McCain's Solution to the Credit Crisis

I have spent the last several days puzzling over what John McCain meant when he babbled:

"Our financial market approach should include encouraging increased capital in financial institutions by removing regulatory, accounting and tax impediments to raising capital."

It doesn't take much of a genius to realize that most of the financial industry would operate with zero capital if they could legally get away with it. I am of course ignoring the modest discipline imposed on the world's banks by the market. Deutsche Bank and JP Morgan can't operate without any capital; nevertheless, it has been apparent since the early 90's, witjh the emergence and expolosive growth of the deriviatives markets, that the capital a bank shows on its balance sheet may bear little relationship to the actual risks embedded in the institution's assets, including quasi-assets such as swap and other derivative contracts.

Thus in the 1990's the West's central bankers, meeting though the Bank for International Settlements, began formulating risk capital rules that had the admirable, if unattainable, objective of reflecting all the risks that impinged on the institution. These rules were, and continue to be, the focus of struggle and controversy in the industry not because bankers wish to be exposed to risk for its own sake, but because capital costs money, the more capitalized the less profitable, all other things being equal.

Now I suppose McCain may be suggesting a number of things here:

1. He could be promoting a roll-back of seventy-five years of securities regulation. I don't think so.
2. He could be promoting a reduction or elimination of capital gains taxes and taxes on dividends. A possibility, but this goes way beyond our immediate crisis -- a lock-up of the credit markets as a result of a crisis of confidence over the adequacy of firms' ability to withstand losses, i.e., capital.
3. The most likely -- what he means by "accounting impediments" is a return to the bad old days when so-called "off-balance sheet" risk was just that: not a consideration in setting the levels of regulatory capital, and not spelled out in excruciating detail in a firm's financial statements.

I have to say I find any of these suggestions naive and extremely dangerous. We are in the midst of a credit crisis, meaning that market participants don't believe that their counter-parties can honor their obligations. McCain's suggested approaches are at best wide of the mark and ineffectual, and at worst will exacerbate the present crisis.

For the time being, it looks as if the best approach will be old-fashioned New Deal pump-priming. The system, will recover; it always has. The best thing we can do is not make any jerky moves that would put the cart in the ditch.