It's Fantasy Economy! Some Expert Views on What Should Happen Next.

Sunday, October 19, 2008

The current (and gaping) leadership vacuum must be filled. We need individuals who can frame the stakes of this moment for the millions -- perhaps billions -- of people who now have vital interests in a stable system of global capitalism, leaders who can explain what has happened (as FDR did so effectively in the midst of the 1933 banking panic) and lay out a way forward. Such leadership would have to be based on a new call to responsibility, personal and collective. The current crisis has been marked by an overall suspension of such responsibility -- on the part of executives who played too fast and loose with fiduciary obligations (and then took home ridiculous pay packages after destroying enormous value), on the part of households that have been buying more than they can afford for years (against better judgment) and on the part of public officials who have generally been afraid to look hard and long at what was happening in the casino of capitalism.

-- Nancy F. Koehn, historian, Harvard Business School

Experts agree that U.S. house prices still have to fall another 10 or 15 percent to bring them back to a sustainable pre-bubble level. The danger is that prices may keep falling to much lower levels, hurting the financial institutions and reducing household wealth and spending.

Stopping this very deep downward spiral of house prices requires reducing the risk that homeowners with positive equity today will have incentives to default as house prices fall toward pre-bubble levels. A program of partial mortgage-replacement loans provided by the government to homeowners who now have positive equity could do that. Taking steps to halt the overshoot of house prices may no longer be sufficient to bring recovery to the financial markets and the broader economy, but I am convinced that they are necessary.

-- Martin Feldstein, president emeritus of the National Bureau of Economic Research and economics professor at Harvard University

The necessary guiding hand of government will feel stiffer and less relaxed than we have grown used to. As they did with the Department of Homeland Security, Americans will get to know a new czar heading an Office of Financial Stability. New rules for credit, leverage and financial disclosure will usher in an era in which institutions and workers alike will feed at the hand of Uncle Sam instead of the private market, and therefore be forced to adhere to tighter regulations, forcing the downsizing of private risk positions that will be replaced with government credit.

Still, interwoven in recent policies are exit provisions that hold promise for the return -- perhaps three or four years hence -- to a safer yet still dynamic capitalistic system. We should work toward that goal, mindful of the damaging excesses of a too invisible and too exuberant free-market hand.

-- Bill Gross, founder and chief investment officer of Pacific Investment Management Company

What happens next should be up to the public. It's striking to note that this is not even an option here. We saw that with the financial bailout. It was immensely unpopular, and a huge cry of outrage compelled the House to vote it down (at first). In a functioning democratic society, the reaction wouldn't have been just shouting "no" as loudly as possible. Labor unions and other groups would put forward their own proposals. The minimal answer to the problem of an uninvolved public is to accompany pouring liquidity into the market with voting rights. Organized public pressure has worked before -- for example, during the 1940s or the '60s, when many policies were adopted for the benefit of the general population as a result of mass popular mobilization. Today, there's been such success in depoliticizing society, in atomizing people, in breaking down popular organizations, that we're just not in a position to carry out the steps that would be taken in a functioning democratic society. But they are not unimaginable.

-- Noam Chomsky, MIT

With the holidays approaching -- and a plan in place that will stabilize the financial system and encourage banks to start lending again -- I offer a couple of lists.

First, my to-do list: (1) The SEC should immediately suspend the highly destructive mark-to-market accounting system; (2) the FDIC should broaden and simplify its depositor-protection plan; (3) Congress should consider a fiscal stimulus package and provide help for families facing foreclosure; and (4) Treasury should keep some dry powder in its bailout fund to help recapitalize important non-bank financial firms.

Second, my wish list: (1) Treasury doesn't use any of the bailout fund to purchase bad loans, a colossal waste of taxpayer money; (2) political leaders stay off the airwaves unless they have something new and very constructive to say; (3) the media finds the equivalent of another Britney Spears story to obsess over; and (4) the rest of us go out and buy new cars and houses and have a great holiday season.

-- William Isaac, chairman of the Federal Deposit Insurance Corp., 1981-85

What might a New New Deal look like? Here's one element my fantasy version would include: wage insurance, providing a temporary wage subsidy to older workers who are laid off and take a new job at lower wages. This would not be a response to the crisis per se but an attempt to capitalize on the period of exceptional politics to do what has long been needed: address the growing sense of insecurity felt by blue-collar workers. This would be infinitely superior to a bailout for the auto industry, and a way of heading off a more general backlash against the market.

-- Barry Eichengreen, University of California, Berkeley

We need a new regulatory framework that ensures fair treatment of consumers and much higher standards of market conduct. All financial enterprises should be regulated, and institutions of similar size and similar products should be regulated in roughly the same way. Close the loopholes that allow institutions to choose a charter or a name that nets them a lower standard of regulation. Build a new regulatory service and culture. Abandon the bureaucratic alphabet soup of compartmentalized agencies, redesign a unified, coherent regulatory service and train the regulators of the future to staff it.

-- Gene Ludwig, U.S. comptroller of the currency, 1993-98

What should be done next? The same thi ng we should have done first: start refinancing mortgages to avoid as many foreclosures as possible. FDR provided an excellent model in 1933, the last time we faced such a tsunami of prospective foreclosures. The Home Owners' Loan Corporation (HOLC) bought shaky mortgages from banks at well below their face values and refinanced them into new mortgages.

A modern reincarnation of the HOLC could and should buy some mortgages directly from banks, just as in the 1930s. But many mortgages today have been securitized, so a modern-day HOLC would have to purchase many old mortgages out of securitized pools. This changes the mechanics, involves more lawyers and makes the process more complicated. But it does not change the basic idea.

To get this done quickly, we should start with legislation that went into effect this month instructing the Federal Housing Administration to insure new mortgages (with lower face values) rather than grant new mortgages. Unfortunately, that legislation was badly underfunded. But the new Troubled Assets Relief Program (TARP) explicitly instructs the Treasury secretary to use some of the $700 billion for refinancing mortgages. So with a few simple amendments to the current legislation, and a few hundred billion from the TARP, we could create a HOLC-like institution.

-- Alan S. Blinder, vice chairman of the Federal Reserve from 1994 to 1996 and economics professor at Princeton

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