Monday, March 10, 2008


New Yorkers, and Brooklynites in particular should note that the administration is now finally getting ready to take the economic downturn seriously. In a real estate market like Brooklyn, which is relatively strong, that could hold the promise of renewed stability in housing prices. That in my view is where we want to be given that most of the price escalation of the last two or three years was simply built on air given the slipshod government policy on banking regulation.

New Yorkers could salvage this situation by instituting a citywide bailout tax on all real estate transactions done on credit. A borough like Brooklyn then would be free from the vagaries of the free marketeers, and the borough’s primary asset, privately owned housing, would be protected. That in turn would slow the downturn in other credit driven segments of the economy at least locally.

Bankers should not be speculators, nor should they be insurers. They should focus on the careful retention of asset worth, a lesson Americans thought they had learned from the Great Depression. Since the time of Reagan, however, bankers have been more and more deregulated into businesses for which their institutions are unsuited and inclined to folly. Thus private mortgages were created on unsupportable risks like interest only loans and ungoverned variable rates.

Worse still is the sale of mortgages to investment funds. The half-baked notion was that spreading the risk around reduced its volatility. That is exactly like assuming you can insure the value of your chicken ranch by betting on hundreds of horse races. It is the idiocy that always overtakes business, when business becomes so enthusiastic that it forgets about economics.

Americans no longer read very much, so they do not like the word regulation and we are not likely to see insurance, investment, and banking divided again any time soon. What do we do about the mess created by their coming together?

Can Paul Krugman be wrong? Very rarely in my experience, but in Monday’s editorial in the NY Times, he comes relatively close to it by a sin of omission. He argues that the current housing crisis with all its attendant financial fallout may be arrested by yet another interest cut from the Fed. Given the problems of personal debt, currency devaluation and unemployment, that may help the markets but it will do nothing for the American citizen. He adds though that shoring up the bond market is a good way to cool the economy while keeping capital in play. I would agree but that does not fix the bank problem.

He seems right in his analysis but like all the economists of our time, he has no instrument in mind to protect the actual victims of irresponsible banking. They are we, the public who use these institutions under the assumption that somewhere, somehow they are held in check from total instability by something.

If we cannot regulate banks, we should institute a bailout tax. Thus any bank or lending institution should be taxed according to the risk of the loans they make. The revenue should go into a fund like the FDIC. The banks create the risk for themselves, but as we are seeing – and saw with the Savings and Loans debacle of the Reagan administration – they cannot absorb their own losses when their judgment is arrogant, stupid, or simply bad. In fact, with the exception of a few closings among the most egregious offenders, the banking industry never pays for its errors at all. We do.

Let the corporation that owns the bank assume the lion’s share of the risk they allow banks to create. Given the housing market as it stands now, that would also work well with developers. Any developer getting any sort of government subsidy would have to pay a risk tax so that cost over runs, delays, and tax abatements would be balanced out in the public’s interest by this fund into which the developer pays.

Franklin was right that nothing focuses a man’s mind like the knowledge that he will be hanged in a fortnight. It would be a great boon to our community if bankers knew that each time they sold mortgages as a high-risk security to investors, they would have to pay through the nose to do so.

Steven Hart

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