A reader asked me for this.
1. Extricate the government from the mortgage market as soon as is practical. I foresee reducing the maximum mortgage amounts that of Freddie and Fannie to zero in stages over a period of three years, then selling off their portfolios two years after that. I would even get rid of FHA. I would also get rid of the mortgage interest deduction. My guess is that the market would evolve toward higher down payments, and probably toward mortgages like the Canadian five-year rollover.
2. Housing aid to poor people would take the form of vouchers. No other Federal involvement in housing.
3. I would support a law that says that lenders must not make loans with the intent of exploiting borrower ignorance. Allow case law to develop to define rules and norms in support of that principle, rather than try to come up with fool-proof regulations.
4. Break up the top 10 banks into 40 banks. I think that is the best solution to the "too big to fail" problem, although there is no perfect solution to Minsky-type financial cycles.
5. Replace capital requirements with systems that put senior creditors in line to lose money in a default. Let them discipline the risk-taking of financial institutions.
6. Define priorities for creditors in a bank bankruptcy. I think that the solution to the social value--or lack thereof--of derivatives and other exotic instruments can be handled by the priority assigned to them. I would assign them a low priority. That is, first ordinary depositors get paid off. Then holders of ordinary debt. Other contracts, such as swaps or derivatives, come after that. I think that this would provide all the incentives needed either to curb derivatives or lead them to be traded on an organized exchange. I don.t think that getting them onto an organized exchange should be sought after as an end in itself.
7. Get rid of the corporate income tax, which encourages excess leverage. If the private sector, including banks, had lower debt/equity ratios, the financial system would be sounder.
8. Develop emergency response teams and backup systems that can ensure that the basic components of the financial system, particularly transaction processing, can survive various disaster scenarios, both technological and financial.
The overarching principle I have is that we should try to make the financial system easy to fix. The more you try to make it harder to break, the more recklessly people will behave. By reducing the incentives for debt finance and for exotic finance, you help promote a financial system that breaks the way the Dotcom bubble broke, with much lesser secondary consequences.
Excellent plan, Arnold. Given your proximity to various Republicans on Capitol Hill, isn't it time you float this plan to them? Sure nothing may come of it. But if/when they retake congress, maybe some ideas will devolve thru?
Also, what do you think of the Pollock plan ?
No handouts for voters. Check
No handouts for lobbyists. Check
No bailouts for losers. Check
Simple rules for liquidation. Check
Yes, this ideal bill has zero chance of ever being enacted. Arnold, you are letting the perfect be the enemy of the bad. Shame on you.
If the failure of a really big bank is too awful for the government to allow, the simultaneous failure of a handful of smaller banks, with an aggregate size equivalent to that of a really big bank, would be equally awful. There is no economic reason for the government to bail out the failing big bank but not to bail out the handful of failing smaller banks. So the case for breaking up the big banks, not being economic, must be either political or preventive. Political, in that the political influence of a big bank is greater than the combined political influence of a group of smaller banks (so the government will bail out the big bank even when it really shouldn't). Or preventive, in that a failure of the magnitude required to trigger government bailouts is more likely if the banking industry is concentrated than if it is fragmented. Neither of these attempted justifications for breaking up the big banks seems convincing (to me).
You advocate "put[ting] senior creditors in line to lose money in a default." Fine, but how about putting depositors at risk? The system would be much more robust without governmental deposit insurance.
Too-big-to-fail is a misnomer for political cronyism, and should have no place in a good policy platform. Trust-busting the banking system is not a good idea, because size matters, and bigger is better in terms of diversity and shock absorption capacity. I think we need to reduce the number of small banks, by busting the States' licensing systems and get a true federal banking system in place.
The gummint's role should be reduced to providing information about risk, not managing risk -- there's no evidence that they are any better at it than anyone else. I wouldn't mind a govt agency assessing bank behaviors and signaling risks, when they think they see them. We don't need any risk Nannies, but could use honest information brokers.
When loans are not backed by due diligence, I'd like to know before the bubble bursts. I'd like to know the percentage and value of mortgages with less than 20% down, and mortgages costing more than 35% of household incomes. Fix those things, and we'd have to worry a lot less about derivatives.
As for housing vouchers, I don't see any reason for them at all. If the poor are too poor for you, give them cash -- not Food Stamps or vouchers.
And get the special advantage for certain rating agents eliminated. Their ratings are pro-cyclical, so you can't trust them either.
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