The EconomyRethink taxes, revisit the home-mortgage deduction, regulate the investment banks and hedge funds.
Posted Friday, April 4, 2008, at 1:59 PM ETWith President Bush's approval rating hovering in the 30s, just about everyone has an opinion on what George W. has done wrong in the past seven years. But not everyone can explain what the next president must do to fix it. So we've called in some experts to tell us. Fixing It is a 10-part series to be published over the course of the week by some of our favorite writers, offering detailed policy prescriptions for the next president, whoever that may be, on how to quickly undo some of the damage that's been wrought. One of our contributors wryly describes the series as "News You Can Use. If You Happen To Be President." Read the other entries here.
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StumbleUpon• Revisit the home-mortgage deduction. The home-mortgage deduction currently applies to the first $1 million of housing debt and can be used for the purchase of a second home. This proposed fix may be an example of closing the barn door after the barn has burned down to the ground. But the home-mortgage deduction is another example of a tax policy that benefits relatively few while encouraging speculation that has broader negative effects on relatively many. (Roger Lowenstein made the case against it in a 2006 New York Times Magazine story.) Since only a small minority of Americans actually take the deduction (because you have to itemize your deductions in order to utilize it), it makes the after-tax cost of housing cheaper for the well-off while driving up the pre-tax prices of housing for everybody. The advent of interest-only loans provided speculators with tax-efficient means of speculating in housing. And we all know how well that worked. We should consider scaling back the home-mortgage deduction so that it applies only to primary residences (do taxpayers really need to be subsidizing the purchase of summer homes in the Hamptons?) and reduce the limit. Given that the median home price in the United States is about $200,000, the ability to deduct interest on up to $1 million goes far beyond providing an incentive for middle-class homeownership.
• Regulate the investment banks and hedge funds. We should consider establishing capital requirements and an FDIC-like body for investment banks and hedge funds. Currently, these institutions are largely outside the purview of banking regulations. But the walls separating the different components of the system have broken down. Financial institutions have taken on obscene levels of debt in an effort to goose profits. But as we've seen, when a firm like Bear Stearns, or publicly held vehicles like Carlyle Capital, sport $32 of debt for every dollar of equity, things don't have to go too badly in order for the boat to sink. The problem: In today's hyperconnected, hyperleveraged, and hypertraded financial market, the failure of one hedge fund or one investment bank can have catastrophic systemic implications. The bailout the Federal Reserve orchestrated last month wasn't a bailout of Bear Stearns; it was a bailout of the hundreds of firms that were counterparts to Bear. If they're going to come to the Fed for help and make a claim on public assets and public credit—as Long Term Capital Management did in 1998 and Bear and other investment banks did in 2008—then they should be required to submit to capital requirements and pay into a stabilization fund that can be tapped when the next disaster strikes.
None of these measures would prevent the next bubble from forming. (To do so would require an act of genetic human engineering on a massive scale.) But each of them would help restore some sense of equilibrium and sanity to a system that is full of imbalances. Economically, politically, and socially, American taxpayers can't afford to subsidize the reckless speculation that has been cleverly disguised as investment strategies.
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