Thursday, July 10, 2008

My Interview with Top McCain Economic Advisor Phil Gramm

What follows below is an unofficial transcript of my interview on Kudlow & Company last night with investment banker and former Texas Senator Phil Gramm. Mr. Gramm is a top economic advisor to John McCain.

Kudlow: Joining us now is former Senator and chairman of the Senate Banking Committee, Mr. Phil Gramm. He’s John McCain’s top economic dog. Senator Gramm it is a pleasure to see you. Thanks for coming on sir.

Gramm: Thank you Larry.

Kudlow: Unfortunately Senator, this is a rough day. And I want to ask you some questions. Put your hat on.

Gramm: It sounded like a rough day the way you were yelling a minute ago.

Kudlow: Yes, this is not a good day. Markets are down. And I want to ask you, as former chairman of the Senate Banking Committee, Fannie and Freddie are getting clobbered Mr. Gramm. They’re down, really they’re approaching zero. Ten, fifteen points away from zero. The market has completely lost confidence. There’s a Fortune magazine story that’s talking about a doomsday scenario, what would happen if they both failed. I want to ask you, what would happen if they both failed? If the unthinkable happens?

Gramm: Well, let me make it clear you asked me this question.

Kudlow: Yes sir.

Gramm: I’m not speaking for Senator McCain.

Kudlow: Yes sir.

Gramm: Freddie and Fannie are not going to fail. Obviously they have not only the implicit guarantee of the government, but clearly that’s not going to happen. I think today was a very rough day on financials across the board. I do think it’s important to remember that for everybody that sold, somebody bought. And I think Freddie and Fannie are under stress, as the financial sector is. I think maybe Congress ought to go back and look at this taking of Freddie and Fannie funds to fund a program for housing. But Freddie and Fannie are important to the American housing industry. The way our system is structured, if we could go back to the Depression and start over, I don’t doubt we would do it differently. But I expect both of them to survive. But we are going through a very difficult financial period.

Kudlow: As I recall Senator, I used to have these accounts when I worked at the Office of Management and Budget many years ago, when you and I first met. As I recall, they have a credit line to the Treasury that is something like $2.5 billion dollars, which goes back many, many many decades. And obviously is nothing even remotely close to the assets on their balance sheet or the downside risk in the event of default, or worse, bankruptcy. I mean, how should taxpayers look at this? This thing could be a time bomb.

Gramm: Well I think people are obviously concerned about the financial markets. I think at some point here we’re going to feel the bottom of our housing problem. Obviously, I hope it’ll be tomorrow. And when we do, I think confidence will rebuild quickly. But I think clearly we have a problem today. And it’s not just in Freddie and Fannie, it’s in the whole financial sector. But, underlying the financial structure of the country, most of the major institutions are profitable except for their write-offs on subprime. If we can get through this period, I think we’ll see a quick recovery. But I think what anybody who is a policymaker today, and I am not, I’m an investment banker, but I think what anybody’s got to do is try to do the things that will get us through this period quickly. And that is basically trying to stimulate economic growth and investment.

Kudlow: Before we get back to stimulating growth and investment which is always a heck of a good idea, let me ask you about Ben Bernanke. In his speech yesterday, this was a speech heard ‘round the world, he said the Fed is going to have to accept the mantle of promoting financial stability, number one. Number two, he said the Fed is going to have to regulate and supervise the Wall Street banks, the investment banks. I don’t know whether your bank UBS fall into that. It’s certainly Merrill Lynch, and Morgan Stanley and Goldman Sachs and so forth. Number three, and this is a criticism coming from many people, that’s going to give [the Fed] two more mandates, stability and regulation of Wall Street. Their first two mandates, low unemployment and low inflation have not been met. Unemployment is rising. Inflation is rising. Sources tell me The Wall Street Journal editorial page may call for Bernanke’s resignation tomorrow. Do you think Bernanke and the Fed are on a power grab? Do they deserve this added turf? Is this the right thing? Or maybe the stock market’s telling us it’s all wrong?

Gramm: Well we’re already regulated by the Federal Reserve Bank. Look, Larry, when the Federal Reserve Bank stepped in, trying to deal with systemic risk – and I think they did a very good job, and I give Bernanke very high marks on it – they basically changed the nature of investment banks and non-bank financial institutions in America. Having the data to make judgments about systemic risk makes sense. And I think it has been clear since their intervention that this was going to happen. Any move can turn into a power grab. I don’t see this as one as of today. I’m afraid that I think Bernanke has done a very good job. I think he was very clever in auctioning off loans and getting rid of the stigma of borrowing from the Federal Reserve Bank discount window. I think he’s done a good job. Especially given that he had not established a long reputation as Greenspan had. Any idea of him stepping down I think would be wrong. I would be adamantly opposed to it. I’m sure Senator McCain would be opposed to it.

Kudlow: Alright.

Gramm: These are not easy times.

Kudlow: Right.

Gramm: And when you’re being decisive, as he is being, and when you’re beginning to face a threat to the dollar, the inflation threat, in addition to the softness of the economy, this is a tough job. And I think he’s doing a good job at it. And I think we’ve got to be supportive. Leaders, when they face tough decisions, deserve our support.

Kudlow: Alright. So ultimately the buck stops here in the Oval Office, and President, possible President to be John McCain. You’re a top advisor. What would Mr. McCain say? We have rising unemployment. We have rising inflation. We have a falling dollar. What’s he gonna say? How are you advising him? How will he get the economy back on track?

Gramm: Well I think, first of all, he’s going to try to go back to programs that work. We’re not talking about faith; we’re talking about evidence. And we know the evidence, that fiscal responsibility works. It will strengthen the dollar. It will bring down oil prices. We know the corporate tax rate in America is the second highest in the world. And when you bring in state corporate tax rates – which none of the other OECD countries have – we have the highest corporate tax rate in the world.

ITT says they can build a plant and operate it in ten years, for ten years, in Ireland for a billion dollars less than they can do it in the United States because of the corporate tax rate. Obviously, we can’t live with that rate as it is. And I think we can collect more taxes by attracting more investment, by bringing it down from 35 percent to 25 percent. Senator McCain wants to do that. I know it looks popular for some in Congress, and for Senator Obama, to be calling for raising the top tax rates. But the problem is 85 percent of the taxes paid in the top bracket are paid for by small businesses filing as subchapter-S corporations or with pass-through income. And so you’re socking small business at the very moment that we need to create more jobs.

Kudlow: Okay. Let me just get you to react to—you know Senator Obama has been very critical obviously, and this is going to be a major part of the campaign and the debate. Senator Obama says Senator McCain’s plan is for millionaires and big corporations. Instead, he says he’s gonna give everybody under $250,000 a year a $500 tax credit, a thousand dollars per family, per household, to offset Social Security expenses. Let me ask you this, does Obama have a more direct assistance in this plan to the middle class than Mr. McCain?

Gramm: No. Now let me ask you a question. How many people poorer than you have ever hired you?

Kudlow: [Laughter]

Gramm: Zero.

Kudlow: Listen I’m not sculpting Obama’s message. But Obama is ahead by six or seven points in the polls or thereabouts. And I’m just saying that’s the distinction in this campaign. [Obama] says he’s going to give everybody $500 bucks, a thousand per household, help them pay off their Social Security liabilities, and that’s gonna help the middle class. The middle class is up for grabs Senator. Is Senator McCain in favor—does his plan resonate with the middle class as much as Obama’s, in your view?

Gramm: Yeah I think it will. Let me give you an example. Both Senator McCain and Senator Obama came out in the primary for doubling the dependent exemption. Senator Obama came out for doubling it by raising the top tax bracket, which is a tax on small business. Senator McCain came out for a program to reclaim the budget authority from the add-on of $18 billion dollars with earmarks in 2007, and an add-on of $17 billion dollars in 2008. Now when you ask Americans, do you want to fund doubling the dependent exemption so that families have got more money to spend on their own children – something both candidates agree to – do you want to do it by stop building bridges to nowhere, and stop pork barrel add-ons, or do you want to raise taxes on small business? I think the choice is pretty clear.

Kudlow: Alright. Thank you for that. One last one sir. We appreciate your time very much. I’m sorry to bring you on in a rough day. Cap-and-trade, Senator McCain has kind of shifted toward a pro-production, pro-energy production, he’s now in favor of offshore drilling. I think he’s in favor of drilling up in the oil shale. He’s not quite there yet on ANWR. I noticed in his two latest economic speeches – which were very much pro-growth, supply-side speeches – he did not mention cap-and-trade. I also noticed in his 15-page policy pamphlet, which most people don’t read, but I did, and you may have written it, there is no mention of cap-and-trade. Many conservatives think that would be the biggest expansion of government in American history. Is cap-and-trade dead in the McCain campaign?

Gramm: No. But let me make it clear. You know some people have been critical of the senator for moving so aggressively on nuclear power and opening up the [Outer] Continental Shelf where states agree and share in the revenues. But look, if you don’t see the world differently at $140 dollars a barrel then you did at $40 a barrel, something is wrong with you. I mean, the world has changed dramatically. And we need to act dramatically. The old tired clich├ęs of the past—speculators, big oil companies—that’s not gonna get the job done. If we want more energy, we got to produce it. If we can produce more of it here at home, at a price people can afford to pay, we’re going to be better off.

Senator McCain is concerned about the environment. There’s no conflict between trying to expand our ability to produce energy at home and being concerned about the environment. In terms of cap-and-trade, I think we’re gonna have to make a fundamental decision. If the objective is to change the relative price of carbon-generated products, that’s one thing. But the tax also makes people poorer. And I think what we need to do, if we take this policy, and we go in that direction, is we need to take the revenue and give it back by cutting the payroll taxes, income taxes and corporate taxes to eliminate the wealth effect. To simply get the substitution effect to try to deal with global warming. But the idea of letting government spend that money is very frightening. And it would be a disaster for freedom and for America.

Kudlow: Alright, that’s great stuff. Thank you very much, Senator Phil Gramm. We appreciate it sir.

Gramm: Thank you. Calm down. America will survive.

Kudlow: I’m with you. You got to look at the optimism for the long run. Free market capitalism is the best path to prosperity.