There are a lot of problems with the proposed bailout. Yesterday I described a scenario where the government winds up causing a rise in interest rates and inflation. But it is also possible that this plays itself out in a deflationary way as it did in Japan following their real estate bubble. That could happen if instead of resuming to lend, the financial institutions hord government bonds and the global confidence in the US remains sufficiently strong. The trouble in essence with the plan is that the purchase of securities from financial institutions is a highly indirect way of influencing their lending behavior. That is why it is troubling that Paulson is asking for unfettered authority. Once approved there will be little control even if the program does not work at all or the Treasury decides to pay ever higher prices for assets to try to make it work (“cash for trash”). Seems to me an alternative would have been for the US to use this money to back the banks that can survive with an equity infusion (getting an ownership position and also influence over lending practices of those banks) and to let those too wounded to go on fail.
