This from Money Morning:

With his landslide election victory Tuesday – coupled with Democratic gains in the House of Representatives and in the Senate – U.S. President-elect Barack H. Obama II will have the ability to pursue more or less any policy he wants.

For investors who have been trying to analyze the economic outlook for the New Year, the election of U.S. Sen. Obama (D-Ill.) provides a major piece of the forward-looking jigsaw puzzle that these analysts hope to assemble. That’s because the likely trends of the United States and other economies around the world – and the relative success of different sectors within those economies – depends crucially on who’s in the White House, what policies they have, and how effectively they can pursue those policies.

Only one thing keeps the triumph of the incoming Democratic president from being totally complete: The Republicans appear to have held onto 41 Senate seats, enough to prevent the Democrat majority from overriding a united filibuster. In practice, however, there are few issues on which the Republicans will be completely united. Thus, on only a few “litmus test” issues – such as the “Employee Free Choice Act,” which removes the secret ballot from union elections – is this filibuster threat likely to be effective.

Obamanomics: From the Environment to Health Care

A review of President-elect Obama’s economic policies – characterized by the term, Obamanomics – clearly offer profit opportunities. Let’s take a closer look at some key areas to consider in 2009.

In the economics area, Obama’s two signature policies are a promise to institute a “cap-and-trade” system of carbon emissions permits to combat global warming, and a substantial expansion in state healthcare provision, notably to include universal healthcare provision for minors.

On the energy front, the support of U.S. Sen. John McCain (R-Ariz.), for the “cap-and-trade” system will make it much easier for Obama to pass legislation quickly, probably in the first half of 2009. Under Obama’s proposed legislation, emission permits will be auctioned to utilities and other businesses with substantial carbon emissions. This has the advantage of being more of a free-market approach than McCain’s plan to give away the permits for free, which would have required the creation of a huge government bureaucracy to decide who would get those permits.

Even so, Obama’s approach has the disadvantage of imposing gigantic new costs on utilities and other carbon emitters. Indeed, Obama himself has said that new coal-fired power plants would become hopelessly uneconomic under his plan – chiefly because of the costs of the emissions permits they would need. That suggests that nuclear power plants (which he does not oppose) would account for the majority of new power-station construction during the Obama presidency – although solar, wind and other power-generating technologies that look pretty and can be made to work also will fare well.

The corollary of Obama’s emissions permit program, therefore, is that an investor should sell coal-producing companies and coal-fired electric utilities, and invest in nuclear power stations and uranium-mining companies. In principle, there should also be opportunities in the solar- and wind-power sectors, but the “new energy” fad of the last couple of years has already driven their valuations to uneconomic levels.

On the healthcare side, investment recommendations are more difficult to isolate. Generally, Democrats are skeptical of the patent protections enjoyed by pharmaceutical companies – as well as the high prices those protections create – so the major manufacturers of patented drugs should be avoided.

Conversely, the producers of generic drugs appear poised to benefit from the increased spending on healthcare – especially the manufacturers of pediatric healthcare products, including pharmaceuticals – should benefit from the Obama program’s emphasis on children’s healthcare.

Financial Crisis Redux

Of all the questions investors will have about the New Year – following Obama’s victory – is what the new administration will do about the current financial crisis.

A federal bailout package – consisting chiefly of spending increases – seems almost certain in the short term; that will cause the federal deficit to balloon even more than it has already, will make U.S. Treasury bond financing increasingly difficult, and will further stoke inflation. In those circumstances, avoid Treasury bonds, except the inflation-protected buying Treasury Inflation Protected Securities (TIPS), the principal and interest of which are linked to the Consumer Price Index (CPI). TIPS currently have an attractive yield around 3.0%.

It seems likely that an Obama administration will tend to impose costs on the financial-services sector in return for the bailouts it receives – perhaps, for example, banks will be required to funnel lending into low-income areas, or toward other chosen beneficiaries. Limits on financial-sector remuneration also may make it difficult for the major banks to do business, particularly in the trading area. The Democrats have a more aggressive attitude toward “predatory lending” than the Republicans, and will undoubtedly find innumerable examples of such lending in the mortgage and credit card area over the next few years, which they will wish to punish. Hence, financial sector investments should be generally avoided.

Potential Profit Plays

On the other hand, both Obama and the Democrats seem more likely to propose bailouts for states and municipalities that find themselves in budgetary hot water because of the recession that’s sure to come (if it’s not here, already). Thus, municipal bonds, which carry a considerable credit risk under a tight-fisted Republican administration, may be thought of as less vulnerable to default under an open-handed Democrat administration with sympathy for the issuer’s problems, particularly if that municipality represents a core urban Democratic constituency.

When New York City got in trouble, U.S. President Gerald Ford – the Republican who succeeded the disgraced Richard M. Nixon – took an unsympathetic attitude and The New York Daily News captured his perceived attitude with the headline: “Ford to City: Drop Dead!” No such episode will occur under the urban-oriented, free-spending Obama!

And that makes munis a “Buy.”

Also in the “Buy” category are automobile and auto-parts companies. No matter which candidate ended up winning Tuesday, the victor would almost certainly decide to bail out U.S. carmakers, as well as the suppliers that rely on them. After General Motors Corp. (GM) was rebuffed in its bid for aid by the Bush Administration, the bailout of U.S. carmakers is now being billed as a top priority for the incoming President Obama.

Automakers such as GM and Ford Motor Co. (F) benefit from being the headliners in an iconic U.S. industry – especially because it’s one that employs lots of potential Democrat voters in industrial states and suffer from international competition that increasingly riles the more protectionist Democrats. A bailout is thus inevitable, probably without involving the automobile companies in a Chapter 11 bankruptcy. And that makes their shares worth a “flutter.”

President-elect Obama’s supporters celebrated ecstatically Tuesday night. Investors should be more skeptical. But looked at carefully, an Obama administration – and Obamanomics – would still seem to offer opportunities for profit in the New Year.

Source: Money Morning Outlook 2009: Obamanomics Offers Investors Plenty of Profit Plays in the New Year

JP Morgan Chase has announced it will delay foreclosure proceedings while it works with struggling homeowners.  Over the next 90 days, the bank will look at loans and determine if the loan is eligible for a reduced interest rate or loan balance.

The company has already helped over 250,000 families with over $40 billion in troubled loans, and over the next two years plan to help another 400,000 homeowners with over $70 billion in loans. Loans held by Washington Mutual (NYSE:WAMU) and EMC Mortgage Corp, which were recently acquired by JP Morgan Chase, will also be eligible for revision.

What remains to be seen is the effect this will have on foreclosure rates. Reducing a borrower’s interest rate slightly doesn’t necessarily translate to a large reduction in a mortgage payment. A drop of $75 or $100 a month in the mortgage payment would be welcome for the homeowners, but the savings could quickly be eaten up by rising costs elsewhere.

Hopefully the plan relies more on reducing principal balances to more accurately reflect fair market values. This would help by stabilizing home values at fair-market levels, rather than letting foreclosures decimate neighborhoods.

For example, if a home bought a few years ago for $250,000 gets re-appraised for $180,000 and the borrower can now afford the payments and avoids foreclosure. This drops the value down to $180,000 for comparables, but avoids a potential drop to $125,000-140,000 if the home goes into foreclosure and gets sold at auction. Not a perfect solution, but anything is better than another foreclosure.

Source: Focus Can Now Shift To The Collapsed Housing Market

This from Investor’s Daily Edge:

It’s finally here.  The long awaited and hard fought election will end tomorrow (at least I hope we don’t see a repeat of 2000 where we don’t know who won for weeks).  Rather than make predictions about the election itself, I want to tell you how I think things will play out after the election.

First, I think the overall market will rally after the election regardless of which candidate wins.  There could be a knee-jerk reaction to the downside should Obama win, but this is part of the old belief that Democrats are bad for business and investing.  History tells a different story than the actual belief though.

The thing that will happen on Wednesday is that the uncertainty will be removed.  The uncertainty of the election has been weighing on the market for the past few months.  It’s been hard to tell, because of the credit crisis, but trust me the election has been weighing on the market as well.

So overall we will likely see the market rally over the next couple of months.  Historically the market rallies after elections, regardless of whether it is a Republican or Democrat that is elected.

Secondly, as I have expressed in recent articles, the market is extremely oversold and the sentiment is extremely bearish.  So even if this weren’t “the most important election of our life” we would likely see a year-end rally.

As far as each candidate and the sectors they will impact the greatest, the scenarios are very different in some areas and very similar in others.  Let’s look at the winning and losing sectors under both Obama and McCain.

The big winners with an Obama victory will be Biotechnology and Alternative Energy.  With Biotech, the fact that Senator Obama wants to give the healthcare system a complete overhaul will push for new technology that improves healthcare at a lower cost.  Look for incentives to flow into this sector whether it is with tax credits or grants, there will be a push for new developments from the group.  Senator Obama also supports stem-cell research and should he win, look for a boost to stocks in this arena.

Alternative Energy, particularly solar, will be a big beneficiary of an Obama administration.  On the campaign trail he has said he wants to direct $150 billion towards alternative energy and lowering our dependence on foreign oil.  As we all know, what is said on the campaign trail and what is done after the fact can be very different.  While he might not able to direct the whole $150 billion toward the sector, you can bet there will be money pushed that way, how much money is available will be determined later.

One sector that will certainly get hurt with an Obama administration is big-cap pharmaceuticals.  The same desire to overhaul the healthcare system that I mentioned as a benefit to biotech will be a hindrance to pharmaceuticals.  The reason for this is that he will likely push for lower drug prices at the consumer level.  This will limit what the drug makers can charge and limiting their revenues.

As for McCain, the obvious winners will be the Defense sector and oil and gas sectors.  While Obama believes a timeline should be set for withdrawing from Iraq, McCain doesn’t believe such a mandate should be put forth and the U.S. will likely continue to spend heavily on Defense should McCain win.

A McCain victory should also provide a boost to nuclear energy companies. He has made it clear on the campaign trail that he is in favor of finding alternative energy sources beyond oil, but where Obama prefers wind and solar energy, Senator McCain prefers nuclear energy.

One area that will likely lose should McCain win is the infrastructure sector.  Senator McCain wants to curb government spending, at least that is what he is saying on the campaign trail.

Like I said about Mr. Obama wanting to spend $150 billion on alternative energy sources, what is said on the campaign trail and what actually happens after the election are two different things.  Remember President Bush campaigned on less spending as well, but there haven’t been any cuts in spending over the last eight years.

Regardless of which candidate wins, they will be inheriting one heck of a mess.  The current economic environment is one of the worst I have seen in my lifetime, the deficit that we are facing is astronomical, and the job losses we have had over the last year have combined to make this a daunting task for the next administration.

Consumer confidence is at an all time low recently.  The best thing the new President could do for this country is lift the spirits of our citizens.  Consumers are not likely to open up their wallets until they see hope that the economy is improving.  Lifting the confidence level might get them to open their wallets a little.

Regardless of who wins tomorrow, I wish them luck.  They are going to need more after the election than they need it in the election.

Source: Winning And Losing Sectors After The Election

This from Taipain Daily:

For the last 25 years, Soros observes, the “motor of the world economy” has been the American consumer. And not only has the American consumer been aggressively consuming, he “has been spending more than he has been saving.”

“So that motor is now switched off,” says Soros. “It’s finished. It’s run out of — can’t continue. You need a new motor.”

The declines of that truly awful week when the Dow lost 18% were tied to the credit crisis. Before governments across the globe stepped up, there was a fear that nothing would be done.

The declines that followed Monday’s rally, however, were tied to a separate issue… rooted in fears that the US consumer may, after many years and countless false alarms, be well and truly tapped out.

If so, we don’t know what the new “motor of the world economy” is going to be.

Soros has a notion of what that new motor could be. Moral aspects aside, I think he is right. It’s an idea some readers will like and others will hate…

“We have [another] big problem,” Soros says. “Global warming. It requires big investment. And that could be the motor of the world economy for years to come… instead of consuming, building an electricity grid, saving on energy, rewiring the houses, adjusting your lifestyle where energy has got to cost more until you introduce those new things. So it will be painful. But at least we will survive and not cook.”

The Green New Deal

Concerns over global warming and the high cost of fossil fuels are closely aligned. Whether or not you embrace the concept of global warming – and there is still real debate on the subject – you no doubt remember the sky-high fuel prices the world had to deal with earlier this year.

Energy prices are falling now, mainly due to deflation fears and the phenomenon of “demand destruction.” But when global growth resumes, energy prices will go right back up again. And then there are the indirect costs, like the rampant pollution and quality-of-life issues that plague China and India.

Many top thinkers thus agree with Soros. There is a very strong feeling that the world needs a “Green New Deal”… an alternative-energy-focused motor that can get the global economy humming again.

2008 versus 1932

Let’s take a quick look at the similarities between now and the 1930s.

When FDR took office in 1932, a devastating financial crisis was in full swing. (Sound familiar?) The country was desperate for leadership. Partisan lines were blurred as the whole of America demanded change.

FDR wasted no time laying into the bankers. His harsh words were right in synch with today’s times: “Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men….The money changers have fled from their high seats in the temple of our civilization.”

Fled from their high seats, indeed. After declaring a bank holiday, FDR wasted no time in drafting new legislation, overhauling the system, and generally trying to get America back to work.

American farmers were a major focus of FDR’s New Deal. The general belief was that farming held the key to getting the economy back on its feet. In the end, many controversial programs and measures were put in place… more than a few that live to this day. While farming served as the linchpin back then, green energy can serve as the linchpin now.

So was the original New Deal effective? Was it a good thing? That’s a can of worms your humble editor would rather not open.

Some feel FDR did little more than dig holes so he could order men to fill them up again. The skeptics further argue it was really only World War II that brought the United States out of its epic slump. FDR’s defenders, on the other hand, feel that the programs implemented and leadership provided were absolutely necessary for the times. Your humble editor shrugs.

Pragmatic Thoughts (Not Moral Pronouncements)

We are more interested here in sussing out what’s likely to happen, rather than debating the right or wrong of whether it should. And in that regard, it looks like the pieces are in place for the new FDR (i.e., America’s next president) to implement a Green New Deal.

Consider the backdrop of current events:

• We are in a time of unprecedented financial crisis (not unlike 1932), with little or no dissent toward the assertion that free-market capitalism has imperiled its very existence (and must be reined in).

• The American public – and the world at large – is desperate for leadership, to a degree that is only possible in a time of true crisis. (When things are better, people focus on their day-to-day lives.)

• Political leaders have the added impetus of avoiding at all costs a repeat of the mid-to-late 1930s. Their desire to sidestep the full “Great Depression experience” creates an added sense of urgency.

• In terms of economic thought, John Maynard Keynes rules the day. When all the “guarantees” are added up, trillions have already been committed on both sides of the Atlantic. Trillions more could well follow.

• U.S. consumers account for 20% of world GDP in spending terms (Martin Wolf). Global leaders everywhere are deeply aware of the danger of John Q. Public sputtering out, and thus deeply keen to get a new “motor” up and running.

• Alternative energy is the “motor” candidate for which all the right boxes are checked. There is moral authority (via global warming concerns); global buy-in (via the energy issues all non oil-exporting countries face); massive scale and scope (projects too vast for the private sector to handle, i.e. retrofitting tens of thousands of gas stations across the U.S.); and, last but not least, a genuine need for massive spending (many trillions for new and upgraded infrastructure).

From Pelosi to Eisenhower

We are likely to see more crisis spending in the days ahead. Like the war in Iraq, the final tally for government involvement in the global financial system will only rise and rise. (Unlike Iraq, however, there is at least the possibility that taxpayers will profit… but that’s a speculative notion, and a very long-term one at that.)

On October 8, House Speaker Nancy Pelosi gave a foretaste of this with her call for a $150 billion stimulus package aimed at Main Street rather than Wall Street. Assuming an Obama win, the Democrats are planning to hit the ground running on November 5. That means breaking out the checkbooks for Round Two (and Three, and Four, and so on).

If McCain wins, the spending outlook doesn’t change that much. He, too, has plans to bail out U.S. homeowners. A Republican White House paired up with a Democratic Congress might even touch off a “top this” contest to see who can be more generous.

Whoever wins, the U.S. budget is going to be busted like never before…. and it will not be long before the “Green New Deal” starts taking shape. As it does, do not be surprised to hear a buildup of references to good old Dwight Eisenhower.

Roughly one half century ago, President Eisenhower signed the Federal-Aid Highway Act of 1956. As a result, there are just under 47,000 miles of interstate highway crisscrossing the United States today. The longest stretch, route I-90, runs a full 3,000 miles across the continent.

Ike’s highway system was not at all cheap to build, and still costs upwards of $80 billion a year to maintain. But given all we’ve gotten these past 50 years, who will dispute it was worth it? The open road is an indelible part of American life and culture – not to mention the incalculable value of transport, or the millions of truck stops, burger joints and bedroom communities that sprang up on the new interstate.

From Roof to Shining Roof

When you start with Ike’s highways, it’s not hard to imagine the same type of grand vision applied to green energy solutions.

The soaring speeches practically write themselves. Just imagine it: Millions of proud, hard-working Americans climbing up on the roofs of their eco-friendly homes, installing the solar panels that will set them free from the burden of high energy costs, while leading an industry boom that restores and renews the nation.

Or picture fresh-faced toddlers waving from the back seats of biodegradable electric cars – cars built by American hands in freshly capitalized Ford and GM plants, designed to travel up to 300 miles per day on near-zero emissions, plugging into the natural gas and nuclear-powered grid at night to refuel. My Country ‘Tis of Thee, Sweet Land of Li-ber-ty…

OK, that was a little cynical. But you get the idea. If the US consumer is tapped out, then America — and the world — will need a new deal. So why not make it a green one? And on top of that… whisper it now… who wouldn’t mind another investment bubble (this time in alternative energy shares)?

Mind or not, we’re going to get one of those, too… a new bubble, that is. When the next mania comes, alternative energy is almost certainly where it will take root. Financial panics will come and go, just as they’ve been doing for thousands of years — did you know Wikipedia has an entry for “The Business Panic of 33 AD”? — but human nature never changes.

Who Pays for All This?

By now you might be wondering: Who’s gonna pay for all this stuff? Where will the money come from?

It’ll mainly be taxpayers, of course… the same people who always pay. But a mass investment wave in global green infrastructure will at least have some nice follow-on benefits. Like Eisenhower’s highways, we’ll get something solid in return for our investment — unlike the trillions that simply vanished into the maw of the great Wall Street housing bubble ponzi scheme.

Over-eager investors will also voluntarily pay a big chunk of the “green” bill, too. I speak here of those who will wind up plowing their money into the green tech bubble (once it inflates) at the very height of the boom, paying for excess capacity that plummets in price to become a cheap consumer good later.

In other words, excess capacity in the short run will lead to wonderfully cheap green energy in the long run. It will happen with “green tech” the same way things are playing out now with bandwidth. A few years back, bubble-hyped telecom investors fudged the profit calculations on thousands of miles of fiber-optic cable. In result, they were forced to sell their stakes at a blowout loss, leaving the cable in the ground for you and me to enjoy at low cost.

It’s an old historical pattern. We saw it even earlier with the railroad boom and bust. After the great railroad investment debacle, the trains and tracks were still there for the country to use. On the heels of the Green New Deal will be the Green Mega-Investment Bubble – and then, when that bursts, a wonderful glut of energy saving technologies on the other side.

But now we’re getting ahead of ourselves… There will be huge profits to be made on the run-up in all things green, likely sustainable for many years, before we circle back round to bust again. And so it goes.

Source: The Return of FDR, Part III: The Green New Deal

The cure is not more regulation – in fact, the current rules are a big reason why we’re in this dire situation.

Almost a year ago, an accounting rule known as FAS 157 went into effect. This rule has been called the “fair-value rule,” but it’s not working that way. FAS 157 is forcing companies to write off tens of billions of dollars in debt-related investments.

That’s because of FAS 157’s requirement of a “mark-to-market” valuation on these investments each quarter. Mark-to-market essentially means the value of these investments if they had to be sold immediately. Current uncertainties and liquidity issues have chased away just about all of the buyers for many of these investments, so the markets are distorted. When there are no buyers, under FAS 157 the value has to be marked down, sometimes to zero. This is the case even for securities that could be sold in the future at face value once they reach maturity.

Overlaying FAS 157 with the demands of Sarbanes-Oxley creates a recipe for continuous quarterly writedowns until all value is gone. New York has lost its status as the world’s financial capital since Sarbanes-Oxley was enacted, and the harsh requirements of FAS 157 may accelerate that trend.

This is not a blind defense of the companies that have invested heavily in derivatives that Warren Buffett called “financial weapons of mass destruction” in 2002. In the next six years, these financial WMDs grew by 500 percent to more than $500 trillion. The sheer size of these derivatives has greatly increased the risks of catastrophe, and the danger is further elevated because of FAS 157 and Sarbanes-Oxley.

Source: U.S. Global Investors

Because global financial markets are woven in a complex web, turmoil in one sector is felt elsewhere. Some wounded financial companies are desperately selling healthy stocks to raise capital to stay afloat, and this heavy selling pressure is forcing down the price of these stocks. The same is being done by leveraged hedge funds that have been hurt by their investments in financial stocks – they need to raise money for shareholders who want out of their fund, so they are selling good stocks to get cash.

This talk of new regulation reminds me of one good rule that got away. The SEC eliminated the “uptick rule” for short-selling stocks last year, and this has facilitated a rise in illegal “naked shorting” that has hurt financial companies and impaired their ability to refinance.

The New York Times had an interesting op-ed article on this subject on Sept. 14 titled “Too Few Regulations? No, Just Ineffective Ones” by Tyler Cowen, an economics professor at George Mason University.

One of Cowen’s best observations was “financial regulation has produced a lot of laws and a lot of spending but poor priorities and little success in using the most important laws to head off a disaster. The pattern is reminiscent of how legislators often seem more interested in building new highways – which are highly visible projects – than in maintaining old ones.”

He also pointed out that 70,000 new pages of federal regulations in a single year is not an uncommon feat, and that the inflation-adjusted spending by the federal agencies regulating banking and finance has gone up more than 40 percent since 1990.

New rules are what Washington knows how to do best – it’s how legislators measure their worth. And while there are times when new regulations make sense, this isn’t one of those times.

Hearing the solutions offered by McCain and Biden today reduces my confidence that either the Democrats or the Republicans have the knowledge or the imagination to take on the biggest economic crisis in America since the 1930s.

Source: Obama and McCain Don’t Understand Markets

Obama has pledged to introduce a windfall profit tax on oil companies and raise income tax for those earning over $250,000 a year if he wins the White House. McCain favors a lower corporate tax rate (from 35% to 25%) and suspension of fuel taxes during summer. Both seek tax cuts for the middle class.

“Investors should focus their minds around one uncomfortable fact,” says Martin Hutchinson in Money Morning. “Whether it’s Obama or Republican John McCain who wins the White House, expect some policy changes that won’t sit well with investors — or with the U.S. economy.”

Of all the anticipated changes, the most widely publicized is the expected introduction of a so-called “cap-and-trade” carbon-emissions-control system. Both Obama and McCain favor such a system and Congress is currently drafting legislation that is not expected to pass this year (while George W. Bush is still president), but to form a template for legislation from a Democrat-controlled Congress to be signed by either Obama or McCain in 2009.

The most economically efficient way to curb carbon emissions is by means of a carbon tax. Such a tax would penalize emissions by polluters at a flat rate per ton, and could be offset by reductions in other taxes – a decrease in the corporate tax rate, for example – thus neutralizing its overall economic effect.

Provided the tax was set at a moderate rate, it would provide incentives to shift from carbon-based fuels to other energy generation systems, while the market itself would determine which carbon uses would be discontinued and which were too expensive to change. It wouldn’t matter too much at what level the tax was initially set, since a moderate error in setting the level would produce only moderately suboptimal polluter behavior, as the incentives produced either a little too much clean-up and consequent economic damage, or not quite enough.

The carbon tax is unpopular with politicians, because of the word “tax.” From bitter experience, they have found that raising taxes leads to unpopularity and, ultimately, to electoral defeat. Even if other taxes are lowered, the squawks of the complaints and protest of the losers are always much louder than the contented purring of the winners. That explains their preference for a “cap-and-trade” emissions policy, under which politicians pretend to give something away, providing licenses to pollute, which can then be traded among users.

The main difference between the cap-and-trade schemes of McCain and Obama is this: McCain would allow the government to give out permits to polluters while Obama would auction off permits.

At first glance, McCain’s approach appears more pro-business, but consider this: If the government gives out the permits, it gets to choose which companies get what permits. That creates a huge new playing field for lobbyists and opens the door to all sorts of new opportunities for corruption, as polluters “compete” to gain the political favor of an emission permit allowance. Already in the draft Congressional legislation provision is being made for favored groups to be given special allowances of emission permits – essentially the same as the government giving them cash, as the permits will have value.

Under Obama’s proposal, however, the government will auction off the permits. That will ensure that their price is set by a market process, and that companies neither gain nor lose by their special access to legislators. It’s a much more honest process, and a much-better representation of the “free market.” And the extra revenue it generates can be returned to the taxpayers via tax reductions in other areas.

Indeed, the only disadvantage of Obama’s proposal compared to a carbon tax is that the government has to determine initially how much carbon should be emitted. That is a very difficult parameter to determine, and an error of 1%-2% in either direction can have a huge effect – as shown by the 2004-07 European Union emission permits, where too many were given out. As a result, the prices in the permit trading market dropped 98% in a couple of weeks, as companies discovered there were ample permits for all. A market with that degree of uncertainty is far more likely to result in corporate-finance game playing than in any serious reduction in emissions.

McCain’s proposal contains a number of additional potentially detrimental features. Under it, reducing emissions in emerging markets can satisfy emissions requirements. But as the European Union has discovered, one spin-off effect has been the creation of a thriving market in Chinese environmental-cleanup scams. Further complicating the scene is the fact that some industries would be partially exempted in order to allow for transitional difficulties – providing another fertile field for government meddling and corruption. Still, even with Obama’s proposal, a “cap-and-trade” system is likely to do significant economic damage, and given the fact that legislation would need to be drafted by Congress, the chance of huge economic distortions must be considerable.

A second area where both candidates essentially agree is that taxes will be higher. McCain obfuscates this, because he needs to preserve his relations with the Republican “base.” But he has made it very clear that fiscal discipline in terms of balancing the U.S. federal budget is his most important economic objective. And he favors further activity in the Middle East, a fact that’s likely to involve an expansion of defense spending. Since, even without a recession, the federal deficit in the years to September 2008 and 2009 will be close to $500 billion, McCain’s balance-budget objectives cannot be achieved without tax increases, both reversal of most of the 2001 and 2003 tax cuts and increases beyond that.

Obama has been more up-front about his desire to reverse the 2001 and 2003 tax cuts, and to impose Social Security contributions on incomes above $200,000. Since he also favored U.S. Rep. Charles B. Rangel’s bill, which increases income taxes on higher incomes, an Obama administration could potentially increase the top marginal rate of income taxes increase from 35% to 52%.

Obama also favors an increase in the capital gains tax rate from its current 15% to at least 20%. On the positive side of the budget, an Obama administration would presumably save money in the Middle East. And his health-care plan, which mandates coverage for children but not for adults, would presumably be somewhat cheaper than Hillary Clinton’s plan.

Nevertheless, tax increases are inevitable no matter who wins in November. And if Obama were to win those new levies might include a supercharged capital-gains tax and even dividend-tax increases – either of which could hammer U.S. stock prices.

A third area of agreement between the candidates is in greater regulation of the financial-services business. From the viewpoint of a retail investor, this may be a good thing: After all, who could object to fewer scams and rip-offs, or-less-egregiously overpaid investment bankers?