Better than a bailout: four steps policy makers could take to help financial markets.

• Author: Lacoude, Philippe

WHAT SHOULD THE federal government have done in lieu of the $700 billion bailout signed into law by President George W. Bush? Here are four common-sense steps that don't involve the partial nationalization of the finance industry:

1) Raise the capital ratio for government sponsored enterprises and other investment banks to at least the level imposed on commercial banks-a cash balance of generally 8 percent of the market value of each firm's tradable assets weighed for the risk of each asset. In a free banking system, there is no need for artificial, one-size-fits-all Securities and Exchange Commission rules. In such a system the amount of capital on hand should be left up to the banks themselves rather than government regulators. Sadly, we are not in a free banking system. We have a central bank, a lender of last resort, and not only does it implicitly guarantee certain banks' losses but it won't let them go under when they make mistakes, which creates some poor lending practices.

In this context, raising the reserve level would force institutions to have enough capital to face sudden increases in their default rates during tight credit markets. The bailout law does nothing to address this question.

2) Extend the capital gains and dividend tax cut past 2010, when it is due to expire under current law. This would raise the rate of return of financial assets at little cost to the Treasury and give a strong incentive to taxpayers to stay in or go back into the market.

3) Lift all Roth IRA contribution and eligibility limits for the rest of 2008. Because Roth IRA contributions are not tax deductible, this measure has no immediate cost to the Treasury, but it would likely pump billions of dollars into a tight market.

Such simple measures would have allowed the market to continue reorganizing its financial sector at absolutely no cost to...