As I pointed out back in early January, because of failing mortgages (see latest blog archives at http://www.roman-empire-america-now.com), this country is facing a Depression, not just an ordinary downturn. The leverage of "securitization of debt" is now working in reverse: since it took one dollar and multiplied it, that multiplication now works this way: a homeowner defaults and his $200,000, part of a home-loan backed security, drives down the latter, which almost surely drives down further derivatives that have been spun from it, so $200,000 probably becomes $2 million. In other words, that one default is multiplied through the financial system because of reverse leverage.
Whether these derivatives are, or ever were, real values, their values are compromised by the default back at the beginning of the cycle.
So, government proposes to buy up all (or a large portion of) the bad debt to calm the financial markets. I think the Democrats should reject this "solution," and tackle the problem from the opposite end: the homeowners.
Despite their tough handling of Lehman Brothers, the Administration has been over-solicitous of the speculators and "bankers" who got us into this mess through their fiendishly complicated "securitization" of all mortgages . The administration has tended to blame homeowners for "bad decisions," but to exonerate speculators, or at least to bail them out.
It is the opposite that the Democrats should demand: bail out the homeowners: assume, unless there is clear evidence to the contrary, that someone who is being forced to default on their home loan is a victim who needs to be rescued; redeem the loan, keep the house-holder whole--and leverage should work the way it ought to.
In other words, instead of tendering $700 billion to the financial industry that created this mess, Congress ought to empower FHA to take over and ensure every mortgage in danger. Congress would thereby, in one stroke, eliminate the fear that the real values underlying all these securitized pieces of paper have disappeared. At the same time, defaults and fear of defaults on mortgages would be eliminated, and real people would keep their homes.
Because of the miracle of leverage, this support of the homeowners, instead of bankers and speculators, would probably cost considerably less than the $700 plus billion bandied about by Paulson, et al.
The problem we face is political. The Republicans think only in terms of banks, bankers, speculators, insurance companies, and not about ordinary people. Paulson's "solution" is a variation on the trickle down theory; help the people at the pinnacle of the financial system and everyone else will be helped. It's not clear that this will work any better than the trickle down tax policy.
Democrats need to think like Democrats, that is, to put ordinary people before bankers: secure home mortgages, insure that people stay in their homes, and keep paying towards their mortgages. The esoteric financial instruments crafted by the speculator-bankers depend, ultimately, on those home mortgages. It really makes no sense to bail out the banks and securities firms, at huge expense (more even than we spend on the military), instead of the homeowners. Instead of attempting to put a stop to the reverse leverage from the end of the chain, begin at the beginning: secure the mortgages and everything else will fall into place.
After that, Democrats should work to put a stop to almost all the securitization of debt, since it is what has made this into a global crisis.