Our new president, Barack Obama, declared in his inaugural address, “That we are in the midst of crisis is now well understood.” If admitting we have a problem is the first step toward solving it, what should our second step be? National Review Online asked the experts what, if anything, we should be doing to buttress the financial system.
NICOLE GELINAS
What to do about the broken financial industry now? Unfortunately, not much.
For two years–since the collapse of the first big subprime lenders in early 2007–the government and the big banks have been trying to hit upon that magic bullet that would avert catastrophe, first within the financial sector and then within the broader economy.
These efforts picked up with the attempted creation of a “Super Structured Investment Vehicle” to hide banking-industry losses in October 2007 and reached their apex–or nadir–with Congress’s passage of the “Troubled Asset Relief Program” a year later. Along the way, politicians hit upon such solutions as ending mark-to-market accounting. And, of course, the feds have been vastly expanding the money supply all along.
The latest such idea is to create a government-run “bad bank” that would purchase bad assets from surviving banks and force them to get the rest of their losses over with all at once so that they can get on with business. This idea isn’t a panacea, either. Sweden did a version of the “bad bank” model in the early 1990s, but lending there didn’t reach pre-crisis levels for a decade, according to the Financial Times.
The truth is not that we haven’t found the magic bullet but that there isn’t one. After the unfathomable credit binge and asset-inflation bender of the early 2000s, disaster was inevitable. The government, through its various experimentations, can at best choose what kind of disaster it prefers to have.
Behind one door, deflation and millions more foreclosures. Behind another door, hyperinflation and wealth destruction. Behind one door, letting credit contract so severely that even good businesses can’t expand. Behind another, allowing credit to continue to expand, including to uncompetitive but politically powerful companies and industries, on Uncle Sam’s dime–until global creditors cut off that last line of borrowing.
But even the government’s ability to “choose” a particular disaster through policy is tenuous because the unintended consequences of each action won’t be known for years.
Okay–so maybe we should direct our attention toward figuring out better regulatory policies so that all this doesn’t happen again.
The good news is that many of the regulatory fixes–politics aside–just aren’t that hard. To wit: after the 1930s, FDR, Congress, and the new Securities and Exchange Commission put in place straightforward rules to discourage dangerous levels of borrowing against rising stock values. It’s easy to do the same with other assets, including houses. Regulation also mandated that important companies–then defined as firms with thousands of public shareholders–be open about their market activities. Systemically important firms like big hedge funds have to do the same.
The most important regulatory fix, though, is to find a systemic, credible way to let big, failed financial firms go out of business in the future–without undermining the rest of the economy.
Some steps toward this goal are straightforward. For example, we should change the bankruptcy code so creditors to a company like Lehman Brothers can’t sell off all of their collateral assets at once. Such sales, which further distressed prices, forcing other asset holders to sell, exacerbated market instability in the current crisis.
It’s more complicated than that, though. But while there’s still much to think about in terms of how to create a system in which big, bad financial firms can fail, the most important part is establishing that as a political goal. Politicians on both sides of the aisle still seem to think that the answer to big, complex companies is more regulation of such companies.
But regulators have been behind the curve at every step in this crisis and always will be. The boom times in which dangerous speculation flourishes engender confidence in the politically powerful private-sector firms that are doing well, not in public-sector regulators.
–Nicole Gelinas is a chartered financial analyst and contributing editor for City Journal.
LARRY KUDLOW
The best way to buttress the financial system is to reignite economic growth. Instead of nationalizing the banking system, or making our big financial institutions wards of the state, or interfering with real estate markets through foreclosure bailouts, or expanding any other aspects of Bailout Nation, let’s have some pro-growth tax policies. All our problems can be solved if the economy grows and asset values rise in the process. Growth also will correct the problems associated with asset-backed bonds for mortgage, consumer, student, and other loans.
Right now capital is on strike and so are investors. Let’s help them out.
Here are some possible courses of action:
‐ Reduce the capital-gains tax rate–or initiate a capital-gains tax holiday–and substantially increase tax write-offs for capital losses. In other words, rejuvenate investor incentives.
‐ To promote business investment, slash the tax rate on large and small companies, allow full cash-expensing of capital put into service, and reduce the business capital-gains tax rate.
‐ For individuals, my perennial first choice is a 15 to 20 percent flat tax rate. Failing that, abolish the 28 and 25 percent brackets, get rid of the 10 percent bracket, and flatten the code so the whole middle class is paying 15 percent.
All of the proposed government spending is just a transfer of resources. There’s no net growth impact. I agree with Harvard professor Robert Barro, who says the Keynesian government-spending multiplier is virtually zero. On the other hand, the Federal Reserve has already created about $550 billion of new M2, which is going to be a big stimulant for the economy.
Almost 30 years ago President Reagan successfully fought inflationary recession with reduced tax rates and tight money. Today we should fight the credit-deflationary recession with reduced tax rates and expanded money growth. Lower tax rates will address the downturn and expanded money growth will offset the credit problem.
If anything, Washington should be curbing its spending growth, not expanding it.
–Larry Kudlow, NRO’s Economics Editor, is host of CNBC’s Kudlow & Company and author of the daily blog, Kudlow’s Money Politic$.
DONALD L. LUSKIN
The Treasury and the Fed should continue to do just what they are doing–except that they should make it clear that this is their intention, eliminating crippling uncertainty about their future course. Both should make it clear that the mission is to strengthen the banking system at its foundation, not to “get banks lending again” or any other specific social-engineering objective.
The Treasury should announce that it intends to use the remainder of the TARP funds for capital injections, as and if necessary, on the same terms as those made to Citigroup and Bank of America–perpetual, non-voting preferred stock with modest warrant coverage. Providing capital is a more high-powered use of the Treasury’s funds than would be its acquisition of troubled assets.
The Fed should announce that it intends to keep on creating guarantees for troubled asset portfolios for a fee, much as it has done for Citigroup and Bank of America. This takes the worst uncertainty about such assets out of the market without the government’s having to actually buy them. If troubled assets are to be bought outright, that is the natural province of the Fed, which can do so by creating new money rather than having to borrow it from already stressed capital markets (as the Treasury must). This serves a dual function–first, the Fed steps in as buyer-of-last-resort in frozen credit markets, and second, it expands the monetary base in the face of a potentially disastrous monetary deflation.
–Donald Luskin is chief investment officer of Trend Macrolytics LLC, an independent economics and investment-research firm.
DAVID SMICK
We need to support President Obama’s efforts to repair our financial system and stimulate an economy experiencing a destruction in demand not seen since the 1930s. It is important, however, that the administration target not only existing demand but new forms of demand (i.e. the creation of new products and services for consumption). Stimulating new forms of demand requires policies that encourage innovation. Stimulating existing domestic demand via infrastructure spending and other fiscal measures will only keep the economy from drowning. The key to a soaring, jobs-creating economic environment is a buoyant economic climate that encourages private-sector entrepreneurial risk. Success will come from the startup of the next round of Googles and eBays. Here’s the problem with Washington policymaking: Existing businesses employ a myriad of lobbyists arguing for every conceivable targeted tax credit and government subsidy imaginable. Small startup firms that are yet to exist, logically, have no Washington lobbyists. Yet the continual creation of these new enterprises remains an essential ingredient for getting us out of this mess. Will Barack Obama, more pragmatic than most of us expected, break from his natural constituency and become the champion of the American entrepreneurial spirit? That is the question of the hour.
–David Smick advises some of the world’s largest investment funds and is the author, most recently, of The World Is Curved: Hidden Dangers to the Global Economy.
SAMUEL STALEY
As the U.S. economy stumbles through the opening months of 2009, the temptation to succumb to crisis policymaking is increasing exponentially. At root, the U.S. financial system is going through a necessary (if painful) cleansing process. Indeed, the real risk to the economy is that regulators will do too much.
Federal policy aimed at dictating the terms and types of loans available to private individuals and businesses, in a vain attempt to create a safe and secure financial services industry, will shut off an essential source of liquidity critical to an entrepreneurial, globally competitive economy.
Subprime loans, for example, serve an important and valid purpose by providing a high-cost lending option to individuals and businesses that don’t qualify for more conventional loans. Banks and investment firms remain in the best position to determine for themselves what risks they are willing to take on what kinds of loans. Some banks, including Wells Fargo, JP Morgan, and Bank of America, have weathered the mortgage meltdown reasonably well because they were not overexposed in this higher-risk lending practice (although they still engaged in the practice).
First and foremost, regulators need to let the market sort out the fundamentals. As the economy becomes even more services-based, the kind of painful market discipline we see today will become more frequent although less destabilizing as the industry recalibrates its approach to assessing and marketing new investment products. Markets, not government, will need to develop the tools necessary to evaluate the risks and uncertainties inherent in this type of economy. That’s what the financial services industry is doing right now, and we need to be patient as it finishes the task.
–Samuel R. Staley is director of urban and land-use policy at the Reason Foundation.
ROBERT STEIN
Any package aimed at improving the financial system should provide some sort of safe harbor from mark-to-market accounting requirements. For example, financial companies should be allowed to declare that certain securities previously categorized as held for trading purposes are now going to be held to maturity, in which case mark-to-market need not apply. In an environment in which mortgage securities are often trading far below any reasonable estimate of future cash flows, limiting M2M will immediately reduce the fire-sale prices at which certain securities are trading, buttressing capital across the financial system.
–Robert Stein is a senior economist at First Trust Advisors. The views expressed in this article are Mr. Stein’s, not those of First Trust Advisors.