A free market fix for the financial crisis

Today I saw Dave Ramsey on Neil Cavuto. He touted his "common sense fix." The basics are:

1) Insurance

Insure the sub-prime bonds/mortgages with an underlying FHA-type insurance.

2) Mark to Market

Remove mark to market accounting rules for two years on only sub-prime Tier lll bonds/mortgages.

3) Capital Gains Tax

Remove the capital gains tax completely. Investors will flood the real estate and stock market in search of tax-free profits, creating tremendous - and immediate - liquidity in the markets. Again this costs the taxpayer nothing.

Ramsey is one of the few "financial gurus" whom I respect because the main gist of his advice is to get rid of debt and he analyzes the current crisis in the same way. (Okay, maybe I only respect him because I agree with him.)

The capital gains tax is the most destructive tax on the economy closely followed by corporate taxes and death taxes - all of which should be gotten rid of immediately. The only taxes that can be justified (or should I say "somewhat rationalized?") are income and consumption taxes.

You can read the details of Ramsey's "common sense fix" on his website.

I see that the SEC just suspended mark to market accounting today and the McCain team had this to say about it:

ARLINGTON, VA -- Today, Doug Holtz-Eakin, McCain-Palin 2008 Senior Policy Adviser, issued the following statement on the SEC's plan to relax mark-to-market accounting requirements:

"John McCain is pleased to see that the SEC has finally decided to permit alternative accounting methods to mark-to-market accounting for securities where no active market exists. There is serious concern that these accounting rules are worsening the credit crunch, making it difficult for small businesses to stay afloat and squeezing family budgets. In March, John McCain called for a meeting of accounting professionals to discuss whether mark-to-market accounting was magnifying problems in the financial markets."

Background:

In March, John McCain Called For A Meeting Of Accounting Professionals To Analyze The Current Mark To Market Accounting Systems. "[I]t is time to convene a meeting of the nation's accounting professionals to discuss the current mark to market accounting systems. We are witnessing an unprecedented situation as banks and investors try to determine the appropriate value of the assets they are holding and there is widespread concern that this approach is exacerbating the credit crunch." (John McCain, Remarks, Santa Ana, CA, 3/25/08)

If you don't know what "mark to market" accounting means here is Wikipedia's fairly adequate explanation:

In accounting, mark to market is the act of assigning a value to a position held in a financial instrument based on the current market price for the instrument or similar instruments. For example, the final value of a futures contract that expires in 9 months will not be known until it expires. If it is marked to market, for accounting purposes it is assigned the value that it would fetch in the open market currently.

[...]

The practice of mark to market as an accounting device first developed among traders on futures exchanges in the 19th century. It was not until the 1980s that the practice spread to big banks and corporations far from the traditional exchange trading pits, and beginning in the 1990s, mark-to-market accounting began to give rise to scandals.

To understand the original practice, consider that a futures trader, when taking a position, deposits money with the exchange, called a "margin". This is intended to protect the exchange against loss. At the end of every trading day, the contract is marked to its present market value. If the trader is on the winning side of a deal, his contract has increased in value that day, and the exchange pays this profit into his account. On the other hand, if he is on the losing side, the exchange will remove the appropriate amount from his account. If he cannot pay, then the margin is used as the collateral from which the loss is paid.

Like all "creative accounting," (versus straightforward common sense accounting) mark to market is open to abuse and it has been abused badly in the past nearly 20 years. It has a place in the futures markets but not in banking. It only became acceptable in banks and corporations recently because they too started operating their businesses using borrowed money instead of liquid assets. Good riddance!

PS I just noticed that K-Lo at the Corner posted this:

Everyone seems to be sending me this Dave Ramsey proposal tonight. I'm thinking he might be Newt or T Boone Pickens in disguise, his pr seems that good.

Now, let's hope that they'll also send it to their Senators and Reps.