Nationalization has the best chance of avoiding large losses and possibly even making money for the taxpayer. And it is the best way to deal with the moral hazard problem.
It might work like this. Congress:
- grants the Federal Reserve Board the power to take any financial firm whatsoever with liabilities and capital of more than $25 billion that is not well capitalized into conservatorship
- requires the Federal Reserve Board to liquidate any financial firm in its conservatorship when it judges that the firm is insolvent (paying off in full or not paying off in full the liabilities of the firm at its discretion), unless
- the Federal Reserve Board finds that preservation as a going concern is in the interest of the taxpayer, in which case Congress
- grants the Federal Reserve Board the power to transform equity stakes in the firm into junior preferred stock at par value and then transfer ownership and custody of the firm to the Treasury
- requires the Federal Reserve to terminate conservatorship if the firm becomes well-capitalized once again.
In addition, Congress:
- grants the Treasury the power to issue up to $500 billion of troubled asset redemption bonds, the proceeds of which are then to be loaned to the Federal Reserve to be used to cover the liabilities of those liquidated firms that the Federal Reserve judges it is in the interest of the taxpayer to have their liabilities paid off in full.
Paulson had his shot. It's time for the Democrats to pass a nationalization in the taxpayers' interest bill and dare Bush to veto it. If he does, then announce that the congress will pass it again the day after the election. And if he vetoes it again, announce that congress will pass it yet again on January 21, 2009.
Comment: As DeLong notes, we want to avoid doing nothing and allowing fear to freeze liquidity. My only concern is that he doesn't seem to be distinguishing between any of the many types of financial firms. I guess he's seeing them all as a kind of public good no matter their particular stripe.
What I also like about his idea is that is avoids the poison pill as discussed below and regains political clout for those proffering this kind of sensible plan. It could be the Democrats if they have any brains.