Bailout Options

In today's Washington Post, David Ignatius and others talk about the bailout and the greatest generation. Whether the current bailout works or not, the Alt-A mortgage bubble will force the need for a new one. We need to be careful that we do not simply repeat the mistakes which set this one in motion by having too low interest rates leading to a reinflation of the housing bubble.

There are five reasonable options here. The first is liquidation - providing a means through bankruptcy or some other systematic default mechanism to allow people to get out of debt that does not work.

The second option is to end tht toxic practice of allowing people to get home equity loans to "cash out" equity for vacations and the payment of credit card balances - since this simply leads to more debting. Ending the deductibility of these interest payments would take care of this nicely, possibly as a part of comprehensive tax reform.

A third provision is to create government progams for borrowers to refinance their Alt-A morgages at lower fixed rates through their state housing finance agencies. This could be done either with or without adjustment of the principal balance. If the principal balance is adjusted, however, the government needs to reach back and capture through taxation some of the extreme capital gains people made in when the housing bubble was growing. For some, this would be a wash, since they sunk their gains into a new property which is now worth less then the purchase price - however other sellers got out and stayed out - although many of these probably lost money by investing in the toxic paper that resulted from these very transactions. If we bail them out for these investments, it must be net of their undo capital gains. This is why a government bailout is necessary, as the private sector has no place making such distinctions.

The fourth and most important piece of any bailout should be higher incomes. If incomes catch up to housing values, much of the problem goes away and housing prices can stabilize and debt will be repaid. Calls for governmental budget cuts, teacher furloughs, lower union wages need to be resisted - since they will exacerbate the problem. If anything, people should be getting raises and the minimum wage increased. For any who are displaced in the private sector, massive education funds with stipends should be made available when people are operating at a human capital deficit.

The fifth point is to increase the top tax rates, not at $250,000 but at $150,000, to at least Clintonian levels - as well as restoring the capital gains and investment rates to those levels as well. This will put more money in the consumption and government sector and take it out of the chase for overpriced investment instruments. Stock prices and real estate values were bid up because the wealthy and upper middle class had more money then the productive sector had investment opportunities - so toxic investment opportunities were created and unrealistic profit goals were required to compete. Take away the fuel for the fire and all will settle down.