Coyote Blog

This is taken from and expanded from the end of this post.

Everyone involved in the bailout plan says, at least publicly, that they are not trying to bail out a bunch of Wall Street folks who lived high off the risk premium of these investments but now want to avoid the costs when the actual risks become clear.  They claim to be bailing out Wall Street and various large banks because they fear that a financial meltdown and liquidity crisis will starve main street businesses of cash, and create a deep economic slowdown.

OK, if this is the real policy goal -- to maintain the ability of main street businesses to borrow -- then here is my alternative proposal:

1. Immediately increase the SBA loan gaurantee authority by $100 billion dollars.  That is enough for a million new small business loans of $100,000 each.
2. Authorize treasury to spend up to X hundred billion to buy rated new issues of bonds and commercial paper of US non-financial companies.  Some limits should be applied - such as the feds cannot buy any more than 30% of a single issue and/or more than 10% of the entire outstanding debt of one company.

That's the plan.  Here are the advantages:

• The government is addressing the actual policy goal of keeping liquidity in main street business directly
• The government is investing in success, in main street companies trying to grow, and not in failed banks and financial institutions
• Moral hazard issues are avoided with financial institutions. 
• The SBA loan guarantees cost nothing today.  In fact, they are cash positive in the short term due to loan guarantee payments by borrowers.  Of course, they risk future losses,  but such losses in the future are in part covered by the guarantee payments, and a future loss is cheaper than a loss today.
• Investments in corporate bond issues are much easier to value, and are far less risky, than investments in illiquid mortgage securities.  The taxpayer is far less likely to take a beating on these purchases.
• Banks may still fail, but the FDIC has an infrastructure and experience for handling this.  If necessary to calm people, the FDIC could make a public commitment to assisted mergers to maintain all depositors.
• If there is some big financial meltdown, which I still doubt, there might be a need to inject some mortgage liquidity, but since the Feds now own Fannie and Freddie, the vehicle for doing so is easily available.

Update:  I was not clear -- this is actually an alternative to by alternative.  My first, preferred alternative plan is "do nothing."