Another Free Market Approach

Luigi Zingales with a free market approach. I like it, in the same way I liked Mankiw's plan and Randazzo's plan:

"Tomorrow is too late

The United States (and possibly the world) is facing the biggest financial crisis since the Great Depression. There is a strong quest for the government to intervene to rescue us, but how? Thus far, the Treasury seems to have been following the advice of Wall Street, which consists in throwing public money at the problems. However, the cost is quickly escalating. If we do not stop, we will leave an unbearable burden of debt to our children.

Time has come for the Treasury secretary to listen to some economists. By understanding the causes of the current crisis, we can help solve it without relying on public money. Thus, I feel it is my duty as an economist to provide an alternative: a market-based solution, which does not waste public money and uses the force of the government only to speed up the restructuring. It may not be perfect, but it is a viable avenue that should be explored before acquiescing to the perceived inevitability of Paulson’s proposals."

You need to read the post which is quite detailed. Here's a part with a good explanation:

"Suppose that you bought a house in California in 2006. You paid $400,000 with only 5% down. Unfortunately, during the last two years the value of your house dropped by 30%; thus, you now find yourself with a mortgage worth $380,000 and a house worth $280,000. Even if you can afford your monthly payment (and you probably cannot), why should you struggle to pay the mortgage when walking away will save you $100,000, more than most people can save in a lifetime? However, when the homeowner walks away, the mortgage holder does not recover $280,000. The foreclosure process takes some time during which the house is not properly maintained and further deteriorates in value. The recovery rate in standard mortgage foreclosures (which will not take place in the middle of the worst crisis since the Great Depression) is 50 cents per dollar of the mortgage. I am generous in estimating that under the current conditions it might recover 50 cents per dollar of the appraised value of the house; right now, it is only 37 cents per dollar of the mortgage, which given a house appraised at $280,000 equals only $140,000 for the mortgage holder. In other words, foreclosing is costly for both the borrower and the lender. The mortgage holder gains only half of what is lost by the homeowners, due to what we economists call underinvestment: the failure to maintain the house."

Please read on.

My problem with these approaches is that they are simply not going to be considered. Nothing less than total government intervention is going to work this time, because of the assumptions that have been made prior to this crisis. Since, again, Zingales knows more than I do, I hope that I am wrong.

A Few Points About The SEC And The New Bill

Today, the SEC adopted one of Anthony Randazzo's proposals from the free market proposals I recommended:

"Third, the SEC should suspend the "mark-to-market" accounting rules for long-term assets that are driving firms into bankruptcy. Essentially, these regulatory rules are forcing firms to value their assets at much lower prices than what they would be worth long-term. The intent of mark-to-market regulation was to keep firms from overvaluing themselves and deceiving investors. Instead the law has artificially devalued financial institutions as a whole, which hurts their investors. As Steve Forbes noted recently, "The mark-to-market mania of regulators and accountants is utterly destructive. It is like fighting a fire with gasoline."

This accounting clause has significantly contributed to the bankruptcies (or near bankruptcies) of Lehman Brothers, Merrill Lynch, AIG, Bear Stearns, Morgan Stanley, Citigroup, Washington Mutual, and many others. In order to keep firms from overvaluing themselves, Newt Gingrich has proposed a three-year rolling average mark-to-market policy.'

Here from the Washington Post:

"Under intense political pressure, regulators for securities and accounting standards this afternoon issued what they called a "clarification" to provisions that have come under fire from bank executives and some lawmakers for contributing to the credit crisis...

The standard, also known as "mark to market," has led portfolios to plunge in recent months as banks affixed fire sale prices to their assets, a move that sometimes required them to raise still more capital to meet regulatory requirements. The measure also led to clashes between corporate executives and independent auditors over how low the markdowns should be forced to dip. "

Also, I backed this proposal from Jim Harper of Cato which looks to be in the new bill:

"And from the “This May Make Some Sense” department, there’s H.R. 6986, which would raise the maximum Federal deposit insurance coverage to $200,000. This seems to update the amounts covered by federal deposit insurance not in response to the crisis, but in response to the possibility that it could be needed. Nice to see someone possibly getting ahead of the curve, rather than following along behind it. But I have to say “least bad” is not high praise . . ."

Here from the NY Times:

"But those Democratic opponents did say that they would be willing to back an increase to $250,000, from $100,000, in the amount of a bank deposit that would be insured by the federal government — an idea that on Tuesday gained fast currency as a consensus change in the initial plan.

Mr. Obama and Mr. McCain early Tuesday both embraced the deposit insurance proposal, sparking a bit of a political tiff over who deserved credit for initiating it. House Republicans claimed to have offered the insurance increase in weekend negotiations over the plan only to have it rejected."

I might also add that Randazzo advocated tax breaks, but probably not these being considered:

"The Senate tax bill would cost more than $100 billion and extend and expand many individual and business tax breaks, including tax credits for the production and use of renewable energy sources, like solar energy and wind power. The bill would also extend the business tax credit for research and development, expand the child tax credit, protect millions of families from the alternative minimum tax and provide tax relief to victims of recent floods, tornadoes and severe storms.

Members of the House and the Senate say the bill would create tens of thousands of jobs and reduce the nations’ dependence on foreign oil. But the two chambers have been at odds over whether and how to offset the cost of extending the many tax breaks covered by the legislation. The major obstacle has been Representative Steny H. Hoyer of Maryland, the majority leader, and other centrist Democrats."

Maybe Randazzo would be for the business tax breaks.

"Second, Congress could cut corporate taxes and small business taxes in general. Trimming taxes for "the rich" opens up new capital to be invested in a struggling economy. At a time when investor confidence in the stock market is low, a tax cut for businesses would encourage innovation and entrepreneurial activity. The effects would be similar to that of a stimulus package, only without the government's involvement or a redistribution of wealth."

More about this new bill as I find out more about it, and understand it.

To Be Libertarian Or Swedish?

I'm officially admitting that I'm addled about this Crisis. Only two plans are even understandable to me. One will anger libertarians, the other Democrats.

First, I understand this libertarian response by Anthony Randazzo on Reason:

"No More Bailouts!Congress should unleash the private sector to address the current financial meltdown

Anthony Randazzo | September 23, 2008"

Second, I understand the Swedish Plan, and it seems to have worked:

"September 23, 2008

Stopping a Financial Crisis, the Swedish Way

By CARTER DOUGHERTY

A banking system in crisis after the collapse of a housing bubble. An economy hemorrhaging jobs. A market-oriented government struggling to stem the panic. Sound familiar?"

And I understand this even more radical plan which helps me understand Credit Default Swaps:

"Credit Default Swaps: Evolving Financial Meltdown and Derivative Disaster Du Jour

by Dr. Ellen Brown"

So, there you have it.

What I don't seem to understand is anything in the middle. What am I missing?

How Much And What Kind Of Pain?

Anthony Randazzo gives a free market solution to the current crisis on Reason. It's interesting, but he asks the following:

"Ultimately, the debate over what to do comes down to a threshold of pain and perspective. Capitalist philosophy suggests that short-term financial pain—even a great degree of pain—will prevent long-term financial destruction. The markets, in other words, are going through a cleansing process. But this is not acceptable to many, particularly the politically motivated, who always prefer to solve future problems at a later date.

Here's the issue: Are we willing to consider all treatment options, or will we dive for the quick, easy, and untested procedure and then hope for the best?"

The problem is that some of the pain will fall on parts of the economy not directly involved in this financial crisis.

In order for people to accept such pain, I believe that we would have to put in place a more significant social safety net which would address the issue of people being destitute or wiped out in such a crisis.

So, there are really two options:

1) Put in place regulations to keep such crises from occurring.

2) Have a social safety net to address the problem of the truly needy, in which case such pain might be accepted.

Otherwise, no matter how much we might want to leave government totally out of this equation, it won't be possible.