Government as Lender
Critics of the administration's plan argue that one alternative could be crafted to minimize the exposure of the government -- and taxpayers -- to risk. Johnson, the MIT professor, suggested that the government, instead of taking on the bad debt, could offer loans to troubled banks, allowing them to put up their compromised portfolios of mortgage-backed debt as collateral.
This would give the banks access to badly needed cash at attractive interest rates set by the government. But it would not completely let them off the hook for making those bad investments in the first place. Because government money would come in the form of loans, rather an outright purchase of the risky investments, taxpayers would be offered greater protection. Ultimately, the banks would have to pay off the loans and take back the securities, though at a time when the market for them may have improved. If the value of the securities is still depressed, that would be a problem for the banks, not taxpayers.
"The risk to the government/taxpayer is that the bank goes out of business and so isn't around to settle up," Johnson said. "But the government is also the regulator, and they can do a more forceful job of making sure the banks have enough capital, so the incentives are pretty well aligned."
Interest rates would be set at a level attractive to banks, the relatively low rate at which the Treasury borrows plus a small premium. Only if the banks were nearing default would the government take a more active role in propping them up, perhaps even taking them over.Government as Hedge Fund
Some market analysts and fund managers worry that the Paulson plan would allow Wall Street to dump the worst kind of mortgage securities on the federal government. One solution could be the establishment of a fund that limits its purchases to profitable mortgage securities and other assets.
The creation of a $700 billion investment fund could help reinvigorate the business of trading mortgage securities, greasing the wheels of the credit markets by bringing in a new, cash-rich investor: the federal government. While this solution runs the risk of not cleaning up enough of the bad debt on firms' books, taxpayers could be more confident of getting their money back because the government would be selective about which securities it bought.Mortgage Breaks
Liberal analysts say the government could intervene in the financial system by addressing the ailing mortgages at the heart of the crisis. Under this approach, the government could reduce the amount of principal that struggling homeowners owe.
One idea is for the government to take control of some mortgage-backed securities -- most likely by buying them from financial firms -- and then work to restructure the underlying loans into something homeowners could afford. The value of the securities, both those bought by the government and those in private hands, could improve as foreclosures and late payments drop. If so, financial firms holding mortgage-backed securities could see a recovery in their balance sheets.
To make it fair for homeowners who keep up with their payments, borrowers who receive federal help would be required to give the government some of their gains if they eventually sell their homes for a profit.
But advocates of the idea acknowledge that it may take time to address the problems of millions of struggling homeowners. In the meantime, critics of this approach say, the financial system could fall deeper into chaos.Tax Breaks for Wall Street
Conservative analysts take a different tack, though their criticism of the Paulson plan has been no less sharp. They say that because the proposal forgives Wall Street for its past sins, it creates an incentive for investors to behave irresponsibly in the future.
Some of these analysts complain that the government's rescue punishes taxpayers too severely for Wall Street's mistakes. They propose a cheaper alternative that calls for the repeal of the capital gains tax for two years, which would provide Wall Street a stimulus to reinvigorate the financial system.
Accounting rules that require banks to estimate the market value of their troubled mortgage securities would also be suspended for five years, giving financial firms the ability to value these assets at prices more reflective of the market before the panic gripped Wall Street.
Rep. Jeb Hensarling (R-Tex.) said this plan, which he announced on Capitol Hill yesterday, was still being finalized. Hensarling said the cost of the capital gains tax repeal, for instance, was still being determined.
"We agreed that inaction is not an option, but that doesn't mean that we've concluded that the Paulson plan is the only option," Hensarling said. "There are alternatives to consider, and we think we have a worthy one."
All of these alternatives try different ways to get at the root of the turmoil facing the financial markets and the economy. According to Lawrence Summers, former Treasury secretary, the government might have to try multiple approaches.
"If you have hypertension, you're way overweight and you're in the process of having a heart attack, what's your most fundamental problem? It's really not that useful to distinguish between them," Summers said at a Brookings Institute forum. "They're all components of the situation, and you're not going to get to a very satisfactory place unless you address all of them. That's how I think of our financial reality right now."