Next Steps
Fresh financial advice.


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.

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.

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.


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