Administration is clueless on how to fix economy

Washington Post:

President Obama's top advisors are in the final stages of debating several perilous options to right the financial system, all of which are likely to prove unpopular and in some cases carry a significant risk of failure, according to sources in contact with the officials.

The rapid deterioration of the economy has accentuated these hard choices. The health of many banks is getting worse, not better, as the downturn makes it harder for all kinds of consumers and businesses to pay back the money they borrowed from these financial firms. Conservative estimates put new bank losses at $1 trillion.

Senior administration officials are likely to try a combination of initiatives rather pin their hopes on a single, all-encompassing solution to help the financial system, the sources said. But their strategy may require some trial and error, which could make them vulnerable to the same criticism that dogged the Bush administration's seesaw management of the $700 billion rescue program.

On the table are several approaches, which officials have begun to experiment with on a smaller scale. One would give the firms a federal guarantee protecting them against losses on assets that are backed by failing mortgages and other troubled loans. Another would set up new government institutions to buy these "toxic" assets. A third would inject more money into financial firms in exchange for ownership stakes, perhaps ending with nationalization in all but name.

But each proposal is fraught with the risk of undermining the banking system, leaving Obama officials wrestling with how to strike the proper mix of emergency programs.

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One of the reasons they are so clueless about what to do, is they still don't have a comprehensive understanding of the factors that caused the crisis to begin with. There has been a tendency among Democrats in particular to down play the effects of their own screw ups in the mortgage lending business and their failure to regulate Fannie and Freddie. These actions were the source of the "toxic" securities that got sliced and diced in the derivative market which managed to spread the poison rather than create the liquidity they were supposed to.

This suggest you start with tougher lending and regulations of Fannie and Freddie and do away with much of the derivative "market," such as it is. That would require unwinding several trillion dollars worth of instruments, but it would give a clear picture of the value of these instruments which is causing the uncertainty in the market place.