Remembering that I have no economic training, let me propose a humble alternative plan, Instead of using Fed support to induce hedge funds et. al. to buy up the "legacy assets" at large banks (whose presence on their balance sheets prevent them from lending - no one trusts the solvency of the banks), what if the government channeled the TALF/TARP/whatever to solvent, and necessarily smaller banks? Without the slime of any unpriced assets, without the over-leveraged balance of debt to liquidity, without the post-Glass-Seagal interconnection of services and speculation, these mid-sized banks across the nation would be the new financial engine of recovery. Limiting their size by limiting the ratio of debt they may carry (how about ... 6:1?) might create trust in their lending.
As for the big, soiled banks so much in the media? Without government money as a lifeline, they would need to deleverage quickly to get into the action. That means dumping these securitized instruments. Government could assist homeowners through mortgage rate reduction (warning: I am a home owner who owes about what my home is now worth), say to 2.5%, though with no revaluation of the homes. That might help keep people in their homes; the government pays the interest up to the contracted rate (for example, my interest rate is 6.5%; I longer own enough equity to refinance down to the current 4.5%; in my pseudo-plan, I would pay a mortgage at 2.5%, with the government funding the gap up to 6.5% until I once again own enough equity to refinance down to current levels), which may add stability to the securities. Once the big banks are able to start selling their load of toxicities, they can slowly deleverage down in size.
There are many problems here, even I recognize (like who decides which mid-size banks get the money? how independent are they?). Yet I question the justness of a financial recovery by our government. Instead of using the profit incentive to lure in more fantastical speculation (with almost no risk), why should we use the government strength to create a need for the banks to establish their own market for the clogs that are freezing their willingness to loan? In the meantime, added capitalization of mid-sized banks will allow small business and home buyer lending, within reason.
