If you aren’t feeling seasick yet from watching financial markets shoot up and then plunge over and over again over the course of the past year, you must be one of those sane people who ignores the market unless a line is spotted extending down the block from your own personal bank and brokers are raining down from rooftops like cats and dogs. If you are one those lucky few, good for you!

The rest of us are a little queasy at this point.

Since November of last year we have witnessed the kind of drama on Wall Street that belongs in a horror movie, not in a field of finance that impacts our 401(k)s. We’ve watched the Fed, Congress, and the President react with this, that, and the other emergency measure, and with each magic trick, we held our collective breath and watched and waited to see what came next.

While it’s great that the Fed and our branches of government are able to think creatively and act nimbly in the face of possible financial systemic meltdown, it would be even more wonderful if it seemed that anyone actually had a handle on how to smooth the waters with consistent policy that is forward-thinking rather than reactive. It strikes me that each emergency fix (the last one being the Fannie/Freddie rescue package) leaves us less confident than before. Lack of confidence in a financial system is, in general, a bad thing. So while we are in a lull here (knock on wood), I’d like to raise the question, “What, if anything, is the hard choice that will get us back on track over the long run?”

On Sunday, the New York Times ran an editorial about ailing banks and a request by private equity firms for the Fed to drop regulations preventing them from running banks into which they invest large sums of money. Currently, federal law prohibits this to prevent conflict of interest and a too-great concentration of economic power into elite hands. With so many banks hurting for capital and in need of cash infusions, it must be tempting for the Fed to take this proposal seriously and quietly allow something that nine out of ten ordinary people won’t notice anyway let alone understand.

The Times makes the point that this is a terrible idea, not the least of the arguments against it being that it is private equity firms and financiers who operate outside the scope of bank regulation who got us into this mess in the first place. By creating and promoting highly-speculative, mortgage-backed investment securities, they nearly crashed the entire system. To back off on regulation right at at time when what we need badly is more, not less, oversight is tantamount to giving the fox the key to the hen house and hoping that it will all just work itself out, somehow.

The real problem of course is, where is the money banks need going to come from?

Congress can pass all the bail-out bills it wants, but the fact remains, the U.S. is not exactly rolling in it. Cash, that is. If regulations are not relaxed so that private equity firms can bail out banks and then run them however they see fit, what will happen to the banks?

The banks will fail, that is what will happen to them. The one possibility that we rarely hear put forward as a serious solution is that maybe that is exactly what needs to happen. Why are we trying to prop up a banking system that made one disastrous greedy decision after another without regard to the consequences of those actions? If the free-market is self-regulating (and that’s another discussion entirely, the question of whether or not it really is), then why don’t we let it regulate itself by weeding out the weak?*

To take an even longer view, at some point the U.S. will have to set actual policy and stop jumping in with wads of emergency-measure chewing gum to plug the financial dikes. Why do we have a private organization (the Fed) calling the shots on regulation and deregulation that directly hits the pocket books of ordinary people? We are all paying for this: all of us except the CEOs and high rollers who jumped with golden parachutes or escaped with cash before the train started to derail. Those people, those few at the very top, are mostly coming out unscathed. That’s wrong. Everyone knows it is wrong. No one is speaking to that injustice much less taking any aggressive action to change it.

Instead, we have vultures hovering and foxes circling, holding out wads of cash and asking for special favors. And Congress, after having very self-righteously accomplished exactly nothing in regards to energy policy (Democrats wanted to slap the hands of oil speculators who aren’t responsible for high gas prices, and Republicans wanted to drill offshore even though it won’t help either), is now adjourned and the country is talking about whether or not Barack Obama has anything in common with Paris Hilton and Brittany Spears.

That is insanity on a plate.

The hard, longterm fix is to find a way to tie money to actual value again. I know this will sound dusty and lame to fast-track types who are energized by leverage, but somebody has to say it, and since I’m already old I don’t mind throwing it out there. You can make money by moving money around, scrambling numbers, and gambling on outcomes for awhile, but eventually the smoke clears, the mirrors crack, and what do you have? You have what we are looking at right now.

I have three modest proposals, none of which will be taken seriously even in my dreams, but here they are:

1) Create a comprehensive and aggressive national energy policy which includes subsidies for development of alternative energy, generous tax rebates for homeowners who invest in it or in energy conservation, aggressive development of alternatively-fueled vehicles, and redesign and rebuilding of infrastructure. This alone will create new jobs and reduce our dependence on foreign oil. It should be our top priority. Right now it isn’t even on the edge of the map. Energy policy? What energy policy?

2) Require lending institutions to reduce the principal on their property-backed loans to a number that is more in line with the actual value of the property, and then take the loss on the difference. This will cause some financial institutions to go under. Oh well.

3) Re-examine and re-work banking regulations so that banks cannot skirt their fiduciary responsibilities by running around Depression Era safeguards using investment houses and third party financiers. The American people should be involved in this, meaning that it should go through Congress and be discussed publicly at length, not hammered out in private at the Federal Reserve.

If we have to foot the bill for misconduct, we should get a say in what the rules are and how they are enforced. It strikes me that this should be the very least we could do in the interest of fairness and longterm success. It distresses and angers me that to date so little has been done.

The next wave of defaults is just around the corner. How about getting a comprehensive plan together before it hits instead of after?

I don’t know how much more nausea I can personally take.

*Editor’s note: For the Austrian economics point-of-view on allowing Fannie Mae and Freddie Mac to fail on their own, see J.D. Seagraves’ article “Fannie Mae and Freddie Mac: It’s Time for the U.S. to Let Go.”

Related posts:

1. Did the Community Reinvestment Act Lead to the Present Financial Crisis?
2. U.S. Financial Crisis: Why China Has Much to Fear
3. Why Federal Home Loan Banks May Survive the Credit Crisis
4. Bretton Woods II: Will a New Financial-World Order Solve the Economic Crisis?
5. Fannie Mae & Freddie Mac: When Will the Government Learn?