The basic things expected by our people of their political and economic systems are simple. They are:

Equality of opportunity for youth and for others.

Jobs for those who can work.

Security for those who need it.

The ending of special privilege for the few.

The preservation of civil liberties for all.

The enjoyment of the fruits of scientific progress in a wider and constantly rising standard of living.

These are the simple, the basic things that must never be lost sight of in the turmoil and unbelievable complexity of our modern world. The inner and abiding strength of our economic and political systems is dependent upon the degree to which they fulfill these expectations.

Many subjects connected with our social economy call for immediate improvement. As examples:

We should bring more citizens under the coverage of old-age pensions and unemployment insurance.

We should widen the opportunities for adequate medical care.

We should plan a better system by which persons deserving or needing gainful employment may obtain it.

I have called for personal sacrifice, and I am assured of the willingness of almost all Americans to respond to that call. A part of the sacrifice means the payment of more money in taxes. In my budget message I will recommend that a greater portion of this great defense program be paid for from taxation than we are paying for today. No person should try, or be allowed to get rich out of the program, and the principle of tax payments in accordance with ability to pay should be constantly before our eyes to guide our legislation.

If the Congress maintains these principles the voters, putting patriotism ahead pocketbooks, will give you their applause.

In the future days, which we seek to make secure, we look forward to a world founded upon four essential human freedoms.

The first is freedom of speech and expression — everywhere in the world.

The second is freedom of every person to worship God in his own way — everywhere in the world.

The third is freedom from want, which, translated into world terms, means economic understandings which will secure to every nation a healthy peacetime life for its inhabitants — everywhere in the world.

The fourth is freedom from fear, which, translated into world terms, means a world-wide reduction of armaments to such a point and in such a thorough fashion that no nation will be in a position to commit an act of physical aggression against any neighbor — anywhere in the world.

That is no vision of a distant millennium. It is a definite basis for a kind of world attainable in our own time and generation. That kind of world is the very antithesis of the so-called “new order” of tyranny which the dictators seek to create with the crash of a bomb.

– Franklin Delano Roosevelt, January 6, 1941

State Dept.:  Nicholas Kristof, the NYTimes columnist whose annoying persistence has kept a world focus on the disastrous events in Darfur.

Treasury Dept.:  Paul Krugman

Defense Dept.:  Sen. James Webb, former Secretary of the Navy

Justice Dept.:  David Cole, who has surveyed the panoply of legal abuses in the Bush administration and knows where the problems are.

Interior Dept.:

Commerce Dept.:

Labor Dept.:   Thomas Geoghegan, longtime labor lawyer who is now running to succeed Rahm Emanuel in Congress.

Health and Human Services:

Housing and Urban Development:  Dennis Kucinich, who knows how real people live their lives and has executive experience as mayor of Cleveland.

Transportation:

Securities and Exchange Commission:  Harry Markopolos, the investment professional whose documented warnings about Bernie Madoff were ignored, probably because the SEC staff couldn’t understand the math.

Surgeon General:  Joycelyn Elders, the former Surgeon General that Bill Clinton had to throw under the bus because she advocated birth control for teenagers and admitted knowing something about sex.

We are saving too little and piling up too much debt.  And the rationales voiced by the politicians for their bailout plans are starting to wear thin.  We need to free ourselves of myths that have sustained too much national economic policy.

1. Consumer spending will lift us out of trouble.  Actually, consumer spending is getting us into worse trouble.  It may turn out that Detroit’s problems began before the First World War when Henry Ford raised his employees’ wages generously, correctly calculating that this would not only buy loyalty but also turn them into consumers able to buy their own company’s products.  The trouble is that when you encourage consumer spending, you are diminishing the real value of wage increases.  If we mindlessly pump money into the consumer sector, it may generate business but soon will lead to demands for more wage increases from the same employers who are about to go under now.

2. Consumer and mortgage debt is good.  The subprime loan phenomenon is only a small part of the mortgage balloon that has expanded beyond recognition since 1935.  Federal policy shifted the standard mortgage from 15 or 20 years to 30 years, reducing the monthly payment and enabling house prices to rise.  Federal support of homeownership grew dramatically as a way to boost housing construction for returning veterans of World War II.  Mortgage industry demands led Congress to authorize variable rate mortgages and other exotic products in the 1980s, leading directly to no-money-down financing and “no-documentation” loans in the 1990s.  But when all these policy decisions cause home prices to rise, the amount of house you can afford stays the same — it’s just that the price has gone up, the mortgage payment has gone up, and you have been made able to afford it by deducting the interest and spreading out the payments.

Even apart from the current crisis, these props for the homeownership policy no longer make sense.  No one stays in a home for 30 years anymore, so there is absolutely no pretense that a 30-year mortgage will ever be repaid on schedule.  And allowing a tax deduction for interest makes owned housing more affordable, but does nothing for those who have chosen to rent their housing — either because they cannot afford to buy, or because their jobs require them to move frequently.  What these loan products do is to force consumers to invest a large part of their net worth in a single highly leveraged investment, a home which may rise in value (especially in a bubble) but which may also decline in value, disastrously.

Nor is credit card debt a good way to make consumers more secure.  Thanks to Congress, state usury laws have been wiped out as constraints on the amount of interest credit card issuers can charge.  Much of the debt that winds up on credit cards carries a rate of interest that would be considered loansharking if the banks were not licensed — and recent changes to the bankruptcy laws make it much harder to wipe out credit card debt in bankruptcy.  (Astoundingly, even those giveaways have apparently not rendered credit card issuers immune to the financial crisis.)  Any bailout “solution” that increases the debt load on ordinary consumers should be regarded as suspect.

3. All spending is equal.  We measure our economic health by gross domestic product, consumer spending, and other macro measures that fail to distinguish between buying a new refrigerator or buying a video game system.   There is nothing in our economic policy that encourages people (or businesses, for that matter) to spend money on necessities rather than on discretionary items.  We saw this recently when failing banks continued to fund lavish conferences at exclusive retreats for their executives.  It’s all deductible as a business expense, so why not?

It’s hard to construct a federal policy that encourages saving.  The only real way to do so is to end the federal policies that discourage it, and force lenders through better state and federal regulation to do their job of granting credit only to those who can repay it.

1. Lower Credit, Increase Saving. One first step in countering the pernicious effects of these myths would be immediately to repeal the two most significant federal laws that protect the credit card industry — federal preemption of state usury laws and federal bankruptcy laws that treat credit card debt differently from other types of debt.  This would result in a vast reduction of consumer credit, and in the short run would reduce consumer purchasing.  In the long run it would increase consumer saving as a means of accumulating the money needed to buy things that are truly necessary.

2. Make Mortgages Solid; Make Renting An Option.  Allow a tax deduction for rent paid to a landlord.  Reestablish standards that require a 20% down payment for most mortgages.  Make the “slicing and dicing” of mortgages illegal and force a licensed bank or mortgage lender to keep its money on the line for the entire amount of the loan.  End federal preemption of state laws that regulate the more exotic types of mortgages.  These four measures would reduce the volume of mortgage money available and channel it into loans that really can be paid back, stablizing home prices at a more realistic level while putting the rental option on an equal footing with homeownership.

By contrast, the auto industry is asking for funds to keep the individual firms, and the industry itself, alive in the United States despite evidence that they have made poor decisions over the years in relation to foreign car makers.  The rationale is that (a) we need these firms in the US for security reasons (they make tanks); (b) we need the many good jobs they provide directly and indirectly; and (c) eventually times will get better and they will repay us.

Right now the total value of all the common stock of the Big Three companies is probably about $13 billion (Chrysler’s figures are private).  There are lots of people around who have that kind of money.  The biggest billionaires could raid their cookie jars and buy all three for cash, right now.  But Warren Buffett chose to put his money into Goldman Sachs stock rather than a car company.  Why?  Probably because once the subprime mess passes through the python, the financial companies will do well because they are run efficiently.  By contrast, the GM execs evidently felt that a YTD loss of $21billion did not require them to lose their corporate jets or their bonuses.  They are like ship’s captains who have run out of fuel and have forgotten how to hoist a sail.

That leaves jobs and national security as reasons to put federal money into the car makers.  Both are good reasons.  But what form should taxpayer support take, given that we are not likely to get it back?  Remember that private money is not eager to fund these companies, and their execs have not seemed eager to go through Chapter 11 (even though it would permit them to leave the UAW holding the bag to some extent).  So this moment is somewhat akin to government funding of other programs that private industry is unwilling or unable to finance.

Like the space program, in other words.  That’s a program that the US taxpayers own and finance, contracting out production to private contractors (sometimes with less than optimal results).  It may never turn a profit, but we run it because it is useful.  Or like Amtrak.  That’s a government corporation that we formed to take over the hapless passenger railroads and operate them with a taxpayer subsidy that with any luck will turn into a profit over the years.  Either way, the government controls the operations, the executive pay, the perks, and the company’s priorities.  We can, and do, force them to provide the service that is needed the most, not necessarily the service they can advertise the most.

It may be that despite the ubiquity of automobiles, producing them in the US may be a luxury that we can rationalize only because in wartime we may need to produce tanks.  That may not be true in the long run, but it appears to be true now.  If that’s the case, we should pony up the $13 billion, buy every share, and run them the way we want them run — good jobs, good pensions, good fuel economy.  It’s better than paying twice as much to give the captain sailing lessons.

If you’re a trillionaire, you probably have people on your staff who know something about financial markets, business cycles, and tax policy.  And you probably have some experience making deals with strong and weak businesses.

Everyone’s clamoring for help.  The banks say credit will freeze up if you don’t shell out.  The auto makers say millions of jobs are in jeopardy if they don’t get some free money.  But you know that when they get the money, they use it to pay themselves first, and then to fatten their companies by acquiring weaker players.  If there’s anything left, they might just do what they promised to do.

Surely major investors don’t put up with that kind of crap.  Venture capitalists don’t just give money away — they demand a big share of the company, seats on the board of directors, and guarantees of how the recipient of their largesse will behave.  An investment bank like, oh, say, Goldman Sachs doesn’t just drop money in the box either –  it looks at balance sheets, income projections, and detailed evaluations of how the company manages its core business.  You’d think Hank Paulson would remember some of that when he’s investing the taxpayers’ money.

So when our trillionaire gets into the picture, what does it do?  Well, if its chief operating officer is Hank Paulson, it takes the money and ignores the strings attached, and hands out billions without even disclosing where the money went.  If its board of directors is a Congressional committee, it postures, pleads for special favors for the districts of the committee members, and largely fails to understand what it is doing or rein in its rogue manager.

Republicans have long insisted that government should operate like a business, but when they get the chance to do so, they ignore all their business training and throw money into one bad deal after another.  Evidently clearer heads are required.

The first thing to do is to get an accurate picture of what is going on and where the economy is headed if no intervention occurs.  Clearly the financial industry is in trouble, but there are two kinds of trouble:  that which impacts individual companies, and that which impacts society.  It is the latter on which our attention should be focused.  Unregulated greed led to imprudent behavior fueled by the apparent ability to externalize risk to a level approaching 100%.  This was so astonishingly brilliant, it’s no wonder their executives were compensated so handsomely.  They deserved everything that was coming to them, but the nation did not deserve the consequence:  a broken commercial credit system and a system of private homeownership that has left millions destitute and simultaneously laid low thousands of private and public pension plans.

The auto industry’s problems are of a different order entirely; those companies operate on very long timelines and their troubles originated in decisions they made years ago.  Car makers have lost sales for several reasons:  production of gas guzzlers, a distribution network that forces prices up to generate profits for dealers, and of course a drastically reduced ability of consumers either to buy cars or to get car loans.  Although the effects of a depressed auto market will be serious, they are not different in kind from the experience of many other industries that either sell big-ticket items to consumers or supply the basic materials with which those goods used to be made.  If Detroit firms went through Chapter 11, they could cut back on dealerships or even sell direct to consumers at the factory (as they once did, many years ago).

In each of these cases, our trillionaire needs to make hard decisions about what kind of concessions it needs to extract from those it assists.  This is not unfair; people who receive unemployment compensation are required to look for work, and those who receive food stamps are required to spend them on food, not lottery tickets.  Nor is it analogous to government regulation which is imposed on an unwilling industry; these companies are begging for our money.

What’s the best way to unstick the credit system?  We could open our own bank and lend money directly to businesses and individuals, in competition with the private banks.  They’re skittish about lending money right now; our trillionaire sees social value in taking those risks when they are needed most.  If we decide instead to funnel our money through existing banks, it’s entirely legitimate to tell them they have to run the way our state enterprise would run: low executive pay, a requirement to shove money into the credit pipeline, and restructuring of consumer loans to put individuals back on their feet.  And no mergers, dividends, stock buybacks or expensive “conferences” for the duration.

And what do we want from the auto makers?  Most of the above, plus retooling the plants to produce smaller and greener vehicles, or even (heaven forbid) trains.  Big investors follow the “golden rule” — he who has the gold, rules.  That’s how our trillionaire should think.

As a small contributor to the trillion, I have a say too.  My top priority would be to bail out state and local governments before they begin to cut essential services like education, police and fire protection.  The wave of foreclosures is causing a loss of revenue from income, sales and property taxes, which are the backbone of most state governments (other than Alaska, apparently).  And the fall in stock prices is putting retirement pensions in peril.   Before it gets worse, we ought to inject revenue there — say, $300 per inhabitant.  That would cost only $90 billion.  Surely after we’ve helped out the poor investment banks and auto makers, that much should be left over.

Now,  how to get more money into the consumer sector so someone will buy those cars, refrigerators and homes?  One way is to write down their mortgages so they can afford them, and perhaps have the trillionaire take an equity stake in the home in compensation for its generosity.  Another is to create jobs as was done in the New Deal — building roads, bridges, train lines, schools, national parks and water supply systems and forward-funding the future costs of maintenance.

A third priority would be to reward savings and reduce the demand for loans.  Unfortunately, there’s no direct way to do this, although proposals for a consumption tax have their appeal.  The best way, short of that, is to force a tightening of credit standards and terms.  Here are three ways to do that:  Bring back state usury laws (which are now outlawed by federal preemption) to shrink the credit card tumor.  Have Fannie and Freddie change the basic home mortgage term from 30 years to 20.  Change the tax law that excludes gain on the sale of a home, to exclude from taxation only the gain that is attributable to the cash investment of the homeowner.

How could Hank Paulson say no to that?

1.    End mortgage derivatives.  There is no reason to have this toxic form of securitization (which has only been in existence for 25 years) – except that the mortgage and investment banking industries wanted yet another way to generate huge profits.  The bankers proved incapable of valuing these mortgages but forged on in the hope of saddling unsuspecting foreign investors with the risk.  We need to decide as a nation that the freebooter ideology that supports these funny-money tricks, which produce no useful goods or services, is not worth the damage it has caused.

2.    End naked short selling.  Short selling – which was a major factor in the 1929 crash – was supposed to be regulated by the SEC, but the SEC has deliberately (and arguably corruptly) looked the other way.  There is no constitutional right to sell what you do not own, and no useful purpose to be served by allowing people to sell what they do not have in their portfolios.  Brokers should be subjected to heavy penalties for processing naked short sales.

3.    Reestablish the firewalls.  The New Deal’s separation of banking from brokerage and from insurance had a simple goal:  to focus banks on protecting their depositors and insurance firms on maintaining reserves with which to pay claims.  Removing those firewalls made those companies “globally competitive” without providing an ounce of added value to their U.S. depositors; in fact, the only way for them to earn the profits they hoped for was precisely to put their depositors and policyholders at risk, to the maximum extent the SEC will allow; now that they’re all in the same business, it is impossible to wall off temporary risk.  Paradoxically, the attempt of self-interested businesses to avoid inherent risk has multiplied that risk across the entire economy.

4.    End stock option compensation.  Here’s a radical thought on executive compensation: pay them in cash like everyone else.  As with wedding and holiday gifts, cash is always appropriate.  Not to deny that it’s a useful policy for executives to own stock in their companies.  The proper way to implement such a policy is for the company’s board to require top executives to buy a stated number of shares every year – with their own money, like everyone else.

5.    End taxpayer subsidies to hedge funds and CEOs.  There is no economic justification for taxing hedge fund compensation as though it were capital gains.  And in the tax policy context, where nearly every individual deduction is limited in some way, there is no reason to allow an unlimited deduction for executive compensation.  Someone has to step in and say that the duty management owes to shareholders – always invoked to justify unlimited profit – also requires that company funds be spent making whatever product the company makes, not providing free buffet tables for the execs.

6.    End tax favoritism for homeownership mania.  The mortgage interest deduction is an irresistible carrot for most Americans, and led many to overinvest in housing they could not afford.  If this deduction must be enshrined in tax policy, at the very least renters should get a similar deduction for rent payments.

7.    End taxation of debt forgiveness on primary homes.  Homeowners who cannot afford their current mortgages may win renegotiation of their loan terms, only to find that the debt forgiveness is taxable income.  That may prove to be the unkindest cut of all.  Congress enacted a limited, temporary suspension of this awful rule in 2007, but it has been extended to 2013 – will it be made permanent?

8.    End affirmative action for the rich.  Criticism of the estate tax has focused on its effect on owners of small businesses and family farms which have significant value but low liquidity, but the Bush administration’s wholesale cuts in the tax rate chiefly benefit those who inherit publicly traded securities.  Buying shares of existing companies does not inject capital into the economy, and the heirs of deceased owners have not put an ounce of work into the wealth they now own.  The current Bush estate tax regime must be allowed to “sunset” in 2010; in fact, considering our desperate straits, estate and income tax rates could use a return to the progressive levels in effect during the Eisenhower years.

9.    Bail out state and local governments.  In the next few years, the mortgage and real estate meltdown will nearly bankrupt local governments that rely on property taxes in poor areas where the reduced tax base no longer supports the level of taxation needed to run basic programs.  This is on  top of revenues that will be lost through failed investments.  We will soon need to consider bailing out those governments to avoid creating ghost towns across America.

10.   End “too big to fail” blackmail. The management of every public company should be required to answer this question annually:  “Is your company too big to fail?”  If the answer is yes, the company should be broken up immediately.  If the answer is no, they should be held to their answer.

They haven’t done it consistently.  In between were people who were actually qualified for the office — Richard Nixon, George Bush, and Jack Kemp. And of course Dick Cheney, the stealth Veep, who is in a class by himself, having installed himself as Caudillo of a shadow government, all under the constitutional radar.

The selection of Sarah Palin by the Republicans is only the latest bit of evidence that the office of Vice-President in modern times has been useful only as a political device and as proof that our electoral mechanism has descended to a level somewhere between a soap opera and a joke.

The modern Vice-Presidency originated in 1800 with the passage of the Twelfth Amendment to the Constitution, requiring candidates to run separately for each office.  Its purpose was to correct the results of the 1800 election, in which two eminently qualified candidates, Jefferson and Burr, ran for President and received equal numbers of electoral votes despite their political antagonism; only a vote of Congress made Jefferson President and Burr Vice-President.

In our time, we would be lucky to have a Vice-President truly considered by the public to be qualified to step into the Presidency.  Instead, we are forced to vote for two people, one of whom is a comparative unknown and may turn out to be either a nonentity or an uncrowned monarch.

Yes, we ought to abolish the Electoral College and bring government “by the people” to the highest offices in the land. And we ought to restore the role of Congress in the constitutional system — not just by electing strong personalities, but by institutionalizing Congress as the body that initiates legislation, declares war, and ratifies treaties (and by reminding the President that his job is to execute the laws Congress has enacted).

But we ought to go beyond that and reconsider why we have a Vice-President at all, and to what purpose. The job description is simple:  come to the office every day, go to the Senate to break tie votes, and take office as President when the President dies or resigns.  None of these are critical to the welfare of the nation.  And the Cheney example is clear:  we don’t need an unvetted loose cannon running policy inside the Pentagon, planning wars and domestic detention camps.

It no longer takes months for news of the President’s death to spread to remote regions of the Republic.  The line of succession can be filled by appointed officials (as happened when Gerald Ford and Nelson Rockefeller were nominated by the President and confirmed by Congress). And the Senate doesn’t need a presiding officer who also has an office in the White House — if we really need a tiebreaker in the Senate, let’s give the District of Columbia one Senator and have a full-time tiebreaker working on the floor of the Senate.

If we must have a Vice-President, we ought to consider repealing the Twelfth Amendment and awarding the runner-up the second prize.  Contrary to Jefferson’s fears, the potential conflict between the two offices could work to the nation’s advantage, and the effect it would have on third party candidates would make our elections truly interesting.  After all, there really would be something to gain by coming in second.

Want to make things even more interesting?  Instead of awarding the Vice-Presidency to the runner-up, stagger elections so that the Vice-President is elected two years after the President.  The Vice-Presidential elections would be a referendum on the Presidency and the lame-duck period would be reduced from four years to two.

I find your articles and TV appearances enlightening, but I felt impelled to write in response to your Sunday article on subprime loans.  I’m not an economist (although I majored in it) or a particularly successful investor, but I am a real estate lawyer and know something about these transactions at the micro level.

You are right that some borrowers lie or come close to it in their mortgage applications, and you are right to look at the micro side of these loans (which few commentators do).  I believe, however, that the source of the problem is elsewhere.

I have seen plenty of transactions in which immigrants with low-wage jobs and virtually no English language skills went to shady mortgage brokers who tried to put them into zero-down loans, often with success.  These folks enjoyed the American dream of homeownership only until housing prices took a dive.  Since my old-fashioned view is that “ownership” includes the ability to sell the property, I think they ceased to be property owners at that point; instead they became prisoners unable to move or refinance without going bankrupt. They would have been better off renting.

It should be pointed out that most home buyers see a lawyer, if at all, only after they have applied for a loan and committed to that lender.  By the time they have signed a purchase agreement, the only way to get out of the loan is to give up the purchase, and psychologically that is unlikely to occur.  No one wants to hear bad news in legalese when they have already picked out the new wallpaper.

I don’t think any of these transactions would have occurred under the ancien regime you and I remember, when mortgage applications were taken by neighborhood bankers who knew the local market and usually held the loans in their portfolio.  Those banks still exist and are generally doing quite well.  The bank typically lent no more than 80% of appraised value, so the security was practically airtight.  The bank regulators looked at their loan portfolios and cash reserves, and were happy.

With the advent of national lenders funneling money through unregulated mortgage brokers (who have practically no capitalization of their own), the lying began.  Although the lenders require documentation, it’s harder to verify every piece of paper that comes in.  In a rising housing market, the default rate is low even when the loan shouldn’t have been made in the first place.

This is exacerbated by zero-down loans, by variable interest rates and by negative-amortization balloon notes, which make no economic sense unless the borrower is still employed after 5 years and sells or refinances — otherwise the loan balance may exceed the value of the home.

Then we saw the advent of mortgage-backed securities.  This meant that the lender packaged a large number of loans, vouched for the documentation, and sold them in shares to big investors — first domestic, then foreign.  Whatever expertise Countrywide or Wells Fargo has in evaluating mortgages is entirely lacking at the investment desk of Goldman Sachs or Deutsche Bank.  These mortgages have turned into securities and are evaluated by securities standards.  Technically, the investors have recourse against the original lender if the underwriting was bad, but I doubt that happens often; proving it would cost more than it is worth.

I think we’ve made a big mistake in allowing the risk of mortgage lending to be displaced so far from the source.  Home mortgages issued by tiny brokers are being traded as though they were bonds issued by SEC-regulated corporations.  Essentially, Joe Homeowner is issuing a bond to Deutsche Bank without providing the audited financials that Moody’s would require of any other issuer.

We’ve also made a mistake in letting dubious loan products into the marketplace.  This turns the home from a place of security into collateral exchanged for casino chips.  The homeowner bets the house, literally, on rising home prices.

It’s true that homeowners go along with this in the sense that most of them consciously understand most of the essential terms.  But in practice they are relying on the lender and on the real estate brokers to validate the transaction by telling them the house is worth what they are paying and is a good investment.  The off-the-record assurances they often get from these sources would not be tolerated in an SEC-regulated investment broker.  Some of the big real estate firms now have affiliated mortgage operations which have an incentive not to upset the sale by declining a mortgage.  To me, this looks awfully similar to a stockbroker encouraging his clients to borrow on margin, and we know how that turned out in 1929.

The other mistake we have made is in writing the ideal of homeownership into the tax code.  Allowing an unlimited deduction for mortgage interest makes homeowners seem like winners and renters seem like losers.  Historically, this has been a good social policy — if you like social policy in the tax code — but it is becoming less so. People move more often because the job market moves, because they have children, and because they retire.  The transaction cost of each move is substantial — more so for homeowners because they pay sales commissions, attorney’s fees, settlement costs and sometimes prepayment penalties.

The tax code also encourages frequent turnover by limiting the capital gain exclusion to $250,000 or $500,000.  Once the home has appreciated by more than that amount, the homeowner must sell and move somewhere else or lose the tax break.

I can’t prove it, but I’d guess that these frequent sales contributed to the enormous rise in home prices over the past few decades.  In the 1930s, despite increases in personal net worth, home prices stayed about the same and many small homes were bought for cash. Eventually, prices reach a level that working people with decent jobs can’t afford — perhaps that time has come, perhaps not, but it will. At that point the tax code serves to reward the older generation and punish the younger.

My long-term solution, which will not be embraced by anyone in Washington, is to limit the mortgage interest deduction to approximately the amount needed to service a loan of, say, $300,000. I’d say the capital gain exclusion should be replaced by a provision allowing the fortunate homeowner to report the gain over the same period in which the gain was accrued, or by adjusting the cost basis of the home for inflation before taxing the gain.

Sad to say, I cannot help thinking that the risk to homeowners of bad loan products should be mitigated by government regulation forbidding their use.  Borrowers just aren’t savvy enough to know what they are getting into, any more than the small investors of 1928 knew what margin calls could do to them.  Our social policy should go from homeownership for all to homeownership for those who have saved enough for a decent down payment.

For low-income subprime borrowers who are caught between declining home prices and the increasingly strict rules of the Bankruptcy Code, I think the government should become the lender of last resort — on carefully defined terms.  There are now small subsidy programs in existence whereby first-time buyers can qualify for lower-interest loans on a shared-equity basis — if they sell the home within 5 or 10 years, 20% of the appreciation goes back to the local agency that provided the loan.  The same principle can be applied to subprime borrowers caught in a squeeze; in exchange for refinancing, they can be asked to make the government-funded lender a 20% partner in the property.

I’m sure these proposals appeal more to me as a social liberal than to you, but for me the bottom line is that foreign investors can absorb the risks inherent in the products they bought and sold, but people with no assets other than their homes cannot.  And as a nation we cannot afford an epidemic of mortgage defaults with millions of people banging on the door of the Bankruptcy Court — even if they were a little overoptimistic in buying their homes.  We need to start getting serious about the savings rate, and doing so in a way that does not shock the system by changing the rules all at once.