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TOM HUDSON: Just as there`s no shortage of blame for the near collapse of American banks, there`s also a long list of ideas for how to fix finance: a pay czar, more rules on derivatives, even smaller banks. Earlier today, I spoke with Robert Pozen, chairman of MFS Investment Management and author of “Too Big to Save? How to Fix the U.S. Financial System.” I began by asking him if the reform efforts so far are addressing what`s wrong with banking.

ROBERT POZEN, CHAIRMAN, MFS INVESTMENT MANAGEMENT: Some of the problems are being addressed. For instance, we have financial derivatives legislation. We`re also going to register the managers of hedge funds. But there are a lot of other areas, such as capital requirements, mortgages and corporate boards, where we still have a lot to do.

HUDSON: In regards to that, you come up with very specific ideas within the book and I want to go through just a trio of them, beginning with something a lot of potential homes buyers may find unfathomable here, bigger down payments for the housing market.

POZEN: Even now, FHA only requires a 3.5 percent down payment and you can reimburse yourself through a refundable tax credit. So it`s effectively a no-equity loan. And there`s one thing we know that if you don`t have a significant amount of equity in your home, you`re likely to default.

HUDSON: Considering where housing prices have come from and are currently today, wouldn`t this discourage buyers to get in this market and help stabilize prices?

POZEN: There`s a balance. On the one hand we don`t want to make it too tough for homes owners. On the other hand, if somebody really doesn`t have a 3.5 percent or a 5 percent down payment maybe they shouldn`t be owning a house. We can`t afford to set people up for defaults.

HUDSON: Is that where you draw a line in the sand, at least 5 percent for buying a home?

POZEN: I think that`s a reasonable place to draw a line in the sand.

HUDSON: You also talk about fewer Federal government guarantees, specifically the one that most depositors, most banking customers are used to is the FDIC insurance.

POZEN: I`m all in favor of FDIC insurance. That`s for small depositors, but what we`ve done is guaranteed the debt of very large bond holders and this has been done not only for banks and S&L, but for their holding companies. So for example, we guaranteed $2 billion of the debt of John Deere, a tractor company because it owns an S&L and we have companies like JPMorgan and Morgan Stanley that have paid back their TARP money, but they still have their guaranteed debt, billions of it. It`s worth a fortune and we ought to have them repay the guarantee debt.

HUDSON: What about the two guarantees and two names, Fannie and Freddie?

POZEN: Those are the ones that are the most problematic and will probably take us years to work that out and the Treasury is supposed to come up with a proposal in February, but we`ll see what they`re going to come up with.

HUDSON: You also talk about how the Federal government and the Justice Department specifically should discourage big mega-bank buyouts like those that built up Bank of America, that built up Citigroup, that even built up JPMorgan, one of the survivors here.

POZEN: Yes, I think that we should have a lot tougher antitrust policy and not allow these institutions to grow so much. In some cases we even encouraged these acquisitions. On the other hand, it`s very difficult to break up institutions that are already there. So let`s take a preventive approach and not let these institutions get so big to begin with.

HUDSON: You talk about too big to save. Is U.S. finance currently too big to save?

POZEN: No, I don`t think it`s too big to save, but I do think there are a lot of things that we have to do that we haven`t done and the most important one is to change the nature of our capital requirements. We need to have higher capital requirements, lower leverage and different types of capital requirements. We now allow the largest banks to set their own capital requirements by these very elaborate internal risk models and one thing we`ve learned about these models is that they were wrong. They were wrong a lot and people had a hard time understanding them. So that doesn`t seem to be a good basis for capital requirements.

HUDSON: An interesting read. Robert Pozen, the name of the book is “Too Big to Save.”

Comprehensive in scope, Too Big to Save looks at each of the factors that played a role in the crisis: the housing boom, subprime loans and the impact of mortgage-backed securities; Fannie Mae and Freddie Mac; credit default swaps, AIG and collateralized debt obligations; hedge funds and short selling; and capital requirements. But this is not an alphabet soup. These topics are precisely defined and clearly presented in a highly readable and well-paced narrative. Moreover, as Pozen explains the forces that were at work to disable the U.S., and then global, economy, he presents a series of constructive approaches to righting the financial system.

A few weeks ago, President Barack Obama signed legislation extending an $8,000 tax credit for first-time home buyers. The refundable tax credit, available even if a family has no taxable income, will enable many more buyers to close on a home. But it also could bankrupt the Federal Housing Administration (FHA) and, by doing so, damage an already weak housing market.

The tax credit was put in place as part of the stimulus package signed into law earlier this year. Initially, it was available only to first-time buyers with a combined income of $150,000 or less ($75,000 for individuals). Approximately 40% of all first-time buyers used the credit in 2009, so extending it was strongly supported by real estate brokers, home builders and their congressional allies.

The extension the president signed makes the credit available to first-time buyers, but also to people who have owned a home for at least five years. In addition, it raises the maximum income for a qualified buyer to $225,000 a year for couples and makes the credit available until mid-2010. (It had been set to expire at the end of this month.)

The problem is that the FHA insures mortgages of homes below certain price levels with such a low down payment that it can be funded solely by the refundable tax credit. And, as we’ve seen in the recent housing crisis, buyers with no skin in the game are more likely than others to default on their mortgages when the value of their home falls below their mortgage balance.

Here’s how the credit allows buyers to avoid putting their own money at risk. Suppose a couple making $60,000 annually buys a home worth $200,000. They can get an FHA-insured loan if they put down 3.5% of the purchase price, about $7,000. The couple will also need to come up with another $1,000 in closing costs, for a total of $8,000. The couple can either dip into savings or borrow that money from relatives or somewhere else on a temporary basis.

After closing, the couple can quickly obtain the $8,000 refundable tax credit to pay off their temporary loan (or replenish their savings). In effect, they will have bought a home without putting any of their own money at risk. Owners who don’t sink their own money into a house are much more likely to default on the mortgage.

The FHA already is facing a rising number of serious problems on its insured mortgages. Last week the agency reported that its cash reserves dropped to 0.53% of the $685 billion of total loans it insurers. This is well below the 2% federal law requires the FHA to have in reserves.

Beyond these reserves, the FHA has roughly $28 billion in a capital surplus fund, established by Congress to absorb losses on insured mortgages over the next 30 years. With the reserves and capital in hand, agency officials believe they have enough cushion to avoid needing a federal bailout. But a recent government audit concluded that the FHA would run out of money in 2011 and need a federal bailout if we have a protracted recession.

The deteriorating quality of the FHA’s mortgage portfolio is a critical challenge to the housing market and the federal budget. By the end of next year, the FHA’s portfolio is projected to rise to $1 trillion. Currently, over 20% of all new home mortgages are insured by the FHA.

Meanwhile, the tax credit for first-time home buyers is expected to cost the Treasury approximately $15 billion in 2009—more than twice the projected cost when Congress approved the stimulus package. Some of the cost overrun is due to fraud. At least 19,000 filers who claimed $139 million in tax refunds under this credit did not actually buy a home, according to Treasury officials. In addition, 74,000 filers claiming a total of $500 million in refunds seem to already have owned a home.

We all want to help first-time buyers acquire homes and support the depressed U.S. housing market. Without real down payments, however, new homeowners are likely to default on their mortgages, and the FHA will probably need a taxpayer bailout.

The Obama administration should increase the requirements to qualify for an FHA-insured mortgage. In addition to the 3.5% down payment, the administration should also require that buyers put down at least half of the tax credit they will receive for buying the home.

Mr. Pozen, chairman of MFS Investment Management and senior lecturer at Harvard Business School, is the author of “Too Big to Save? How to Fix the U.S. Financial System” (Wiley, 2009).

It’s clear by now that a failure of regulation on multiple fronts helped to fuel the financial crisis. What’s more, according to Bob Pozen — chairman of MFS Investment Management and author of the book Too Big to Save? How to Fix the U.S. Financial System — government has also failed, in certain instances, to clean up the fallout from the crisis.

[Video on CNBC, Airtime: Tues. Nov. 10 2009 | 4:16 PM ET

If we want corporate America to avoid short-termism, we need to help free portfolio managers and company executives from the tyranny of quarterly results.