Howell Jackson (the budget Dean at Harvard Law) writes:

Build a better bailout
The good news is that there is a very promising alternative to consider – one that could be grafted onto the Paulson plan. It represents a much better investment of $700 billion, it's been used successfully before, and it would help troubled homeowners more directly.

At the heart of this crisis lie two sides of the same coin: Heads are the bad home loans. Tails are the toxic securities that financed these mortgages. The former is what's pushing many homeowners into foreclosure. The latter is what's sinking Wall Street.

The Paulson plan primarily deals with the tail side of the coin – the investors who got burned handling hot subprime securities. A better plan would start with the head – the bad loans themselves.

Yeppers.

A more effective strategy would be for the government to target the source of the toxicity by buying actual loans, not the securities that back them. It could do so by taking ownership of entire mortgage pools, starting first with the lowest quality (and most toxic) ones.

With congressional authorization, the Treasury could force the purchase of these assets through eminent domain and make an immediate payment of an estimate of the loans' current fair value, which would then be later reviewed for adequacy by a judicial forum.

This approach has several advantages.

First, purchasing whole pools of loans would force liquidation of the mortgage-backed securities used to finance those loans. Investors would get an immediate distribution of the government's cash plus any residual interest that results from after-the-fact judicial valuation. Critically, whole issuances of the most complex mortgage-backed securities would disappear, and the market would receive strong pricing signals for comparable instruments.

A crucial component of this plan is that it moves whole loans (and not fractional securities) under government control. Once it holds these loans, the government can take charge of workouts and refinancings. This is the approach that the Home Owners Loan Corporation took in the Great Depression, and the Federal Deposit Insurance Corporation (FDIC) is already operating such workout programs for loans held by failed banks under its control.

If the Treasury bought these toxic pools, it could offer relief for borrowers who were misled or abused, and then deal more harshly with speculators. This strategy would empower the government to aid troubled homeowners, not just Wall Street.

A further benefit is that it could change the incentives now facing loan-pool trustees. One reason the market has struggled to adjust to falling housing prices and increasing foreclosures is that mortgage-backed securities trustees have been reluctant to renegotiate individual loans, out of uncertainty and fear of litigation. Facing the threat of forced sales to the US government and with clear guidance on how much the government is likely to pay for their loans, such trustees will be highly motivated to renegotiate loan terms on their own, further clarifying market values and enhancing price discovery.

"Highly motivated." Haw.

HOLC is the plan that Nouriel Roubini supports. It's also the plan that an actual adult supports and has been pushing even before the crisis became fashionable. Since HOLC has been shown to work historically, and even made the government a profit, I think we can assume it will never be adopted by the insane children running what we laughingly call "our" government, but we can try....

So keep those calls coming! And if, by some miracle, the trillion dollar bailout doesn't pass before Congress adjourns, give 'em an earful when they're back in the district!

NOTE Now, I think the objection here would be that we're not bailing out the gamblers who bet, and bet wrong, that the toxicity of the complex financial instruments they were buying and selling each other would never be exposed. And so what?

UPDATE WaPo kinda sorta covers this story:

The critics can be roughly divided into two camps. One group thinks money should be directly infused into banks, which should allow it to trickle down through the financial system to borrowers. A second group thinks the government should buy individual mortgages, thus helping ordinary Americans more directly, with the benefits trickling up to the banks.

"The plan is a trickle-down approach from banks to Main Street," said Alan S. Blinder, a professor at Princeton University. "But if you reduce the flood of foreclosures and defaults" -- which he would have the government do by buying loans directly and then renegotiating the terms -- "it will make mortgage-backed securities worth more."

Blinder (and the "second group" (why second?)) are advocating HOLC (which Blinder first supported in February, 2008).

Unfortunately, WaPo typists Neil Irwin and Cecilia Kang butcher the story because they don't mention the HOLC acronym, so readers won't be able to connect the "trickle up" plan to its non-academic advocates).

And the butchery continues:

That might help ordinary Americans but would be extremely difficult to administer. The government would have to make decisions on the foreclosure and resale of individual houses all over the country.

Bullshit! Once again, by omitting the HOLC acronym, the reporters allow readers to form views based on bad information. Since the HOLC approach was already used under FDR, we know that administering it is possible; and in the 1930s, they didn't have computers!

Still, many economists with left-of-center political views favor some variation of this approach to the plan endorsed by Bush.

Nouriel Roubini, who supports HOLC, is "left-of-center" only in the sense that, in Krugman's Age of the Anti-Cassandra, he called his shot on the crisis and got it right -- unlike all the smart money on Wall Street who are demanding a trillion NOW NOW NOW.

"There is a kind of suggestion in the Paulson proposal that if only we provide enough money to financial markets, this problem will disappear," said Joseph Stiglitz, a Nobel Prize-winning economist. "But that does nothing to address the fundamental problem of bleeding foreclosures and the holes in the balance sheets of banks."

"I totally disagree that this needs to be done this week. It's more important to get it right," Blinder said.

Yeppers.