Sunday, January 4, 2009

The First Step to Solving the Current Economic Crisis and Preventing a Similar Crisis In the Future

The economic crisis of 2008 raises a lot of questions in the minds of civic minded individuals. Why is the economic system so fragile? Why are financial institutions allowed to get so big that their failure will shut down our markets and economy? These are important questions that deserve their own essays, but I think the most important first question to ask is the following: If an individual now in power did not correctly identify the current economic problems as they developed, why would we expect their solutions to the crisis to be effective?

The internet has kept a living, breathing record of events for over ten years. If a corporate executive, regulator, politician or prominent economist has issued a public writing or speech over this time period, the internet has an explicit record of these views. News articles, papers, speech transcripts and even YouTube videos offer abundant research material. Step one is to go through these records and find out who has been right in their predictions and who has been wrong.

Those that brushed off the crisis as it developed are immediately discredited. This includes everyone who laughed at the notion of massive problems in the housing market and with Fannie Mae and Freddie Mac. Others believed that hedge funds and derivatives need not be regulated. Those that continued to state, “The fundamentals of the economy are strong” despite contrary evidence need to be held accountable for their words.

Conversely, the opposite needs to be done as well. Go though the records, find out who has been right in identifying the risks in the system and give them jobs. I do not care if the person is a government regulator, Nobel laureate or blogger - if someone correctly identified the risks we have to find a way to get their current ideas into action. We can use their ideas as a basis for policy going forward.

Let me give one important example. In 2004, the SEC redefined the net capital rule, which specified maximum levels of bank leverage, for certain financial institutions. The five largest investment banks at the time – Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs – applied and were accepted to be regulated under these new rules. This turned out to be a major catalyst of the economic crisis. The SEC Commissioner at the time of the rule change, Harvey Goldschmid said, "If anything goes wrong, it's going to be an awfully big mess." Why then, did he allow the rules to be changed? Who supported the change and who did not? These answers can all be found by anyone with an internet connection.

That is all there is to it. Get the right people in important positions and remove those from power that have done a poor job. Government needs to implement this basic self-correcting mechanism or history will repeat itself. My plan is just the beginning but it is the necessary first step towards solving the current economic crisis and preventing a similar crisis from developing in the future.

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