A Modest Proposal

The federal government and the Federal Reserve have now committed as much as $2 trillion to the banks, AIG, the commercial paper market, the stimulus package and the auto companies in an effort to prop up the economy and reignite lending. And what has it accomplished? There are some "positive" signs that lending is coming back, but the world's economy has been badly enough damaged that confidence is shaken and the self-reinforcing psychology of the "Great Recession" has taken hold.

Meanwhile, public rage at the government bailouts, while in many ways misinformed and misguided, would dissipate if the government's strategy changed. What's needed is a strategy that benefits everyone in the short term.

Consider the following:

Loans are essentially assets for banks, and the big problem right now is that the stupidity of many bankers led them to make bad loans and then overvalue them through securitizing them. Mark-to-market accounting rules, which mandate that assets be measured by current market value rather than purchase or sale price, makes it almost impossible to judge the actual value of the banks, since nobody is admitting fully how badly they are in the subprime and ARM markets. With unemployment on the rise, credit card, student and auto loans will be the next to default - plus commercial real estate.

But, as anyone knows, a bank's assets also include cash on hand and, if they're smart, an adequate reserve fund to cover a portion of loans that go bad. Clearly, the securitizing of debts and the seemingly 'risk-free' purchase of third-party insurance through companies like AIG allowed many banks to misjudge their needed reserve funds. Stupidity and perhaps criminal negligence ran amok.

If the U.S. government wants to pump money into the financial system, it should stop providing cash and guarantees for the securities themselves. Instead, how about using that $2 trillion to "give" every American a fraction of that, paid directly to whatever creditors they have.

A family of four would have their outstanding loans reduced by, say, $24,000. Banks would have loans paid or partly paid back, with increased capital reserves and increased ability to make loans as a result. Individuals or families with no debt would get cash.

Talk about increasing confidence! It might restore the economy to health, and at full capacity individuals could start paying down further debt while the government and Fed work to cut the burgeoning deficits and debt that is currently being created.

Of course that leaves the problem of inflation as we grapple with all this extra government debt. Plus entitlements obligations, solving long-term structural problems in the American economy, increasing the savings rate, revamping the energy infrastructure, fixing health care, etc. etc. etc.

But it would be a start.