I have heard many times that the government "must" do something to "save" us from our predicament recently. Even supposed conservatives have argued that past government misdeeds mean it must intervene. I would mention that the government took a lot of my money in taxes for failed programs yet isn't offering me a refund, but since a lack of fairness is not an argument against a law, allow me to look at this in a bit more detail.

The usual argument is that if we do nothing certain businesses will go under, taking jobs with them, and ruining investments. However, the fact is that inflation has channeled investments into the wrong locations, and that is why our deflation is causing them to fail. When evaluated int he harsh light of realistic valuations, these investments prove to be bad economic decisions. So, if we prop them up, what is the result? We maintain an inefficient investment instead of allowing it to be liquidated and the resources reassigned to uses more important to the public. In other words, any sort of bailout only serves to perpetuate the mistakes made during the inflationary fever. Yes, it may be painful for those who have to look for new jobs. And for those of us invested in companies, the losses will hurt, but that is life. You always risk losing your jobs, and investors always risk losing their investment. It is not the purpose of government to indemnify all of America against any risk.

So, what would I do?

Ideally, I would do nothing. As we have seen during the period between the passage of the Bush bailout and the passage of the Obama stimulus, the market is pretty good at fixing itself. Unemployment has risen, but not even to what was "normal" in decades past. There are other supposedly negative signs (bankruptcies, for example), but as I argued elsewhere, they are not signs of growing economic weakness, but of economic recovery. The indications are, left to its own devices, the economy will quite rapidly correct past errors and return to a much more steady footing. So, instead of a stimulus bill, I would rather see the government do nothing. Or almost nothing. I would like to see them close down Fannie and Freddie, repeal the CRA, stop trying to artificially depress interest rates, and place some sort of restraint on the Federal Reserve, either a moratorium on open market operations, or at least establish a rigid amount by which the money supply can increase each month. And finally, as part of that moratorium, I would like the government to show some discipline and stop deficit spending until at least the economy recovers, or, better, forever. That, along with an end to meddling in the financial market, would be the best path to recovery. At least the best that is even remotely possible at this time. (An end to all economic meddling and regulatory interference and a return to commodity money is not going to happen in the foreseeable future.)

As that is not very likely, the second best solution is to do what was done with the FSLIC. Instead of "stimulus" and "bailout", the government should establish a sort of new Resolution Trust Company. This agency would be responsible for one thing, buying back government assured loans, or at least some well-defined subset of subprime loans, focused on those that were issued as a result of government interference with the lending industry. In any case, it would be set up to simply remove the bad loans from the flow of business, eliminating one of the major causes of the current crisis. That would have two effects. First, it would restore the value of the bundled loans immediately, allowing companies to overcome any liquidity crunch caused by the inability to sell loan bundles they purchased. Second, it would specifically target the source of the problem, rather than tossing money at random into the economy.

I do have three rules this would require. First, no new loans could be issued under the CRA or guaranteed by Freddie and Fannie during this time. As these loans are the problem, we cannot generate more and expect things to get better. Second, the government needs to fund this buyback either by cutting spending, selling bonds on the public market (not to the Fed), or through a tax increase. Any attempt to fund through inflation would simply add to our problems and set us up for a future collapse. Third, I would still want the government to exercise discipline and stop deficit spending while the economy recovers. Inflation has obvious harms, but even resorting to the Reagan solution of borrowing from the private sector to cover shortfalls will put a drag on the economy we don't need. So, more than ever, we need an end to deficit spending.

Other than that, any solution is as bad as another. Whether  bailout is targeted or random, as the current one is, it will certainly be funded by inflation, making the only relevant question "how much will they inflate?" As we are suffering what amounts to a deflationary crisis, any inflation will either start us down the road to a new, and worse, inflationary crisis, or kick off hyperinflation worries and put us immediately into a much worse situation. Of course the public may mistake the first for a cure, but in reality it is only trading a current problem for a worse future one, and we have done that too many times already.

Of course, I am certain neither of my solutions will even be considered. Both parties seem committed to the bailout solution, and so some sort of new inflation, and future collapse, seems inevitable. My only hope is that they keep it as small as possible, and resist any other meddling, to keep the harm to a minimum, and to slow real recovery as little as possible. But I am not very optimistic about it.

POSTSCRIPT

Most of my writing on this topic can be found linked int he postscript to "Not Entirely to Blame". If you wish to see my earlier arguments, or more detailed thoughts on specific aspects, please check out that list of past essays.