@kevingrr

I think there is a lot of reason to be angry, and increasingly a sense that the traditional tools of policy and working within the system have failed us. Jamie Dimon is no hero. He's one of the key people that fought tooth and nail to keep effective regulations from being drafted. They talk big about the natural consequences of the market, and then they go and benefit more than almost any other industry from the government tit. It's disgusting hypocrisy.

I'm also surprised that you would talk about being from the real estate sector, and not be familiar with at least the putative benefits of the securitization of debt (the reason the needed to repeal glass steagall). If you are waiting for a return to the ease of real estate finance you may have experienced in the past decade or two of frothy CDOs you're kidding yourself. The party is over. There needs to be a return to actual underwriting standards, and an enforcement of those standards. That means paperwork. Sorry.

Are you at all sympathetic to the view that there is too much concentration of capital in the financial sector, and not enough in the real economy? I think the compensation has gotten way out of whack in relation to the services they perform. I also think the securitization of debt was a horrible idea. What was wrong with glass steagall you know? What I'd like to see is a return to bankers loaning out deposits, and investors seeking out entrepreneurs. Instead, we have investors seeking to leverage systemic risk knowing full well they have a lifeline because the government can't go ahead and flush our life savings down the toilet now can it?

>> ^kevingrr:

What we are going to see shortly is traditional banks close up shop in low to low-mid income areas.
The banks offered "Free Checking" with the knowledge that people would overdraft and they would make fees on those overdrafts. There is no such thing as a free lunch or free banking. This was always part of every banks business plan. Caveat Emptor.
Those fees are now being restricted by Dodd-Frank. Therefore the banks can no longer turn a profit in many low/mid income neighborhoods. Banks are in business to make a profit and when they cannot make a profit they will close or downsize.
The solution is fairly simple. Banks will close and currency exchanges and payday loan shops will open. I don't think these businesses are preferable to banks. It an unintended consequence of the bill. It will hurt people it was meant to help.
I have free checking. I maintain a four to five figure balance and I have never been charged. I don't have everything I want, but I have more "things" in my life than I will ever need.
Chase lost $2 Billion dollars? Yea that's a bad call, but they have $2.26 Trillion in assets, $90 Billion in revenue, and $19 Billion in net income. I think they can absorb the loss.

A. Overly simplistic, and you're confusing to some degree what is Keynesian. A central tenant of Keynesian economics is counter-cyclical budget deficits. When there's a recession, the government should run deficits, and the larger the recession, the larger the corresponding deficit. That's been a non-stop, although admittedly abused, government policy since the Depression. Also, Keynesian economics had components in it for monetary policy as well. Keynes advocated for lower interest rates during times of recession along with increasing the monetary supply. Yes, he did believe that during more severe recessions that monetary measures would not be enough, but he nevertheless advocated for the various monetary policies. These align up with most recessions as far as what the gov't did from the Great Depression on. Just because Keynesian policies disappointed during the 1970's, the ideas were not altogether abandoned ever since. The simple fact of the matter is aside from 2007, there hadn't been a particularly severe recession since the 1970s, so it's reasonable to assume that direct employment wasn't deemed necessary, not that it was seen as bad policy in all cases.

B. It happened to me by the hand of Microsoft. I'm pretty sure they didn't have flunky MBAs. ;-)

C. There are a lot of similar issues involved. My point was only that you can't just tie requirements to it, and that's that. There are a huge myriad of issues that would come hand in hand with stipulations to unemployment. Your idea is still something I'd be onboard with if those devils in the details were addressed. I do see as an example that some people become unemployed because of structural changes to the economy that causes their jobs to never come back. As a case in point, textile factory workers who lose their jobs due to offshoring are suddenly in a position where market forces have no remedy. They lack the skills to get jobs in areas of growth such as more in depth computer skills, and likely lack the financial resources to get the education and training to get said skills because they're unemployed. This is a perfect example in my opinion where the market and free trade fail from time to time, and some force, likely the gov't, needs to step in for the good of everyone. These people would benefit from retraining, so they can get a good job, business owners benefit from increasing numbers of workers who can do the jobs they're needing people to do, and it becomes a win win situation.

D. The last time we tried no deposit insurance, it failed miserably. Banks lent money for people to buy goods and services they couldn't afford, and stocks on the margin. People stuck their money in banks anyway. The only difference is when fear hit the market after the crash, a lot of people, many irrationally, pulled their money from banks, causing a collapse in the banking system, which tanked the entire economy even further.

People lack the time and/or motivation to stay informed on all kinds of issues from local politics, to PTA meetings. I don't see how they could begin to assess what loans their banks were making as far as riskiness. And the typical American when it comes to finances? Yikes! Next to no savings, can't understand how much they should be regularly investing, etc. And it's not just the stupid people. Most Americans don't even know what a mutual fund actually is. How could they possibly make intelligent decisions about the riskiness of their banks' portfolios? I consider myself smarter than the average bear, but even I'd be paralyzed with fear selecting a bank based what little info I could find of their portfolios. Instead, I make sure they're FDIC insured, because that in and of itself entails objective benchmarks to even get that insurance.

And honestly, I don't see many people making decisions about their banks based on rates alone. As a case in point, very few people I know put money in online high yield savings accounts instead of the local credit union, bank, or large megabank, despite the fact that in most cases online savings account providers such as ING Direct pay 2-3 times the interest. I don't believe that's what caused the madness in the banking industry at all. At the very least, there's a massive list of causes well above FDIC insurance, and even if FDIC insurance did play a role in causing the crisis, it also served well in preventing runs on the banks in general that would have compounded the crisis further.

>> ^bmacs27:

@heropsycho
A. Because we've been leaning on monetary policy as our intervention of choice. Direct employment has been called socialism for 30 years. That doesn't suggest a dominant Keynesian ideology. Really it's been this mix of monetarism and supply-side economics which morphed into some mutilated crony-capitalism.
B. I suppose it could happen, but it would take a rough business climate, or some flunky MBAs. In that situation I'd try to increase my business (i.e. make $200,000).
C. That's why we have food stamps. It isn't a perfect solution, but the kid starves if her folks spend the whole check on smokes too. Vices aren't the kind of "demand side" stimulus I'd like to see (one flaw in the Keynesian argument given the current living conditions of the American poor).
D. I really do believe that if the FDIC didn't exist, "the market" would not have allowed deposits to be leveraged by banks investing in exotic financial instruments. Like you said, even the bankers didn't know what the hell they were doing! Without the FDIC people would very quickly ask, "what the hell you doin' with my money?" Rather, since their money is backed by the government they ask, "what sorts of rates are you offering?" It's that pressure from the distorted marketplace that pushed banks into more and more leverage to stay competitive. Those rates were realized by making massively leveraged bets that were only possible by hedging with exotic instruments. Once upon a time people knew their banker. I think that's the best FDIC there could be. There might be some legal patchwork of the Glass-Steagall flavor that might make it work, but chasing down all the unintended consequences would be a challenge. Certainly figuring out how to unwind all the securitized mortgages that already exist makes that sort of policy direction seemingly prohibitive.
F-. Dude, Peter Schiff is a quack.

@heropsycho

A. Because we've been leaning on monetary policy as our intervention of choice. Direct employment has been called socialism for 30 years. That doesn't suggest a dominant Keynesian ideology. Really it's been this mix of monetarism and supply-side economics which morphed into some mutilated crony-capitalism.

B. I suppose it could happen, but it would take a rough business climate, or some flunky MBAs. In that situation I'd try to increase my business (i.e. make $200,000).

C. That's why we have food stamps. It isn't a perfect solution, but the kid starves if her folks spend the whole check on smokes too. Vices aren't the kind of "demand side" stimulus I'd like to see (one flaw in the Keynesian argument given the current living conditions of the American poor).

D. I really do believe that if the FDIC didn't exist, "the market" would not have allowed deposits to be leveraged by banks investing in exotic financial instruments. Like you said, even the bankers didn't know what the hell they were doing! Without the FDIC people would very quickly ask, "what the hell you doin' with my money?" Rather, since their money is backed by the government they ask, "what sorts of rates are you offering?" It's that pressure from the distorted marketplace that pushed banks into more and more leverage to stay competitive. Those rates were realized by making massively leveraged bets that were only possible by hedging with exotic instruments. Once upon a time people knew their banker. I think that's the best FDIC there could be. There might be some legal patchwork of the Glass-Steagall flavor that might make it work, but chasing down all the unintended consequences would be a challenge. Certainly figuring out how to unwind all the securitized mortgages that already exist makes that sort of policy direction seemingly prohibitive.

F-. Dude, Peter Schiff is a quack.

Okay, explain how this magical fixed money system works? What would be used to fix the money supply? How could we ensure that people don't decide to keep their money in banks, where the banks can issue "bank notes" which people then use as surrogates for your fixed money supply? When we had a specie backed currency, these problems still existed.

Also, yes, the derivative securities market is the largest driver of inflation out there at the moment. Many estimates put the value of all these unregulated securities (that's right, poof, I have money, securities) at around $600 Trillion dollars. Makes our debt seem kinda trite doesn't it?

>> ^davidraine:

First, to my original point, a fixed money supply does not allow for fractional reserve banking -- By definition, fractional reserve banking varies the supply of money. Second, I don't remember massive inflation caused by the sale of unregulated securities, though I do remember a massive speculative bubble bursting and an economic crash.
>> ^bmacs27:

Fractional reserve banking has nothing to do with the medium of exchange. Banks have engaged in fractional reserve banking since long before the abolition of the gold standard. A better argument is that the securitization of debt (deregulation of finance) has caused massive inflation by encouraging the underwriting of bad debt by allowing the risk to be sold off.

First, I'm not proposing anything -- I was just pointing out that inflation and speculative bubbles could be largely mitigated making the supply of money fixed. Second, a fixed money supply does not presuppose (or require) price fixing, so you can still use various property as a value store.
>> ^bmacs27:
Further, the video doesn't seem to explain that in our current system I can use my wages to purchase gold at market, and can thus use it as a store of value (if I actually believed it to be fairly valued against e.g. wages or real estate). In the government price fixing system you are proposing that wouldn't be possible, and the value of my gold would be subject to systemic risk (bad policy) just like currency is today.
>> ^davidraine:
I don't think they're calling for anything -- Simply explaining. Also, the point is that everything they point out is not true for any medium of exchange. The hallmark of fiat currency that makes it true is banks' ability to conjure money out of nowhere, which starts the inflationary and speculative balls rolling. With a fixed money supply, this can't happen.

First, to my original point, a fixed money supply does not allow for fractional reserve banking -- By definition, fractional reserve banking varies the supply of money. Second, I don't remember massive inflation caused by the sale of unregulated securities, though I do remember a massive speculative bubble bursting and an economic crash.
>> ^bmacs27:


Fractional reserve banking has nothing to do with the medium of exchange. Banks have engaged in fractional reserve banking since long before the abolition of the gold standard. A better argument is that the securitization of debt (deregulation of finance) has caused massive inflation by encouraging the underwriting of bad debt by allowing the risk to be sold off.

First, I'm not proposing anything -- I was just pointing out that inflation and speculative bubbles could be largely mitigated making the supply of money fixed. Second, a fixed money supply does not presuppose (or require) price fixing, so you can still use various property as a value store.
>> ^bmacs27:

Further, the video doesn't seem to explain that in our current system I can use my wages to purchase gold at market, and can thus use it as a store of value (if I actually believed it to be fairly valued against e.g. wages or real estate). In the government price fixing system you are proposing that wouldn't be possible, and the value of my gold would be subject to systemic risk (bad policy) just like currency is today.
>> ^davidraine:
I don't think they're calling for anything -- Simply explaining. Also, the point is that everything they point out is not true for any medium of exchange. The hallmark of fiat currency that makes it true is banks' ability to conjure money out of nowhere, which starts the inflationary and speculative balls rolling. With a fixed money supply, this can't happen.

>> ^davidraine:

>> ^crotchflame:
Literally everything they're harping about here is true for any medium of exchange...be that fiat money or gold.
So what is it they're calling for here?

I don't think they're calling for anything -- Simply explaining. Also, the point is that everything they point out is not true for any medium of exchange. The hallmark of fiat currency that makes it true is banks' ability to conjure money out of nowhere, which starts the inflationary and speculative balls rolling. With a fixed money supply, this can't happen.


Fractional reserve banking has nothing to do with the medium of exchange. Banks have engaged in fractional reserve banking since long before the abolition of the gold standard. A better argument is that the securitization of debt (deregulation of finance) has caused massive inflation by encouraging the underwriting of bad debt by allowing the risk to be sold off.

Further, the video doesn't seem to explain that in our current system I can use my wages to purchase gold at market, and can thus use it as a store of value (if I actually believed it to be fairly valued against e.g. wages or real estate). In the government price fixing system you are proposing that wouldn't be possible, and the value of my gold would be subject to systemic risk (bad policy) just like currency is today.

@Winstonfield_Pennypacker

You're addressing two separate issues with one broad stroke.

The housing credit bubble was caused just as much by certain public institutions as it was private. The error on behalf on the parties involved was in misjudging expected defaults and in the moral hazard of entrusting mortgage brokers who had every incentive to lie to secure commissions.

Securitization is in and of itself not a bad idea and by your own admission it was a private invention (by investment banks). With the right due dilligence and management of risks, loans can be offloaded from commercial bank balance sheets to investors and the banks can then make additional loans (to credit worthy individuals) which generally benefits everyone.

The separate issue from all of this is how much you want to provide to citizens as a basic right. Personally I think this should extend extensively into basic food, shelter and medical assistance. Whether it's publicly or privately provided should be on a case by case basis. Some naturally monopolistic industries will gain nothing from being private as the competitive pressure that makes capitalism work will simply not be there.

If you don't agree with this that's fine but let's not conflate the two issues or pretend as if the GFC is somehow justification for the latter.

Most of those activities you mentioned require the use of force, so they can't be done by private citizens, because the use of force is exclusive to government. Any other activity that doesn't require the use of force shouldn't be done by government because it can be done (and will tend to be done better) by the private sector.

How exactly is force the exclusive domain of the government? What about the polluter that is forcing you to breath lower quality air? I can't do anything about that. I need a government to enforce my property rights over the air. Yes, the government employs force. It's our only recourse against the force employed by concentrated capital.


If anarchy was the end result of libertarian ideals, they would be called anarchists. Corporate oligarchies are much more likely when government regulates the economy, and gets in bed with corporations. You have to realize that any "archy" requires government, force. It can't sprout out of markets where force is not allowed.

Please explain to me the law of nature which prevents corporate oligarchy in the absence of government force. Collusion is the rational selection for a small number of powerful agents. They reap the return, prevent entry into marketplaces, and price gouge when privy to exclusive control over an inelastic market (such as healthcare). You've been reading Ludwig too much... I'd recommend reading more of his brother Richard's work. He actually contributed to knowledge.


Does that overhead in the private sector have anything to do with excessive government regulation of the healthcare insurance market? Maybe it would be less of a burden to compete in a market that is almost 60% provided by government?

Hopefully not. I'm a single-payer kinda guy. Like I stated, healthcare is an inelastic market like police, fire, and water. As such, it should be provided by the government because the status quo of a small number of profit-driven actors in the market leads to price gouging.


Government and the Fed created the moral hazards that led to what you're attributing as the cause. A lot of people acted stupidly, you're saying it's cultural, that people "got greedy", ignoring the incentives and government guarantees that led people to believe there weren't any risks.

I'm not saying people got greedy (though the few did). I'm saying the majority of people got stupid. The laws that were in place to prevent the overextension of consumer credit were withdrawn. That is, they removed government intervention in the marketplace. That allowed unfortunate people to overextend themselves to the benefit of the few. Now, before you go off on some rant about the laws governing entrance into the sub-prime housing market, remember those laws would not have been nearly as dangerous had they not also repealed restrictions on debt securitization, turned a blind eye to insurance market regulation of CDS, and loosened fraction reserve restrictions. Those three de-regulatory events had, imo, far more reaching ramifications in this crisis. They removed the counter-party risk from debt initiators, and instead incentivized predatory lending. It was not government subsidy of the sub-prime market that distorted the incentives. It was the banks writing a junk bond, and slapping a smily face on it.


Ever hear of "cutting your losses"? There's no "sell high" here, the US can't pay back its lenders, not at the rate the US government is spending and willing to spend for the next few years, and not in a recession where government is ruining productivity. China will be part of the recovery effort alright, but they'll much rather do it without the US strapped to its back.
Think about it, if China lent the US more than a trillion dollars, it's better to lose that money than lend us 2 or 3 more trillions just to watch even more money go to waste. They don't need us.

Actually, they do. If our dollar were to suddenly become worthless, they would have no currency reserves. While I agree, they have the upper hand in this, they've already seen what a collapse of consumption on our soil does to their own economic growth. Without that growth, the chinese government doesn't have a political toothpick to stand on. I think you'd be surprised with the swings in currency valuation these days just how much higher the dollar could yet climb back. Our workforce is skilled, and increasingly well educated. In any event, it doesn't make sense to sell all at once. What they'll probably do is wait until the systematic risk has stabilized, and then slowly convert their treasury notes into special drawing rights at a rate which will not drastically undermine valuation of the dollar. I agree however, they will likely discontinue purchasing the debt, forcing us into "quantitative easing" (another winner from the PR team).


The Constitution is a good reference, most things the federal government does that are not expressly authorized in the Constitution are excesses.

So the market for nuclear weapons, particularly when wielded by militiamen, shouldn't be regulated?


NetRunner, is that you? I guess you think hyperinflation is a synonym for "awesome".
If you actually studied Austrian economics and you think it's "non-mathematical" and "BS", yes, we'll have to agree to disagree. You're beyond help.

Net who? No, I'm afraid there can be more than one educated progressive. I didn't say hyperinflation... I said inflation. Between 2 and 4% inflation is a good thing. If you disagree, you are beyond help.

As for the Austrian school, yes, it's BS. It's been discredited repeatedly. The predictions don't hold water, so they say "you can't use mathematics because people are too complicated." Even the Chicago school monetarists (many of whom worked with Von Mises) know it's BS. Once you run out of room with monetary policy what should you do is the only argument left. I think the Keynesians about have that fight won now that they've shown how to explain the late seventies.


Don't worry about that. Keep rules simple, no fraud, enforce contracts, no use of force. Everything else will tend to sort itself out. Also, don't be afraid of technology.

No force, but enforce contracts. Right. You show no regard for the existence of externalities, nor the rampant exploitation of the commons by the private sector. In fact, you explicitly removed that single section from my post indicating either your ignorance of basic economics, or an intentional dodging of the topic.

It's easy not to worry about how the rules are set up so long as they are benefitting you. Once you see that not everybody is getting a fair deal, you realize the moral, and even selfish reasons for entering a broader scoped social contract. In the end, we all benefit from a well educated, healthy society. We just need to put up the VC.

>> ^StukaFox:
"He came in with a recession" -- WHAT?!?!?!


Clinton's entire term was a dot-com stock market bubble whose inevitable and proportionate bust began to occur in 2000 when Bush took office. Greenspan was very loose with money as Fed chairman under both Clinton and Bush, and Bernanke is even worse. Not wanting the painful withdrawal to happen under his watch, Bush did what was politically expedient and shot up the veins with record deficit spending and artificially low lending rates. Greenspan price fixed interest rates down to a record low 1% rate in the middle of a recession and held them there for a year. That transformed the speculative misallocations from stocks to real estate, got consumers borrowing and spending instead of saving to produce, and the day of reckoning was effectively postponed and enlarged until Obama's term. Obama is essentially choosing the same reinflationary path, and it's really only a matter of time before our creditors become net sellers of our bonds and turn the game into a hyperinflationary nightmare.

It also helped that Clinton repealed Glass-Steagall, which allowed much higher leverage and the securitization of mortgages. Ideally, we'd just get rid of the spiker and stop trying to regulate the drunken behavior, but Republicrats don't seem to think in those terms, they're quite party-whipped. I talk to Democrats who think Clinton decreased the national debt, social security is a success, Vietnam was a Republican war, banks don't create money, the dollar is still backed by gold, trade deficits are good. It's quite sad, just two socialist parties who spend all day trying to figure out who's more to blame while libertarians sit back and watch the country go to hell.

Tags for this video have been changed from 'credit crunch, mortgage, broker, interest, securitization, incentives' to 'credit crunch, mortgage, broker, interest, securitization, incentives, enspire' - edited by doogle

Roubini has some very good ideas on how to do this right, and not be a scam:

HOME (Home Owners’ Mortgage Enterprise): A 10 Step Plan to Resolve the Financial Crisis
Nouriel Roubini | Sep 24, 2008

Even if the Treasury TARP plan is implemented fairly and efficiently the US will not avoid a severe U-shaped18-month recession and a severe financial and banking crisis: the recession train has already left the station in Q1 and the financial/banking crisis will be severe regardless of what the Treasury and the Fed do from now on. What a proper rescue plan can do is to avoid having the US experience a multi-year L-shaped recession and extreme financial crisis like the one that led to a decade long stagnation in Japan in the 1990s after the bursting of their real estate and equity bubbles.

I have also argued that, in order to resolve this financial crisis it is not enough to take the bad/toxic assets off the balance sheet of the financial institutions (a new RTC); it is also necessary and fundamental to reduce the debt overhang of millions of insolvent households via a significant debt reduction on their mortgages (an HOLC program like the one that was implement during the Great Depression); and also recapitalize undercapitalized banks with public capital in the form of preferred shares (as the RFC did with 4000 banks during the Great Depression). An RTC scheme without an HOLC and RFC component would not resolve two fundamental problems: millions of households are insolvent and unable to service their mortgages; the financial system is vastly undercapitalized and needs capital to avoid an ugly credit crunch and to foster new credit creation that is needed for future growth.

That is why I proposed the creation of a HOME (Home Owners’ Mortgage Enterprise) that would be a combination of an RTC, a HOLC and a RFC. Let me flesh out this proposal and its key elements and compare it to the Treasury TARP proposal that in its current form has many flaws.

There are 10 steps in this HOME proposal to resolve this most severe financial crisis. Here they are:

First, like in the Treasury TARP plan you need to buy illiquid/toxic assets and take them off the balance sheet of banks and financial institutions to reliquify them and allow new credit creation. The biggest problem here – as the debate between Bernanke and senators yesterday is one of the proper valuation and the proper price at which the government should buy these assets (the RTC did not have this problem as it was working out assets of failed S&Ls): if the government buys the asset at at price that is too high (too small of discount relative to face value) the fiscal cost will be huge and you massively subsidize reckless bankers and their shareholders. If you buy at a discount that is too high you minimize the fiscal cost in the short run but many banks could go bust and the eventual fiscal cost of bailing out the depositors of failed banks could be large. You can debate endlessly whether such assets should be bought at current market price or at prices closer to hold to maturity values (as Bernanke suggested). Given that these assets are impaired pricing the long run value of them is mission impossible. Thus, there is only one solution to this fundamental uncertainty: avoid the government overpaying by having the government having some of the positive benefits of an upside gain in case the banks’ values recover after the bailout. I.e. you need for the government to have some equity in the banks whose assets are purchased by the government. This leads to step 2 of the proposal.

Second, in exchange for the purchase of illiquid asset (at whatever price it is agreed) the government gets preferred shares in the financial institutions that senior to existing common and preferred shares and that are convertible into common shares to allow government to participate into any future upside.

Third, even if the government gets preferred shares as in step 2, the banks will need more capital if they are undercapitalized and they have not fully reserved/provisioned for the losses coming from writing down the asset being sold to the government. So you will need to inject further actual public capital in the form of preferred shares in the financial institutions ( this is what the RFC did during the Great Depression).

Fourth, given the risk to the government deriving from the public injection of capital in the financial system the existing shareholders of the banks need to take a first-tier loss to minimize the risks for the government share. How to do that? First, you need to suspend dividend payments on common share and possibly even existing preferred shared; you also need to force to partially match the public capital injection with new Tier 1 capital.

Fifth, public and private recapitalization of financial institutions unfairly benefits unsecured creditors (all creditors but insured depositors) of such institutions. So, you also need to convert some of this unsecured debt (the sub debt and other debt unsecured debt) into equity (a debt for equity swap). Such swap further reduce the leverage of the financial system (leading to a lower debt to equity ratio for financial institutions).

Sixth, after this crisis is resolved the banking and financial system may need lower capital than before this crisis so as to avoid new asset and credit bubbles; and if you recapitalize some banks that will be able to lend more (still with lower leverage ratios) you still need to let other insolvent banks and financial institutions to go bust and disappear. Only healthier institution should survive. So you need to a systematic triage between banks that are distressed, undercapitalized and illiquid but solvent once the private and public recapitalization occurs from those that are fundamentally insolvent and that need to be shut down. You need to destroy the bad apples to let the good ones or the sick but curable ones survive and thrive.

Seventh, as in the case of the RTC the assets of the banks that are bankrupt and are allowed to fail go to the HOME for workout (debt restructuring/reduction).

Eighth, you need an HOLC-like program for debt reduction of the household sector. Households in the US have too much debt (subprime, near prime, prime mortgages, home equity loans, credit cards, auto loans and student loans) while their assets (values of their homes and stocks) are plunging leading to a sharp fall in their net worth. And households are getting buried under this mountain of mounting debt and rising debt servicing burdens. Thus, a fraction of the household sector – as well as a fraction of the financial sector and a fraction of the corporate sector and of the local government sector – is insolvent and needs debt relief. When a country (say Russia, Ecuador or Argentina) has too much debt and is insolvent it defaults and gets debt reduction and is then able to resume fast growth; when a firm is distressed with excessive debt it goes into bankruptcy court and gets debt relief that allows it to resume investment, production and growth; when a household is financially distressed it also needs debt relief to be able to have more discretionary income to spend. So any unsustainable debt problem requires debt reduction. The lack of debt relief to the distressed households is the reason why this financial crisis is becoming more severe and the economic recession - with a sharp fall now in real consumption spending – now worsening. The fiscal actions taken so far (income relief to households via tax rebates) and bailouts of distressed financial institutions (Bear Stearns creditors’ bailout, Fannie and Freddie and AIG) do not resolve the fundamental debt problem for two reasons. First, you cannot grow yourself out of a debt problem: when debt to disposable income is too high increasing the denominator with tax rebates is ineffective and only temporary; i.e. you need to reduce the nominator (the debt). Second, rescuing distressed institutions without reducing the debt problem of the borrowers does not resolve the fundamental insolvency of the debtor that limits its ability to consume and spend and thus drags the economy into a more severe economic contraction. So of the five possible uses of fiscal policy – income relief to households (the 2008 tax rebate), rescue/bailout of financial institutions (Bears Stearns, Fannie and Freddie, AIG), purchase of assets of failed institutions (an RTC-like institution), recapitalization of undercapitalized financial institutions (an RFC-like institution), government purchase of distressed mortgages to provide debt relief to households (an HOLC-like institution) – the last option is the most important and effective to resolve this severe financial and economic crisis. During the Great Depression the Home Owners’ Loan Corporation was create to buy mortgages from bank at a discount price, reduce further the face value of such mortgages and refinance distressed homeowners into new mortgages with lower face value and lower fixed rate mortgage rates. This massive program allowed millions of households to avoid losing their homes and ending up in foreclosure. The HOLC bought mortgages for two year and managed such assets for 18 years at a relatively low fiscal cost (as the assets were bought at a discount and reducing the face value of the mortgages allowed home owners to avoid defaulting on the refinanced mortgages). A new HOLC will be the macro equivalent of creating a large “bad bank” where the bad assets of financial institutions are taken off their balance sheets and restructured/reduced.

Ninth, we need to avoid a situation where the recapitalization of the banks and the resolution of this financial crisis leads to another credit and asset bubble. Many things need to be done to avoid this risk but a rapid change of the Basel II capital adequacy ratios to reduce their the pro-cyclicality would be essential.

Tenth, start implementing rapidly a reform of the system of regulation and supervision of financial institutions in a world of financial globalization. With the collapse of most of the shadow banking system most of these shadow banks are now being folded in the traditional banks and will be regulated like banks. Indeed all institutions of large size and that are systemically important (commercial banks, investment banks, non-bank mortgage lenders, hedge funds, private equity funds, etc.) should be supervised and regulated in a similar way. To make the financial system more stable over time and avoid severe financial crises like the current one will require that both banks and former shadow banks be regulated and supervised better than they have been in the last decade. After all traditional banks have performed as poorly – and some more poorly – and have lost more money than shadow banks during this severe financial crisis. So both the poor regulation and supervision of banks (as regulators were asleep at the wheel while the laissez fair ideology and voodoo-cult of self-regulation and market discipline and internal risk management became dominant) and the lack of sensible regulation of shadow banks lies behind the current financial disaster. Thus, folding shadow banks back into the traditional banking system will make the overall financial system more stable only if the proper reform of the regulation and supervision of financial institutions in a world of financial globalization will be undertaken. This important matter is the subject of the chapter (titled “Financial Crises, Financial Stability, and Reform: Supervision and Regulation of the Financial System in a World of Financial Globalization”) that I have written for the recently published World Economic Forum’s Financial Development Report.

This chapter analyzes in detail the episodes of financial crisis in emerging market economies and advanced economy; discusses the causes and consequences of such crisis; measures the economic and fiscal costs of such crises; discusses the debate on whether monetary and credit policy should target asset prices and asset bubbles; studies the weaknesses of financial regulation and supervision in advanced economies financial systems that led to the recent crises; and finally considers eleven separate key issues in the reform of the regulation and supervision of financial institutions in a world of financial globalization that are necessary to prevent future crisis and make them less virulent. These eleven issues that are key in reforming financial regulation and supervision are: the distorted compensation system of bankers/traders and the related agency problems between financial institutions shareholders and their managers; the flaws of the originate and distribute securitization model; regulatory arbitrage and the instability of the shadow banking system given its reliance on short term liquid financing, high leverage and long term illiquid lending; the weaknesses of self-regulation and market discipline and the need of greater rules-based regulation; pro-cyclical capital requirements and other issues with the Basel II capital requirements; the distorted incentives of credit rating agencies; asset valuation and fair value accounting in a world where assets can be highly illiquid and hard to price; the lack of transparency in financial markets; the inadequate regulatory regime; the lack of international coordination of regulatory policies; and the issue of who will regulate the regulators, i.e. how to avoid the regulatory capture by the financial industry of the regulators and supervisors of financial institutions.

So now that the shadow banking system is being folded in the formal banking system it is high time to rethink how both banks and the former non-bank financial institutions should be properly regulated and supervised.

http://www.rgemonitor.com/roubini-monitor/253739/home_home_owners_mortgage_enterprise_a_10_step_plan_to_resolve_the_financial_crisis

Isn't Phil Gramm basically the architect of that financial deregulation that led to this whole subprime mess -- allowing securitization and MBOs?

http://www.politico.com/news/stories/0308/9246.html

...
Between 1995 and 2000 Gramm, who was the chairman of the U.S. Senate Committee on Banking, Housing, and Urban Affairs, received $1,000,914 in campaign contributions from the Securities & Investment industry.[6]

On July 18, 2008 Gramm stepped down from his position with the McCain campaign. However, he often accompanies McCain during the campaign, and continues to be an unofficial adviser on economic and financial matters.[16]