What would an alternative to bailouts have looked like?

I have written extensively about how I believe the bank bailouts were the worst of all possible solutions – fixes that perpetuate too big to fail, moral hazard and crony capitalism.  That ship has sailed, but the questions still linger – in large part because the fix has not trickled down to common folk to better their lot.  Rising unemployment is but one demonstration of this.

Arnold Kling writes a post that goes beyond banking to AIG, mortgages and Fannie and Freddie. He offers real world solutions that don’t require creating special resolution authority, buying toxic assets or orchestrating bailouts.  While there would certainly be costs to these solutions as well, they would be far less than what we are paying now.

The interesting bit is he proposed them in the moment when the bailouts were ongoing. Don’t let anyone tell you that there weren’t other options available because there were in spades.

1. Existing Mortgages and home owners.

Actual policy: attempts to implement loan modification programs

My policy: pay the moving expenses of homeowners who default on their mortgages. But do not interfere with the foreclosure process.

2. Mortgage Markets

Actual policy: keep Freddie Mac and Fannie Mae going, and we now have 90 percent of mortgage loans made by federal agencies.

My policy: Limit Freddie Mac and Fannie Mae to their existing book of mortgage loans (I wrote this in September of 2008) and not allow them to purchase any new mortgages. Let banks take up the slack in mortgage lending.

3. AIG

Actual policy: creditors bailed out 100 percent.

My policy: Send in a "stern sheriff" to protect the liquid assets of AIG from creditors making "collateral calls." I was thinking of a government-suggested mediator, perhaps a former bankruptcy judge. If the parties did not like it, they could go to court. But my guess is that the parties would have preferred a mediated solution.

4. Big banks

Actual policy: bailouts of nearly all of them

My policy: Triage. Shut down the ones that have clearly failed, using FDIC procedures. Those that are clearly solvent should be allowed to proceed. Those that are neither clearly failed nor clearly solvent should be given forbearance, but with tight supervision to ensure that they do not use this forbearance to expand their risk-taking. Again, this was what I advocated in September of 2008.

Why proposals of this sort were not followed is the subject of much debate.

Source

Was TARP Necessary? – Arnold Kling