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The chief bogey man held out by those advocating the $700 billion bail out is that not doing so would cause credit to freeze up, bringing the economy to a halt.  But there is no guarantee that spending $700 billion on bad assets will unfreeze credit. And what if much of the money ends up paying to unwind derivative bets leveraged at 30 to 1? Instead of investing $700 billion in assets we know are bad to worthless, why not invest a fraction of that amount in eliminating any possibility of a credit freeze?

Banks typically have a 3% equity, or reserve capital, requirement.  By creating 538 new banks, one for each electoral vote and a minimum of three new banks in each state, with $500 million reserve capital each, a total new loan capacity of $8.96 trillion is created for a total public investment of $269 billion.  This is a very significant fraction of current total loan capacity and this much new loan capacity may well be too much.  The program could authorize a total of $500 million per bank but start with $100 million per bank.  This first step alone would likely solve credit availability problems,T as solvent existing banks would have to re-enter the market to hold market share.

The government provided equity capital should be provided by senior stock held by a federal agency.  The banks could be required to adhere to conservative, stogy banking practices, required to devote a certain portions of their loan portfolios to commercial paper, to real estate finance, to student loans and to renewable energy investments.  The real economy would no longer be held hostage by Wall Street and we could let the current situation play out and intervene and invest where possible to prevent avoidable damage with what is left of the requested $700 billion rescue fund.

This will be bitterly opposed by the banking industry.  They will cry that this is unfair competition by government sponsored entities when they are burdened by bad assets. Supporters of this plan can respond that the obligation for government action is to act for the good of the taxpayers and the overall economy, not for the good of Wall Street and bad actors in the finance community.  And in two or four years time these banks can be made available for sale on the same terms as private banks are sold, given the size and quality of their assets.

Profits from the sale of these banks could be used to pay for shortfalls in Social Security and Medicare, VA  benefits and other worthwhile public needs.  A process that saves and clearly protects the real economy, lets Wall Street stew in its own toxic juices and turns a profit for the public in the bargain should be wildly popular if it is ever clearly presented to the voters.

This plan would break the frame of "We must bail out Wall Street to save the economy." Something like this will likely have to be done in the end.  Why flush $700 billion before trying a sure thing?

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Oct 1st, 2008 at 02:16:30 AM EST
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