Policy Solutions, Part Two of Four

The early Romans honored familia, virtus, and dignitas, but the later citizens of the Empire exalted the machinery of the state and fell from excessive hubris. History has shown that the regressive tax scheme of ancient Rome wiped out its middle class. If America crafts a bipartisan solution to the financial crisis, it is sure to have an even more progressive tax scheme that would eviscerate the middle class of today.

The über-rich can and will take care of themselves, for their influence has been unmistakably great, in ancient Rome as well as in modern America.

Robert Schiller of Yale is one of our most credible observers of the financial situation, for his gift of insight that the Internet bubble and later the real estate bubble would end badly was remarkable. So what wisdom does he offer? He says our financial system failed to practice “enlightened risk management,” encouraging people to borrow heavily against their life savings to buy houses.

He therefore recommends giving different advice to people engaging in the mortgage process, and planning ahead with them through writing into their contracts how a loan would be modified in the event monthly payments could not be made. Such a mortgage would be called the “continuous workout mortgage,” and it would not cost more than a regular one, because it would have reduced foreclosure costs, and it would benefit society through reducing the pain of “neighborhood effects.” New and better government agencies would improve upon Great Depression solutions, offering insurance for default. In his words, his solution would, just like the innovation of moving from three- and five-year mortgages to 30-year loans, advance us out of the Stone Age of real estate finance.

One would think that super-bright professors like Schiller would understand moral hazard. Surely he is familiar with the concept, but this solution brushes it aside in the most condescending terms. If he thought moral hazard were an important ingredient in the crisis, he would know it would never be the case that a speculating public could be met by bankers consistently counseling less usage of the commodity they sell.

In every major up-cycle, willing lenders supplied other people’s money — deposits — to willing borrowers. Animal spirits of bull markets run in herds. How would a “continuous workout mortgage” not invite default, and why would it ultimately not develop into a system where large financial institutions become REITs that rent real estate to tenants month after month — ultimately dooming the middle class to lose title to its lands through subtle changes in legal definition just as happened in ancient Rome?

Schiller once had enormous vision to see that the great Internet craze was a giant bubble. But today he sees the financial mess too narrowly. It is a subprime problem. Like modern liberals who believe socialism failed in the past only because it had not yet been perfected or expanded adequately, Schiller’s viewpoint of evolutionary finance believes the penetration of finance into the fabric of the economy is an advancement that failed because it was not innovated upon adequately. Instead, the financial calamity begun in 2008 is broader, an infection of both the monetary and the fiscal regimes; it is moral hazard.

Still, you say I offer the reader no solution. But the sad truth is that asking what my solution is reveals a subconscious denial that the answer is everywhere in this book. If we continue to run with the herd and not demonstrate character or exercise self-discipline, we will prescribe more of the same medicine: higher taxes, bigger transfer payments, more crowding out of the private sector by government, more regulation, absorption of more lending risk, and big business favored over small business. How can we escape the conceit of thinking we can solve our own problems from the top down? What feeds character and self – discipline, our innate tools for doing the job right? Was not religion devised to remind us that we are weak and fall prey to our own desires? Does it not try to awaken us to a higher, more complex logic that by our nature we can never completely understand? If we reject humanism, relativism, and the urge to play God and arrange layer upon layer of intricate rules and laws that become our own undoing, then a simple gift results: The beauty of our condition is that once we submit ourselves to respect others and not envy them, there is a natural tendency for betterment and harmonious behavior.

So now, with great humility, I offer some thoughts for solutions. I place these before you with sadness, because with our culture having decayed and hubris and condescension never having been so palpable, surely they are far less likely to be followed than the great ideas of the Schillers of the world. We need strong banks. Not behemoths that cannot be allowed to fail. Small ones, medium-sized ones, inevitably some large ones. If deposits are known to be at risk in banks generally, then bank managements will resume the role of safekeeping. Not to compete for depositors based upon safety would risk a migration of deposits to safer competitors. Stop encouraging large semi-weak banks to take over large weak banks, with the Fed providing a backstop for these transactions.

Instead let these more poorly run banks fail. For a time, print money to make good on deposits and accounts held at these banks and brokers. It ’ s only fair, because there have been no safe financial institutions for people to use, thanks to bad governmental policy. Eventually, close down the SIPC and the FDIC. Remove the tax loss carry forwards of the large banks, for with those in place along with refreshed balance sheets no small, sound bank could possibly compete against them. As bad banks fail, money will be printed in accommodation, lots of it. While this riles the libertarian sensibility, morally it is reprehensible that a populace trained for nearly 100 years to entrust deposits to banks should be impoverished as if they had been duped by Bernie Madoff.

The taxpayer should never again be called upon to subsidize anything other than government ’ s duty as originally enumerated in the Constitution: national defense, border security, yes; entitlements, no. Of course, those who are old and dependent should still be taken care of. But phase it out — all of it — according to a preannounced timetable. With a dramatically shrunken government, there will be less need for taxes. But there will still be an overhang from past debt and entitlements (even if they are reduced), which vastly exceeds the capability for their servicing by those in today’s top brackets.


Bill Baker,
for The Daily Reckoning

[Editor’s note: This passage is reprinted from William W. Baker’s book, Endless Money: The Moral Hazards of Socialism, with the permission of John Wiley & Sons, Inc (©2010). You can get your own copy of his book here.]