The House Republican Study Committee is set Tuesday to officially unveil its proposal to address the financial crisis through a “market-based” approach.Justin Fox points out a glaring flaw in the Republican plan:
The conservative group, which has strong objections to a federal bailout that would cost hundreds of billions of dollars, is touting its plan as a “true alternative” to Treasury Secretary Henry Paulson’s plan to rescue the financial markets.
The RSC plan, which will be unveiled at noon, calls for a two-year suspension of the capital gains tax.
“By encouraging corporations to sell unwanted assets, this provision would unleash funds and materials with which to create jobs and grow the economy,” an outline of the proposal said. “After the two-year suspension, capital gains rates would return to present levels but assets would be indexed permanently for any inflationary gains.”
The group’s plan would also transition Fannie Mae and Freddie Mac to private companies “in a reasonable time,” seeks to stabilize the dollar, and would “suspend the mark-to-market regulatory rules for long-term assets.”
[The plan] of the House Republican Study Committee, seems to be a joke. It calls for a two-year suspension of the capital gains tax to "encourag[e] corporations to sell unwanted assets." But the toxic mortgage securities clogging up bank balance sheets are worth less now than when they were acquired. Meaning that no capital gains tax would be owed on them anyway. If you repealed the tax, banks would have even less incentive to sell them because they wouldn't be able use the losses to offset capital gains elsewhere.In short, suspending the capital gains tax when everyone's sitting on losses is harmful.
Stabilizing the dollar would also be harmful. A nation's currency should fall during times of economic weakness, because a falling currency stimulates the economy.
I hypothesized yesterday that mark-to-market accounting may be causing a vicious cycle in the credit markets. If this is correct, their plan to suspend mark-to-market accounting for long-term assets might help in the short-run. The problem is that the alternative is "mark-to-make-believe," which in the long run would give financial institutions too much leeway in making up unrealistic numbers.