He proposes a sort of similar solution for banks.  Holders of bank debt would be able to force the bank into bankruptcy, wiping out the existing stockholders but giving ownership of the bank to the debt holders.  To avoid this happening to solvent banks, stockholders would have the option of paying their share of the debt and keeping their stock.

Zingales notes that both of his proposals are simple standard ways of doing what more often involves hordes of lawyers and complex negotiations.  Foreclosure is a very expensive process, for both sides, and corporate bankruptcy is hardly simple.

It seems to me there’s another advantage, which is that this plan gets the incentives right.   Those who wrote inappropriate mortgages will suffer a cost, but, if they were correct that “house” values are increasing they’ll eventually come out well.  If they weren’t, they won’t.   And stockholders who failed to keep control of bank management will also suffer.

The net result would be people staying in their homes, with manageable mortgages, and banks with enough equity capital to make loans. At virtually no cost to the general taxpayer, by the way.   It’s not especially Georgist, and it does little to prevent a future repeat, but it’s a lot better than what is actually going to happen.

What causes a meltdown?

Fundamentally, it’s caused by speculation in ownership of nature.  We divide the economic world up into:

• (a) things people can make
• (b) things people can’t make

It’s tough to make money speculating on (a), because as the price goes up, people produce more of it.  But the price of (b) can rise, theoretically, without limit, because it’s impossible to make more.  The principal example of (b) is land, or more precisely, locations.   Nobody can make more locations.  (b) also includes mineral deposits such as petroleum, by the way.

So what happens is that speculators, seeing the price of (b) rising, anticipate further increase and bid up the price beyond what people who need (b) can pay.  (b) is of course needed for houses, and the great increase in “house” prices in recent years was essentially an increase in location prices.

So if people can’t afford to buy a house, they may rent, but they see house prices continuing to increase and see no benefit in waiting, their savings don’t increase as fast as the price rises.  So, unless they have exceptional patience, they just go ahead and buy, paying more than they can afford.  (Possibly they don’t realize it’s more than they can afford, as so many mortgages were marketed with little attention to the inevitable rate increase.)

Now this is a situation which will lead to a meltdown, one way or another.  There are various ways it could be postponed.  One is interest rate reductions.  Another is derivative securities, which could make subprime mortgages appear largely secure.  But these just worsen the severity of the eventual collapse.

What ends a meltdown?

Henry George identified three developments which get the economy restarted after a period of collapse.  Not all three necessarily occur in every recovery.  They are

1. Labor accepts lower wages, and investors in capital goods accept lower returns.
2. Technological advance allows some increases in production without using any additional land, labor, or capital.
3. Land prices decline so that it is easier to obtain land for use.

What will the bailout do?

It is not going to reduce the cost of employing labor or capital.  It is not going to speed improvements in productivity.  And it is certainly not going to reduce land prices.

On the contrary, the main effect of the bailout on the three components of recovery will be to raise land prices, or at least to reduce their further decline.  It seems to me, therefore, that it will retard the recovery rather than speed it, and make wage declines more severe than they would otherwise have been.  Yet, by keeping land prices higher than they would otherwise be, it seems that it might be accelerating the next meltdown.

And this is not to mention the impact of any tax increases which may be imposed later to pay for the bailout.

The above, of course, is a grevious simplification of what Henry George said, but I think it’s adequate to explain what is going to happen.  Which is why I said earlier that we would be better off doing nothing than doing anything like this bailout.