Free Market Alternatives to the Bailout

Pat Toomey of the Club for Growth hosted a conference a call to discuss the economics of the proposed bailout. Toomey commented that the financial market does not seem to be near as dire as made out to be. Another “Great Depression” is extremely unlikely (Toomey noted that the 1929 crash was followed up by massive tax increases, massive tariffs, and the fed constricting the money supply. He doesn’t think the government is that stupid today). Toomey pointed to the stock market rising today, even though the bailout was in limbo, and pointed out that many banks (e.g. Wells Fargo) are at all time highs, and noted JP Morgan’s takeover of WaMu’s holdings is evidence that the financial market is not in collapse. He noted that the number of banks failing (or in danger) during the Savings and Loan crisis was several times the number in jeopardy today. He also pointed to evidence that capital is available for main street businesses and there isn’t evidence of a “credit crunch” (Alex Tabarrok makes the same points).

For a quasi-rebuttal, Greg Mankiw notes that he didn't sign the letter with the other economists opposing the plan (though he has leanings against the bailout) partly because he doesn't have all the info, but Bernanke does, and Bernanke is as smart as anyone.

My rejoinder to Mankiw is that we should never put too much trust in anyone to rule over us because they are smarter than us, especially when the advice they are giving involves giving them more discretionary power - that is the thesis behind totalitarianism and central planning. Secondly, if Bernanke and Paulson have data the rest of the country doesn't have, why doesn't the rest of the country have that data? In an era of greater transparency, any data that shows an impending crisis, being used to create one of the largest government programs in decades, should be made publicly available.

Toomey suggested the plan as revised by the House, to act as an insurer of these mortgages (like the FDIC for savings accounts), was a less-bad proposal. As far as good solutions go, Toomey suggested a number, including reforming mark to market accounting rules, repealing parts of Sarbanes-Oxley, and paying interest on reserves. This mirrors some of the proposals of the Republican Study Committee.

Here is a quick summary of free-market reforms that should be adopted, as a replacement for a bailout (or even with a bailout) both for the “crisis” and for long-term economic growth.

1) Repeal Mark to Market Accounting Rules: Essentially the mark to market rule requires banks to count the value of assets based on the latest market price (e.g. sale) of that asset. In this case, when “toxic” mortgages are being sold off at discount, or “fire sale” prices, banks are required to dramatically reduce their value of assets accordingly, whether they intend on selling their mortgages in the near future or not. Since banks are required to keep a certain amount of reserve, the lowering of the book value of assets reduces the capital available. See a better explanation from the Capital Research Center. In contrast City Journal doesn’t think the mark to market rules have much of an impact.

2) Privatize Fannie Mae and Freddie Mac: Free market advocates have long called for the privatization of Fannie Mae and Freddie Mac. The corruption, the political ties, the contributions and lobbying , and – most importantly – the implicit (now explicit) backing of the government which encourage these agencies to push subprime mortgages, creating our financial crisis, is reason enough to away with these government-sponsored enterprises.

3) Cut Capital Gains and Dividend Taxes and Cut Corporate Income Taxes. These are key to encourage investment in our economic engine. Reason’s article on the bailout alternatives discusses why cutting taxes will help stimulate the current economy.

4) Repeal the Community Reinvestment Act. The CRA and other efforts to encourage homeowner led to subprime lending. Read more on that here

5) Repeal Sarbanes Oxley. This series of regulations is enormously costly, and clearly failed to prevent the current crisis. This Out of Control post on free market choices has more on Sarbox.