Former American Express (AXP) CEO Harvey Golub recently wrote an editorial in the Wall Street Journal commenting on a number of public policy points that intersect with financial markets. There are three facets of his argument that I want to comment on – incentives, government financing, and liquidity.

Golub’s center point is that policies encouraging increased indebtedness are destined to fail. Now, the overextension of credit (call it “cheap and easy” lending) is a major cause of this problem, and more cheap and easy lending – this time by the government – is not the solution, unless the acceptable range of problem solving includes simply inflating the current issues away. He says, “Public policy should support higher savings rates, and avoid encouraging increased consumer spending funded by further debt, which may be helpful in the short term but catastrophic in the longer term.”

To take that a step further into specifics, I have one idea to address each side of the equation. The tax deduction available for interest paid on mortgages (ignoring similar status for corporate borrowings) costs the government something like $90 billion annually, but as Slate’s Daniel Gross pointed out long ago, such an incentive disproportionately benefits higher-income borrowers and does not address the core problem of affording a down payment. Instead, why not provide a tax incentive encouraging prepayment of mortgage principal after a standard down payment? This would promote buyers building equity, which is the entire point of home ownership.
As for saving for a down payment, create a tax-exempt savings vehicle similar to a Roth IRA, but with looser rules regarding its applicability to home purchases – namely, savings should be able to be withdrawn at any time to be used to buy a home. And while things are being changed, remove the restriction on existing Roth IRAs having a time delay before they can be used to fund first time home purchases. The net result of this would be more buyers with greater down payments; if we’re going to subsidize something about housing, that seems like a common-sense place to start.

Mortgage lending is so restricted right now that lending actually declined according to the latest Federal Reserve data. Borrowers with good credit – and money down – are needed for the residential real estate market to find a bottom.

Another area Golub says must undergo deleveraging is government, including the state and local levels. The zero- (or negative) yield on short-term US Treasury debt is a widely circulated puzzle, especially given that perceptions of credit risk on the US have never been higher, judging by the credit default swap prices. Similar trends are evidenced in the CDS market for municipal debt, where a few Wall Street firms have come under fire for recommending CDS on certain state issues – and the price of that credit protection has almost tripled since.
The current bailout plan seems to involve leveraging (literally) the cheap borrowing available to the US government in an attempt to revive the economy; federal debt to GDP is already high and set to climb much further. This could further complicate a potential crisis brought about by underfunding of entitlement programs, many of which are now even more in the hole due to investment losses.

The final point I want to touch on is where Golub is somewhat unclear – he says:

“So, are the current credit easing actions likely to be helpful or not? In my judgment, measures to create liquidity are likely to be helpful. Financial institutions that lend money to credit-worthy people for reasonable purposes have experienced a substantial reduction in available funding from which they can make loans. Hence the programs to support the securitization markets are sensible because money used for this purpose will be lent and used for purchases. Programs that deliver a short-term reduction in mortgage rates will, at the margin, help absorb some of the available housing stock, reducing the time it will take for housing to reach market-clearing levels.”

Because of how many programs the Fed and Treasury seem to be operating, I don’t know which one(s) are being referenced – but I am less enthusiastic about trying to aid liquidity. Multiple people have pointed out that government backing of certain areas in the lending markets only serve to move dollars there, and drain liquidity elsewhere. Overall, it seems more and more like Treasury/Fed tacitly acknowledges the problem with banks is one of solvency, and the liquidity programs are just an attempt to buy time for the banks to recapitalize themselves through interest spreads. That could take a long time, and is one reason I won’t be buying even the best bank stocks in the foreseeable future.

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