Megan nails it:
[T]here are things that I think would have helped, but cannot see where the political will would have come from:
Keep Fannie Mae and Freddie Mac out of risky mortgages, and give OFHEO some teeth. Bush and several Republicans tried, and failed, to do this. My preferred solution, an explicit strip of the government guarantee and a supervised breakup, wouldn't even have gotten on the radar. Fannie and Freddie were politically powerful, as were voters who wanted to buy houses.
Regulate mortgage brokers at the federal level. Given the way mortgage funds now flow across state lines, this made sense. But the state governors would have screamed bloody murder. Moreover, no one knew about the fraud when it would have helped--i.e., before most of it happened.
Mandate 20% down payments. Political suicide. Affluent people would continue to borrow downpayments in private family loans, while the poor were shut out of the housing market. Poor neighborhoods would have been devastated by the credit cutoff. House prices would have dropped sharply everywhere.
Change regulatory standards to take more account of small-probability, devastating systemic risk. Nassim Taleb has been talking about this for the last few years. But I didn't hear more than academic interest in this until mid-2007. Most people on the Street really believed that they had gotten better at assessing credit risk.
Unify the bank regulators, including the SEC, into one agency. At least some of this crisis might be traced to the fact that the regional banks who originated many of the bad loans were often regulated by a different body from the investment banks who bought them. It might have been done, I suppose. But each of those agencies has powerful constituencies among their employees, and the firms they regulate. Moreover, the transition process would have involved some ugly internicene warfare that probably would have eroded regulatory effectiveness in the short run.
Mandate contingency plans for the dissolution of large firms, and other unlikely but devastating scenarios. If people had some certainty about the likely outcome of an insolvency, the panic selling wouldn't be so rampant, and people would be more willing to loan money, albeit at a discount. But again, I didn't hear anyone talking about this in, say, 2006. I certainly didn't think of it. Is it reasonable to say that this should have been utmost on the mind of Bush or his advisors, while other big priorities, like trade deals, loomed large?
Make subprime loans illegal. As long as most subprime borrowers are still making their payments, I can't endorse cutting them off to protect the fools. Moreover, this would simply not have been possible, no matter who controlled congress or the presidency. Cutting off subprime loans would have prevented more people from buying homes. The politics of it are terrible.
Make option ARMs or negative amortization loans illegal. Option ARMs are debateable-they're actually useful for people who have uneven income flows, like, er, a lot of journalists. But clearly they were abused, and negative amortization loans are nuts. However, these exotic instruments are only a fraction of the toxic subprime loans. They appeared mostly late in the process, when lenders were scraping the bottom of the barrel to keep the boom going.
Change the way that these securities were accounted for. Most risk models for ABS and MBS were focused on prepayment risk, not default risk, which was assumed to be fairly well known. This assumes a rather stunning level of prescience on the part of regulators or legislators.
Force banks to keep some amount, say 10% of the loans they originated. Spain does this, and its housing market is even more bubbleicious than ours was, believe it or not. It might have made the banks more secure. But there are good reasons to want banks, especially small banks, to have the flexibility to match the durations of their asset portfolios to those of their liabilities. When interest rates skyrocketed in the early eighties, banks were stuck with long-term mortgages at low rates, but forced to offer high interest rates on savings accounts in order to keep business. The result was, ultimately, the S&L crisis. And again, while there may have been someone proposing this somewhere, I didn't see a lot of people talking about it in 2003, when it really might have helped.
I don't understand all of this, but the parts I do sound right. Let me stand in the line in favor of finding the political will!
Then there are the things that people think would have helped, but which wouldn't have done anything I can see:
Repealing Gramm-Leach-Bliley, or at least the provisions that repealed Glass-Steagall's ban on commercial banks entering other lines of financial business. If this were part of the problem, it would be the commercial banks, not the investment banks, that were in trouble.
Lowering CEO pay. Whaaaaaa? If Dick Fuld had been paid a dollar a year, we'd be in exactly the same mess. Probably worse, because what kind of CEO do you get for a dollar a year?
Raising the Fed Funds rate. The MBS money was long money, not overnight funds. And when a bubble is truly going, raising rates may just attract more long money, without deterring speculators who are expecting double-digit annual returns.
Requiring better disclosure of loan terms. Disclosure of loan terms is already quite exhaustive, including a term sheet right on top that provides a congressionally mandated summary. You can't make people read things, and the extra disclosure you mandate goes into the "fine print" that people claim they can't read. Moreover, the fundamental problem for most borrowers are things that aren't hard for buyers to understand, like "I have an adjustable rate mortgage"; "Interest rates can go up"; and "My housing payment should not be two-thirds of my gross income".
Changed the neo-liberal "culture". The president and congress are not the parents of Wall Street, and believe me, bankers do not look towards Washington for moral guidance. The "Miasma Theory" of political influence is the last refuge of partisans who know they are full of it.