Here is my wish list of policies. First we will need a comprehensive package of policies to deal with the immediate crisis. Here I will not delve deeply into the causes of the financial meltdown--interested readers are referred to my Policy Notes and Policy Briefs at www.levy.org, which foresaw and then analyzed the processes that created a "perfect storm" (the title of a piece I wrote in 2000--perhaps a wee bit prematurely?). It is, however, necessary to remember that "stability is destabilizing"--successful resolution of this crisis and restoration of a semblance of stability will encourage a return to risky practices. That is why we also need a package of policies for the medium- and longer-term. While we can never go back to the New Deal institutions and regulations, we can certainly learn from them. Recall that we did have quite a long run of good times after WWII, and Roosevelt's New Deal had a lot to do with that. The unraveling of the social and economic fabric over time--partly in response to deregulation but mostly due to "natural" profit-seeking behavior of innovative firms--created conditions in which "It" (a debt deflation and possibly a depression) became possible again. Hence, what we want to do is to promote institutions, regulations, and practices that can constrain modern capitalism's inherent thrust to fragility.

Originally I had planned to put all of this into one post, but due to length I have decided to devote Part One to the current crisis, and Part Two to the longer-run.
(And sorry for the back-to-back posts; I'm on Oz time and I guess the rest of you are asleep on USA time.)

Policies to deal with the immediate crisis:
1. Liquidity: As I stated previously, the Fed finally figured out that it must lend without limit to any financial institution. Forget collateral--it doesn't matter (we are on the hook, anyway). Forget the auctions--just lend at the discount window. Provide loans of different maturities to meet the needs of the borrowing institutions. Raise the FDIC's limit to infinity (we are going to bail out the depositors, anyway). Continue to increase coverage to money market funds and other kinds of deposits. If the Fed had done this in the very beginning, the liquidity crisis would not have been nearly so bad.
2. Paulson Plans: Paulson famously held a gun to his head, demanded $700 billion from Congress with no strings attached, and insisted that the sky would fall the next day if he didn't get the money. Wrong. It didn't. He next tried to buy bad assets--but they are all bad, so he would need ten, or perhaps 100 times as much money as Congress had allocated. So then he proposed to inject capital into the banks. Ditto--too little, too late. So his "final" plan has been to use the capital to promote consolidation--picking and choosing which favored institutions would get subsidies to take over other institutions. Who needs socialism when Wall Street runs the Treasury? Advice to Obama: discard (and reverse where possible) all of Paulson's actions.
3. Insolvency of financial institutions: Paulson's premise was that insolvency is a matter that must be resolved immediately. But that is false. Financial institutions can stay in business for years with liabilities greater than assets. If the economy recovers, many of those assets will rise in value; the insolvency problem can conceivably solve itself if we have sufficient patience. That is how we resolved the epidemic of bank insolvency in the early 1990s. Unfortunately, if you leave the crooks in charge of insolvent financial institutions, they like to "bet the bank" (take huge risks--since they've got nothing to lose). That's what happened to thrifts in the 1980s. So here is what we need to do: a) insist that the owners of troubled institutions inject their own capital (to put some skin into the game); and b) if they refuse to put in enough, the appropriate regulatory agency (FDIC in most cases) moves in and places the institution into a sort of limbo. Management is replaced; the institution is closely supervised with tight constraints on growth imposed; and then we hope for economic recovery. Hopeless institutions will have to be resolved--but rather than adopting Paulson's consolidation approach, we should close the institution, sell off the assets, and pay off the depositors. This could include thousands of institutions. There will be collateral damage--for example, pension funds hold stocks in such institutions, so we will need to bail them out through the Pension Benefit Guarantee Corporation, which will itself go bankrupt so we will need to bail that out, too. Total estimated cost: trillions. Can we afford it? See previous blog. Finally, there has long been a doctrine of "too big to fail", which counseled that we can let small banks fail but we must always bail out the big ones. This current crisis has revealed such policy to be nonsense. I advocate a "too big to save" doctrine: the big Wall Street banks serve almost no public purpose. Let them fail. Save the small and medium sized banks that actually lend to firms and households.
4. Immediate tax relief: I advocate an immediate payroll tax holiday--stop collecting the OASDI portion of the payroll tax from employers and employees. Both the employer and employee pay 6.2% (the self-employed pay 12.4%) up to a current maximum taxable base of $102,000. Approximately 163 million people paid Social Security taxes on earnings in 2007. Total tax revenue raised was $656 billion, which amounts to an average of $4025 per taxpayer. A tax holiday would provide immediate tax relief to workers and their employers, injecting $12.62 billion each week into the economy. Take-home pay would rise by an average of $77 per week for each taxpayer, with an equivalent saving per worker for each employer. A worker who earned $40,000 a year would get a tax cut of $2480 per year. Just as important, that worker's employer would also benefit from $2480 of tax relief, which may help keep workers on the job. If desired, we can phase the tax back in when the stimulus is no longer needed--although payroll tax reform is included in my longer-run policy proposal.
5. Fiscal stimulus: Many argue that government spending is more stimulative than is a tax cut, since part of the tax cut is saved. So what? Households have been spending more than their incomes for a dozen years, and the geniuses on Wall Street have just wiped out about half of their retirement savings. The answer is that we need both: a payroll tax holiday to strengthen household balance sheets, and more government spending to restore the economy. To do immediate good, we need spending that can get underway quickly. Increased unemployment compensation and other forms of social spending are needed. It is also important to help state and local governments, which are reeling from the double whammy of higher expenses and plummeting tax revenues. I suggest at least $400 billion of "block grants"--perhaps based on population--to be spread among these governments. Maybe some of the money would be targeted (public infrastructure projects that were already underway, or are on the shelf and ready to go), some would go to Medicaid, and some would come with no strings attached.
6. Mortgage relief: Millions of homeowners are underwater (outstanding mortgages greater than home value), and it will get worse. Millions were duped into subprime loans at resetting rates they cannot afford. Millions more used homes as cash-out ATMs, have fallen behind in payments, and now face job loss or at least reduced hours and wages. Economic recovery, job creation, a payroll tax holiday, and rising wages will all provide relief because they will make it easier to service debt. But more direct measures will also be required. The FDIC has been just about the only part of the current administration with any clue about what to do. Many mortgages need to be refinanced on more favorable terms. That includes lower, fixed, mortgage rates as well as reduction of the principal to reflect current market value of the properties. Because most mortgages were sliced and diced to serve as collateral underlying securities, it is very difficult to renegotiate terms. I am not a lawyer so cannot provide any informed advice, but perhaps there is a way for Congress to force securities holders to accept losses. (Again, there will be collateral damage that will have to be resolved.) Failing that, existing mortgages can be paid-off, with new mortgages issued. If securities holders cannot be forced to take losses, the Treasury will have to take them. "Socializing" losses in this manner is not normally a good thing, but these are not normal times. A debt deflation is not the right time to try to worry about moral hazard. Who will issue the new mortgages? Let's renationalize Fannie and Freddie and put them to work in the public interest. This time, they should be run by civil servants earning normal GS salaries, they should hold the mortgages, and they must adopt reasonable underwriting criteria. Finally, homeownership is not for everyone, and at least some owners will opt for Dean Baker's "rent to own" plan. Give them back their downpayments (plus fees paid to mortgage originator swindlers), let them stay in the homes paying fair market rents, and give them a couple of years to decide whether they really want to be homeowners.
7. Jail the crooks: Vastly increase the budgets (and hire criminologists) for pursuit of fraud all the way up the real estate food chain: mortgage originators, property appraisers, risk rating agencies, accountants, and--most importantly--Wall Street money managers that created this mess.