Much of what has been written about the financial crisis has focused on the why, as opposed to the what now? This has led to the inevitable finger-pointing, posturing, grandstanding and the like. Personally, I'm sick of it. We're in trouble: the time has come for the conversation to shift from bad guys and witch hunts to what the hell are we going to do now?
Greg Mankiw, in an Op-Ed in Sunday's New York Times, summed up the key question when thinking about policies and actions to be taken to extricate us from this ongoing chaos: But Have We Learned Enough? Based upon the steps taken to date: probably not.
While I'm neither economist nor policy-maker, I've got a few thoughts on what I think has to be done before we can even entertain the possibility of a macroeconomic recovery.
#1: Rigorous application of mark-to-market accounting rules, with the further tightening of the rules enabling certain assets and liabilities to be carried off-balance sheet. Bottom line, without full financial statement transparency and integrity in financial reporting, investors will remain cynical and suspicious about the financial health of firms across all industries. This needs to be fixed immediately.
#2: Immediate push to list over-the-counter (OTC) derivatives transactions. Partially related to #1 above, the magnitude and lack of transparency around all manner of off-balance sheet contracts is creating fear among counterparties and investors alike. If we can put a man on the Moon, we can work rapidly to move OTC transactions - interest rate swaps, credit default swaps, etc. - to a listed medium where transparency and counterparty credit management are the hallmarks of its operation. This is where exchanges like the CME need to step up and lead us forward.
#3: Work with laser focus to keep credit-worthy people in their homes. This is absolutely critical. The decline in housing prices, spurred on by rising foreclosures and a rising inventory of unsold homes, will be the root cause of the next big leg down in economic activity. Debt will eventually overwhelm equity value in much of our housing stock, causing people to either walk away from their mortgages or to default. Without a brake in the decline of housing prices, consumption will plummet, unemployment will rise and a downward deflationary spiral will take hold. We are well beyond the issue of "fairness" (e.g., if somebody agreed to a poorly-structured mortgage that's their problem) and onto figuring out how to stop the negative loop in its tracks.
#4: Revamp corporate compensation structures. Leaders need to be aligned with shareholders. Current compensation structures don't do this nearly well enough. Board of Directors and investors alike have failed miserably in supporting, and, in fact, insisting upon, rational and fair compensation regimes. What once used to be a PR issue is now an issue of survival. A lack of trust is one of the biggest problems facing investors today, and being able to believe in both the integrity of firm financial statements and firm management would go a long way to making companies far more investable than they are today.
#5: Rebuild core infrastructure. Forget about "bridges to nowhere." Our roads, airports, bridges, subways and sewers are in a state of staggering disrepair. We will have millions of hard-working, skilled employees out of jobs as soon as the U.S. auto industry and several others pare back in order to have any chance of survival. These workers should be re-trained and re-deployed into projects that can benefit from their skills and experiences, and which can provide them with a fair wage to keep them in their homes and to hopefully keep them as able consumers. Because without the consumer, which still accounts for 2/3 of our economic output, we're screwed. I know we have a cataclysmic deficit. Believe me, I know. But the way we can pay off the deficit is by getting our economic engines going again, and investments in productive projects like these will help individuals, states and local governments through the difficult times, while laying the foundation for an economic boom when conditions turn back up.
#6: Maintain domestic control over our policies but coordinate closely with our global allies. Given the startling interconnectedness of our economies, unilateralism is simply an insufficient vehicle for addressing our deepest problems. It is akin to controlling pollution - if the U.S. sharply reduces emissions but India, China and Russia preserve current policies - the impact of our efforts will be sharply muted. Without having elements of 1-5 pursued by our Eastern and Western partners, who are suffering from many of the same problems we are, our actions will work with disappointing effect.
#7: Leverage cooperation with our allies around our economic welfare to bleed into social welfare. At times of economic unrest, seeds of social discontent are sown that can have catastrophic effects. We need to be extremely attuned to this risk and to work together with our allies to ensure that we remain united and strong against hostile, divisive forces, be they terrorists, hate groups, or others that seek to capitalize upon people's fears by making them insular, angry and, ultimately, hostile. This also applies to governments that seek to use war as a vehicle for distracting an unhappy populace, harm innocent people and threaten ourselves and/or our allies.
The key problems are that of a weak economy and a lack of trust. Banks aren't motivated to lend because they don't see a risk/reward profile that warrants it. Why lend to businesses if consumption is collapsing? Why offer mortgages if housing prices are falling? Why lend to other banks if I don't believe their financial statements? What Messrs. Paulson et al didn't internalize is that simply giving banks capital doesn't mean they will offer it. They would rather sit back, be hyper conservative and ride the yield curve on their cash. Safe. Stable. Low returning, yes. But they won't go bust.
Without question, all policies should be geared towards getting our economic engines going again, and protecting against those forces that could threaten it. There are many more ideas beyond the seven listed above, but I believe these represent the least we can and should do to give ourselves the best shot of averting a truly ugly economic outcome over the next decade.