Finally, to ensure that mortgage money is available, banks have to be able to quantify their current losses on their –residential-–mortgage bonds. Right now, most of the toxic instruments the banks hold that might go belly-up are insured by two large financial insurers, Ambac and MBIA. The losses on these pieces of paper are so much greater than those companies can absorb that the banks can't count on getting paid from them in the event of a default. The uncertainty is paralyzing the major banks. What the federal government should do is guarantee the insurance that has already been written, taking warrants in both companies, à la the successful Chrysler bailout of the eighties. If we are worried about the cost of those guarantees, we can limit it, allowing only a 50-cents-on-the-dollar payout on the insurance. With this guarantee in place, banks would be free to make the loans they can't afford to make now and get the economy moving again. Given the low rates that they would have to pay to depositors (they're also keyed to the federal-funds rate), banks could lend at 5 percent, a good deal for borrowers, and still make terrific profits that could be used to offset the losses they would have to take on the portion of their bad loans that are not guaranteed.
What about inflation? We only need a temporary dip in rates, just long enough to refinance everyone, then we can take rates back up again. Frankly, the mortgage mess is so deflationary it wouldn't hurt to have a few months of inflation.
Why hasn't a plan like this been suggested before? We have a Fed that only recently woke up to the crisis and is so ridiculously independent despite its obvious incompetence that it can't be counted on to take rates to levels that would make my plan work. When this problem is fixed, and rates are then brought up higher once refinancing is in place, Congress should investigate why the Fed keeps getting it wrong and whether the power and independence of these unelected academics is a good thing, considering their endless recklessness. Meanwhile, you can spend $150 billion making sure that the mall is jammed for a couple of Saturdays. Or you can spend virtually nothing by slashing rates and offering mortgage-insurance guarantees to banks and get the country moving within a matter of months. It's the free solution to a trillion-dollar problem that will never be cured by a bogus stimulus boondoggle.