Ways We Can Fix This Giant Mess

Robert Rubin
Chair of Executive Committee of the Board of Citigroup and Former Clinton Administration Treasury Secretary

Although I and others saw financial excesses developing, hardly anyone anticipated the full combination of factors that has now led us into uncharted waters. You had the underweighting of risk, low interest rates, the faulty AAA ratings of some subprime-mortgage-backed securities, extended good times—which led to a loss of caution—and "financial engineering," the creation of complex instruments that even many sophisticated investors didn't fully understand. It's unclear how serious the resulting economic strains will be, but I think the risks are high enough that we should be highly proactive.

On the whole, the Fed has done a good job. The stimulus package was the right thing to do. But we should also see what further measures we might take in the mortgage area. There is a risk of rapid declines in housing prices, more large losses on mortgages for financial institutions and widespread foreclosures that would damage neighborhoods. There are a lot of proposals around for the government to write down existing mortgages for borrowers, with the original lenders taking some loss. If the Federal Housing Administration charged realistic insurance premiums for guaranteeing new loans, you should be able to do something that doesn't involve a loss of public money. The harder question is whether you should use some public money to aid borrowers and lenders who made poor decisions. I understand the moral hazard problems of bailing them out, but the pros and cons of these proposals should be studied.

We should also take a look at financial-engineering products like collateralized debt obligations and collateralized loan obligations. These securities offer investors a wider menu of choices; but they may also encourage excessive risk-taking. We should consider higher capital requirements for banks and investment banks, plus higher margin requirements for other investors. Putting up more of their own money would make people focus on the risks. Of course, if we did it and the rest of the world didn't, this activity might move offshore.

Carly Fiorina
Chairperson of Republican victory '08, Chair/CEO of Carly Fiorina Enterprises and former CEO of Hewlett-Packard

We have two problems. In the short term, an economy that is no longer growing robustly, as it needs to, and in the long term, a challenge to the competitiveness of our nation. We have, of course, a housing bubble, which was created by the same kinds of factors that created the technology bubble. In both cases, the bursting of the bubble hurt some investors and speculators—and for them I have no sympathy—but it also hurt some real businesses, job creation and ordinary American workers and families.

We ought to do what we can to help those families and small businesses—which are the engine of growth in this country—and let the chips fall where they may for the investors and speculators. All of the things that have been done to date—the Federal Reserve stepping in to put money into the system, for instance—have been positive. I personally would go one step further, and I'll take a page from the technology industry. When the technology industry puts a product out that they believe might harm their customer, the company bears the burden of recalling that product. I think the mortgage companies and the banks should step to the plate and say, "We have put products out there that have harmed our customers, either because we didn't explain them well, or because we pushed them into homes or mortgages that they couldn't afford." And those lenders need to sit down with their creditworthy but cash-strapped customers and say, "How do we help you?"

One specific thing we can do, and this is something that John McCain has said for years now, is to lower the tax rate on business. We have the second highest business tax rate in the world, second only to Japan. Lowering it by 10 points would have a huge impact.

Gene Sperling
Adviser to Hillary Clinton Campaign and Senior Fellow at The Center for American Progress

People are going to see communities that were coming back spiraling down. In a solid suburban, middle-class neighborhood, the housing prices are causing pain, but when we pull out of the economic downturn, that community will likely still be standing. But a cluster of foreclosures in urban communities can fill it with the signs of urban blight—vacant properties, which are associated with crime—and could lead to a quick downward cycle that may not be so easy to repair. There's been disturbingly little attention paid to empowering local government authorities to help save these neighborhoods. In Senator Clinton's stimulus plan, we put in a $30 billion emergency housing fund for state and local governments to go beyond counseling and foreclosure prevention and buy up vacant properties. How can you have a housing-led recession and have no housing-based remedies?

I think the policy world is moving our way. Federal Reserve chairman Ben Bernanke has spoken of purchasing vacant properties and reselling them to provide low-income rentals for people who may indeed end up losing their homes. Minneapolis isn't doing so bad fiscally, so they're offering people $10,000 incentives to move into areas where there have been foreclosures. Where these funds are used well, there could be very significant savings and prevention of long-term damage.

Bob Lutz
General Motors Vice Chairman

I'm not an economist, but after the rate cut you saw a sharp rebound in the stock market. And all of a sudden, Bear Stearns went from $2 to $6. That shows you that it's a very delicate thing right now. If we have some stability in the stock market and easing in the credit markets, we'll steer through this fine. We're looking for a rebound in the second half of the year. We don't see a recession. I don't think we're in a recession now.

By the second half of the year, the mortgage meltdown will have been absorbed by the system. I read a story recently that said the good news is that houses in the Detroit area are starting to sell, but the bad news is that the prices are very low. We're probably reaching the bottom and we're at the restart point, where people are buying houses again. We're in a part of the country where this hit early. If the Detroit area is starting to sell houses, that's a good sign.

Real economic growth is created by value-added production. You cannot create real economic growth by trading pieces of paper. We have to relearn that lesson over and over again. We can't live off imported goods and export nothing. That's like living off I.O.U.s.

Joseph Stiglitz
Columbia University Professor, Former Chief Economist of the World Bank and Former Economic Adviser to President Bill Clinton

There are two issues at the heart of the problem. First, the millions of households that are likely to have mortgages beyond their ability to pay, and secondly, the fact that both America and Americans have been living beyond their means for many years.

The two are related: Americans borrowed against inflated home prices to sustain their consumption binge. This enormously expensive war in Iraq has played a role, too—a war that was supposed to cost $50 billion is costing that amount upfront every three months. The national debt, from the Afghanistan and Iraq wars alone, will be nearly $1 trillion higher than it would otherwise have been by the end of the Bush administration. It is this mountain of debt that is undermining others' confidence in America, and rightly so.

The Fed has at least finally grasped that something needs to be done (though they've waited much too long). As more houses go into foreclosure, house prices will fall and more houses will be "underwater." There needs to be an immediate write-down of mortgages—perhaps encouraged through a homeowners' Chapter 11, which would allow them to discharge a part of their debt and still stay in their houses. Many homeowners will still need some assistance—we subsidize upper-income homeowners through large tax deductions. Changing this into a cashable tax credit would help many poorer Americans as well as helping the financial system.

Of course, there is something peculiar about what has been going on. While the administration has been vetoing any suggestion of a bailout for poor homeowners who have been taken advantage of by predatory lenders, there has been a bailout for investment banks. The Fed has lent money to facilitate JPMorgan's takeover of Bear Stearns, and has evidently underwritten the risk. It has accepted risky mortgages as collateral—again putting taxpayers' money at risk. These bailouts for those responsible for the mess have been done in a totally nontransparent way. We really don't know much about the values assigned to the collateral, and what the risks are. It seems fairer to help poorer American households, rather than putting taxpayers' money at risk, without even charging appropriate insurance premiums for bearing this risk.

The last time there was a housing crisis of serious magnitude wasduring the Great Depression; in 1933, Congress created the Home Owners' Loan Corporation (HOLC), whose business was to buy distressed mortgages from mortgage lenders. In the process, they renegotiated the terms of the loans to homeowners, so families could keep their homes. The government has been trying to get lenders to renegotiate mortgages, but up till now, all their agreements have been voluntary. We need to put real government money behind the talk.

Senator Christopher Dodd has proposed creating a Home Ownership Preservation Corporation, something like the HOLC, which is exactly what's needed--the government must commit serious money to helping distressed homeowners. This is a huge market turn, already the value of our homes has gone down by about a trillion dollars, and if we do not do something there may be millions of foreclosures.

Government help for homeowners is the immediate step we need to take,but in the longer run we have to improve consumer protection. Loans were being made to people who couldn't afford them, and some of these were the fault of abusive lending practices. Elizabeth Warren, a Harvard Law Professor, has proposed that the government create a Financial Product Safety Commission, which would work similarly to the Consumer Product Safety Commission, but would monitor lending and financial practices. Current bank regulators don't do that well enough.

Douglas Holtz-Eakin
Senior Policy Adviser, John McCain 2008 and former Director of the Congressional Budget Office

Subprime mortgages are concentrated in a handful of states, and the real difficulty is getting the lenders together to take a haircut. You want to target taxpayer assistance strictly to people who can afford to be in the house but are in the wrong mortgage. We need more transparency in mortgages. You can put on one page what borrowers need to know. We need better incentives so that people are accountable for the financial viability of the product.

The real economy has some underlying resiliency, and fixing the credit crunch would take some of the pressure off. I don't see any substitute for confidence and capital. If you put more capital into these banks and financial institutions, we'd be in better shape. A lot of it just is a crisis of confidence. Hopefully the stimulus package will help pick things up late in the second quarter or early in the third.

Donald Marron
Former CEO Paine Webber and current CEO of Lightyear Capital

The banking system has always been based on borrowing short and lending long, with investors and savers providing the funds. This system gets tested in times of stress. For example, Bear Stearns is a significant force in the business of clearing for securities firms and hedge funds. Hundreds of their clients with huge sums at stake suddenly were concerned about Bear, withdrew their funds and accelerated the firm's demise. It was important to overall confidence in U.S. markets that the government came to the rescue in this case. JP Morgan is getting an enormous bargain. Bear Stearns is basically strong and its stock is selling for substantially more than the expected deal price in the long shot hope that another buyer will pay more.

In addition to the credit crisis, there's been a liquidity crisis in the securities industry. Products have become so complicated that when investors wanted to sell them, buyers weren't there to buy them at rational prices. The markets can handle almost any change in values but sellers must be able to sell at rational prices. Credit constraints together with lack of sufficient information have created this liquidity crunch. We need greater transparency. But there is still great liquidity in world markets with now over $3.5 trillion in U.S. money market funds, and similar amounts in the rest of the world. U.S. corporations are also very liquid. These funds are generating record low returns—Treasury bills are below 1 percent. Some of this money will return to the credit markets. It's not as though we don't have cash; we're just not willing to commit it now.

And last, there is a confidence crisis, as shown in the dollar, which measures money flow and demand. The dollar is both an economic indicator and a confidence indicator, in the minds of investors and governments. I think (Treasury Secretary) Hank Paulson is doing many good things on both the short term and long term fronts. Short term the government needs to focus on domestic problems, as this week it has done in bailing out Bear Stearns. Long term it needs to focus on balance of trade. Another problem government has to focus on is keeping homeowners in their homes. Foreclosures don't just hurt the owners, they also hurt their neighbors. Federal, state and city governments together with Fannie Mae and Freddie Mac have to simplify a cumbersome process and save the neighborhoods.