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Republican Study Commitee plan now best viable alternative

The stunning defeat of the Hank Paulson's socialism-for-Wall Street bailout on Monday has just made planks of a pro-free market alternative much more viable. As Open Market has noted before, The Republican Study Comittee, a caucus of pro-market members of the GOP Congress, has presented such a plan that would be much more effective at stopping the contagion than the Paulson bailout, and many of its provisions would not cost taxpayers a dime. The RSC plan is chock-full of measures to remove barriers to economic growth and market-distorting subsidies. It would suspend capital gains taxes to put trillions of dollars of capital in the economy, and set Fannie Mae and Freddie Mac, which as CEI has documented were at the root of this crisis, on the road to full privatization. Most importantly for the crisis at hand, the RSC plan would make regulatory agencies suspend the mark-to-market accounting rules that a range of experts agree are spreading the contagion by forcing solvent banks' to "write down" their assets, based on the last fire sale of a highly leveraged bank. As Gary Gorton, finance professor at Yale and member of the National Bureau of Economic Research has written, "With no liquidity and no market prices, the accounting practice of 'marking-to-market' became highly problematic and resulted in massive write-downs based on fire-sale prices and estimates." You can read more about mark-to-market regulations in my op-ed in the Wall Street Journal last weekend. My Open Market post early last week, as well as CEI's new podcast, explains how the Paulson bailout may make things worse by forcing more paper losses that threaten healthy banks with "regulatory insolvency." The problem with the Paulson buy-up plan or some new variant of it is if the government pays pennies on the dollar, mark-to-market rules would make every other bank take this paper loss on its books. So there will be a tension between getting the best deal for the taxpayer and not spreading further systemic risk from massive writedown the government purchase could force. Even Ben Bernanke acknowledged this tension in his Congressional testimony last Tuesday. All the more reason to go with the RSC plan instead of a reformulated Paulson plan, which would throw $700 billion and the free market out the window and still not solve the crisis at hand.