First, we should close down as promptly as possible Fannie Mae and Freddie Mac. There never was a reason for those two institutions, other than to avoid the congressional budget process. The benefit that people got from Fannie and Freddie came from the subsidy to the mortgage interest rate. Congress could have passed that subsidy over and over again. They avoided passing it by taking the program off budget.
I still have serious questions about whether trying to use monetary policy to check speculative activity on a regular, systematic basis would yield benefits that outweigh its costs.
He is still stuck in the monetarist paradigm in which money is this super-powerful tool for controlling the economy, and you don't want to use this super-powerful tool to deal with little things like speculative bubbles. I think that in ten or twenty years, the paradigm will be that we need to focus on financial institutions and regulation, and we don't want to use the tools of regulation to deal with little things like the money supply.
Bert Ely offers a view of regulation dynamics that is consistent with my "chess game" notion. For example, he writes,
The Internal Revenue Code, specifically the laws governing the taxation of personal and corporate income, are perhaps the single most important underlying cause of the financial crisis. Taken together, the tax laws promote overspending and undersaving by individuals and excessive leverage by both individuals and corporations.
One interesting point that Ely makes is that credit rating agencies enjoy first-amendment protection from lawsuits. That is, they cannot be sued for merely expressing an opinion. However, other professionals who express opinions can be sued--accountants, for example.
Ely thinks that Glass-Steagall should have been repealed sooner.
[investment banks] might not have become as focused as they did on buying, securitizing, and trading subprime, Alt-A, and option-ARM mortgages. While the large commercial banking companies also engaged in mortgage securitization and originating nonprime mortgages, they did not get as deeply involved in those activities as did the investment banks. Arguably, then, had the separate, distinct investment-banking industry been melded into mainstream commercial banking years ago, today's mortgage and financial crisis would not be as severe as it is, or may not have occurred at all.
The way forward is to enact tax law changes that will improve the long-run stability of the economy by reducing the incentive for leverage, and by encouraging a substitution of business investment for consumption.