us in very different directions on major public policy issues, from spending and taxation on the one hand, to international relations and the war on terror on the other.

Equally critical will be their direction on how we generate the energy America needs. Over the past 20 years, have our presidents and Congresses allowed us to drill for the additional offshore oil available to fuel our economy and reduce imports? No. Have they encouraged the building of nuclear power plants that would generate pollution-free energy? No. Are they now supporting the building of coal-fired power plants to generate the electricity our economy needs? No.

We have an abysmal national energy policy, and as our population grows and our economy expands, energy needs will increase. From 1980 to 2006 America's annual energy usage increased from 78 to 100 quadrillion British thermal units, and the figure is estimated to grow to 118 quadrillion BTUs by 2030. If our regressive energy production policies continue when the next administration takes office, our economy and the personal lives of Americans will be severely affected.

We have failed to increase our country's crude oil production. Domestic oil production has declined, to 1.9 billion in 2007 from 3.1 billion barrels in 1980, while imports increased to 3.7 billion barrels from 1.9 billion. We now importing about 60% of the oil we use.

One reason for the imports is that our public policy has forbidden offshore oil drilling for much of the estimated 85 billion barrels of recoverable oil and 420 trillion cubic feet of natural gas (an 18-year supply) that are on the Outer Continental Shelf, and another 10 billion barrels of oil in Alaska. Together they could replace America's imported oil for about 25 years, but the first President Bush issued a directive forbidding access to a significant portion of the Outer Continental Shelf. President Clinton extended the restriction through 2012 and vetoed legislation that would have allowed drilling in Alaska.

So America has large amounts of oil and gas, but our efforts to extract it have been significantly reduced by the federal moratorium on drilling. America remains the only nation in the world that has curtailed access to its own energy supplies/ Meanwhile China will soon begin drilling for oil off Cuba and in Venezuela.

Among the worst antienergy policies we have experienced was President Carter's 1980 "windfall profits tax" on oil companies, which reduced domestic oil production by between 3% and 6% and increased imports by 8% to 16%. Yet last week Majority Leader Harry Reid and 20 other Senate Democrats introduced a similar 25% tax.

We have failed to allow the construction of new nuclear power plants to add to the 104 that we have in operation. Nuclear power is clean and efficient, but no new nuclear plant construction has been granted permits in the past 30 years. By contrast, China plans to build 40 nuclear power reactors in the next 15 years -- two or three each year.

Nor are we fully using the huge coal resources America has. We have in the past, but an effort to prohibit them has become the environmentalists' goal. NASA climatologist James E. Hansen said last month that "building new coal-fired plants is ill conceived," and that it is time "for a moratorium on coal now with phase-out of existing plants over the next two decades." The phase-out is under way: Of the 151 coal-fired plant construction proposals in 2007, more than 60 have been abandoned as the result of environmentalist pressure. And last month Gov. Kathleen Sebelius of Kansas vetoed a bill that would have allowed the construction of two new electricity generators at an existing coal fired power plant -- because they would emit greenhouse gasses.

We have also pursued new energy policies that turn out to be mistaken. Ethanol is perhaps the best example, with congressional enactment of ethanol subsidies -- 51 cents a gallon for production of it, and a 54-cent-a-gallon import fee to keep competitive, less expensive and more environmentally friendly ethanol out of America. Congress in 2005 required 7.5 billion gallons of ethanol to be produced by 2012; and then in 2007 upped that to 36 billion gallons by 2022. President Bush enthusiastically supports subsidized ethanol, and Barack Obama believes there should be a 65-billion-gallon ethanol mandate. Only John McCain wants to end ethanol subsidies and import fees.

Ethanol was a bad idea from the start, for as The Wall Street Journal recently reported, producing one gallon of ethanol requires 1,700 gallons of water (primarily to grow corn). The journal Science recently found that "corn-based ethanol, instead of producing a 20% savings, nearly doubles greenhouse emissions over 30 years."

The good news is that an effort to reverse all these antienergy, antigrowth policies is beginning. Earlier this month Sen. Pete Domenici (R., N.M.) introduced the American Energy Production Act to expand offshore oil production, establish a leasing program to get to Alaska's untapped 10 billion barrels of oil, and support the construction of new oil refineries. The last is a particularly good idea, for it has been 30 years since we have built one in the United States.

The May 11 New York Times contained a surprisingly sensible lead editorial: "The time has come to rethink ethanol. . . . Specifically, it is time to end an outdated tax break for corn ethanol and to call a time out in the fivefold increase in ethanol mandated in the 2007 energy bill."

So perhaps America is beginning to rethink its flawed energy policies. And so it must, for our challenge is to remain competitive in a growing global economy, and that requires feeding the engines of growth with more energy. Our next president must advance drilling for offshore oil, building nuclear power and clean coal fired plants, and developing other energies such as solar and wind power. Otherwise America's people will miss future opportunities and slip backwards economically, and our country will become far worse off than it is today.

Tuesday, May 20, 2008

The GOP Must Stand for Something

By Karl Rove

The Wall Street Journal

May 15, 2006

Tuesday's election results highlighted challenges for both Democrats and Republicans.

Republicans received a hard shot in Mississippi. Greg Davis (for whom I campaigned and who was a well-qualified candidate) narrowly lost a special congressional election in a district President George W. Bush carried four years ago with 62% of the vote. Democrats pulled off the win by smartly nominating a conservative, Travis Childers, from a rural swing part of the district who disavowed Barack Obama and House Speaker Nancy Pelosi and hit Mr. Davis from the right.

This blow to the GOP came after two other special congressional election losses in recent months. Republicans lost former House Speaker Denny Hastert's Illinois seat and Rep. Richard Baker's Louisiana seat.

Both of those losses can be attributed to bad candidates. But that only shows the GOP can't take "safe" seats for granted when Democrats run conservatives who distance themselves from their national party leaders. The string of defeats should cure Republicans of the habit of simply shouting "liberal! liberal! liberal!" in hopes of winning an election. They need to press a reform agenda full of sharp contrasts with the Democrats.
Why is it tough sledding for Republicans? Public revulsion at GOP scandals was a large factor in the party's 2006 congressional defeat. Some brand damage remains, as does the downward pull of the president's approval ratings. But the principal elements are the Iraq war and a struggling economy.

Gallup's 2007 report found that fewer voters identify themselves as Republicans now than at any point in the past 20 years – despite the fact that less than a fifth of Americans agree with Mr. Obama's call to rapidly withdraw from Iraq. And while many Americans are concerned about the economy, most are satisfied with their own finances.

As Republican ranks declined, the number of independents and Democrats grew. Has the bottom been reached? It's too early to know. But Americans are acknowledging progress in Iraq, economists are suggesting the economy will be in better shape this fall, and a recent ABC/Washington Post poll found GOP identification rising.

What is clear is that John McCain and Republicans will prevail only if they convince voters that there are profound consequences at stake in Iraq, and that more and better jobs will follow from the GOP's approach of lowering taxes, opening trade, and ending earmarks and other pro-growth policies.

Republicans also face challenges with the young (whose opposition to the war and attraction to Mr. Obama have made them Democrats) and Hispanics (the fastest-growing part of the electorate). A recent survey offers some encouraging news. Mr. McCain is polling as high as 41% with Hispanics – close to President Bush's 44% in 2004.

Democrats shouldn't be complacent after Tuesday. Their problems start with Mr. Obama's 41-point loss to Hillary Clinton in West Virginia. Mr. Obama lost the primary because the rejection of him by blue-collar voters is hardening. The last Democrat to win the presidency without carrying the Mountain State was Woodrow Wilson in 1916.

Barely half of Mrs. Clinton's supporters in Indiana, North Carolina and West Virginia say they're ready to support Mr. Obama against Mr. McCain today. Without solid support from these voters, Mr. Obama will be in trouble in Ohio, Pennsylvania, Michigan, West Virginia, Wisconsin and other battlegrounds.

So far, Mr. Obama owes his success to elites captivated by his personality. But in the general election, most folks will care more about a candidate's philosophy and stand on the issues. And what's considered mainstream values in a general election is different than in a primary.
Mr. Obama knows this, which is why he peppered his North Carolina primary night speech with culturally conservative language. And it is also why he is reaching out to Jewish voters.

Mr. Obama leads Mr. McCain 61%-32% among Jews. John Kerry won the Jewish vote 74%-25% in 2004. A weak performance for Mr. Obama could make it harder to win Michigan, Pennsylvania, Ohio or Florida. It could even put New Jersey in play.

Then there are the record low congressional approval ratings. No Congress has fallen as far and as fast as the Nancy Pelosi/Harry Reid-led House and Senate. Unlike President Bush, congressional Democrats will be on the ballot this fall, and can do little to improve their lackluster record before then. It must also be disconcerting for Ms. Pelosi that the Democrats' winning formula has meant conceding ground on guns, prayer, partial-birth abortion and other issues that matter to social conservatives.

Both parties face major challenges and have little time to alter the dynamics of the election to their advantage. Recognizing underlying problems and correcting them within a matter of a couple of months is one of the supreme challenges in politics. Whichever party does that fast and well will benefit come November.

Talking Versus Doing

By David Brooks

The New York Times

May 20, 2008

In 1965, Mancur Olson wrote a classic book called “The Logic of Collective Action,” which pointed out that large, amorphous groups are often less powerful politically than small, organized ones. He followed it up with “The Rise and Decline of Nations.” In that book, Olson observed that as the number of small, organized factions in a society grows, the political culture becomes more divisive, the economy becomes more rigid and the nation loses vitality.

If you look around America today, you see the Olson logic playing out. Interest groups turn every judicial fight into an ideological war. They lobby for more spending on the elderly, even though the country is trillions of dollars short of being able to live up to its promises. They’ve turned environmental concern into subsidies for corn growers and energy concerns into subsidies for oil companies.

The $307 billion farm bill that rolled through Congress is a perfect example of the pattern. Farm net income is up 56 percent over the past two years, yet the farm bill plows subsidies into agribusinesses, thoroughbred breeders and the rest.

The growers of nearly every crop will get more money. Farmers in the top 1 percent of earners qualify for federal payments. Under the legislation, the government will buy sugar for roughly twice the world price and then resell it at an 80 percent loss. Parts of the bill that would have protected wetlands and wildlife habitat were deleted or shrunk.

My colleagues on The Times’s editorial page called the bill “disgraceful.” My former colleagues at The Wall Street Journal’s editorial page ripped it as a “scam.” Yet such is the logic of collective action; the bill is certain to become law. It passed with 81 votes in the Senate and 318 in the House — enough to override President Bush’s coming veto. Nearly everyone in Congress got something.

The question amid this supposed change election is: Who is going to end this sort of thing?

Barack Obama talks about taking on the special interests. This farm bill would have been a perfect opportunity to do so. But Obama supported the bill, just as he supported the 2005 energy bill that was a Christmas tree for the oil and gas industries.

Obama’s support may help him win Iowa, but it will lead to higher global food prices and more hunger in Africa. Moreover, it raises questions about how exactly he expects to bring about the change that he promises.
If elected, Obama’s main opposition will not come from Republicans. It will come from Democratic leaders on Capitol Hill. Already, the Democratic machine is reborn. Lobbyists are now giving 60 percent of their dollars to Democrats, according to the Center for Responsive Politics. The pharmaceutical industry, the defense industry and the financial sector all give more money to Democrats than Republicans. If Obama is actually going to bring about change, he’s going to have to ruffle these sorts of alliances. If he can’t do it in an easy case like the farm bill, will he ever?

John McCain opposed the farm bill. In an impassioned speech on Monday, he declared: “It would be hard to find any single bill that better sums up why so many Americans in both parties are so disappointed in the conduct of their government, and at times so disgusted by it.”

McCain has been in Congress for decades, but he has remained a national rather than a parochial politician. The main axis in his mind is not between Republican and Democrat. It’s between narrow interest and patriotic service. And so it is characteristic that he would oppose a bill that benefits the particular at the expense of the general.

In fact, in this issue, McCain may have found a theme to unify his so far scattershot campaign. He has always been an awkward ideological warrior. In any case, this year may not be the best year for Republicans to launch a right versus left crusade. But McCain has infinitely better grounds than Obama to run as a do-what-it-takes reformer.

He has a long record of taking on not only the other party, but his own. In the current Weekly Standard, the brilliant young writer Yuval Levin suggests that McCain put reforming America’s decrepit governing institutions at the center of his presidential race.

Levin points out that the health care system, the immigration system, the regulatory system and the entitlement system all need reforms. Instead of talking about personal honor or perpetual tax cuts, McCain should focus relentlessly on modernization.

In fact, Monday in Detroit, McCain declared: “In all my reforms, the goal is not to denigrate government but to make it better, not to deride government but to restore its good name.”

Obama, sad to say, failed the farm bill test. McCain may have found a theme for a nation that has lost faith in its own institutions.