I’ll admit up front: I’m an economic novice. Some of the stuff that’s going on in the market right now just make my eyes go crossed at times (and like many on this site, I find the best info anywhere coming from blackhedd’s posts). So what follows isn’t a “this is what we need to do.” It’s more of offering a starting point for the discussion of “how do we actually fix the situation?”

Two important things strike me about that question – 1) NOBODY has any idea of what the right answer is and 2) standard policy responses probably aren’t go to do it.

With the steps that have been taken in the last few months (killing Bear Sterns, letting Lehman die and ML get bought, and bailing out AIG), it seems one simple fact is obvious – we’re treating symptoms, not the problem. While something like AIG makes me furious, I understand why that move is made – if you don’t take preventative action there, the chest pains become a full blow heart attack. At the same time, it doesn’t actually “fix” anything…such a move just tries to prevent a full-blown panic. So while the market moves (furious as they are for conservatives) might stave things off, they don’t do anything to fix the problem.

The problem is obviously the subprimes – we’ve known this for the last few years. With the Fannie/Freddie move, there’s at least an opportunity to refinance some of these and get people out of their mess. But that’s a long term, slow moving process that doesn’t inject any confidence immediately, which is what is desperately needed.

Like most others, I’ve been pondering ideas of policies to encourage, things to vote for. There’s an idea I keep coming back to (that may not be entirely original, but I haven’t seen it suggested, so forgive me if I’m a copycat) that might buy enough time to solve the majority of the underlying problems, and possibly put us out ahead of the curve at the end of it. So here goes…

1) A 100% tax refund for anyone holding a qualifying sub-prime loan for the next two years, paid directly to the financial institution holding the loan.

I know, lot’s of objections on face, and I’ll get to those. Let’s work through some of the supporting arguments first (working on a number of assumptions which could be wrong…like I said, novice). It strikes me that there are different groupings of sub-prime loans – there are those that are a bit behind that with a little help can make good, and there are those that no amount of help could possibly fix things. My main assumption is that the majority would trend toward that first category, and those especially would get helped most here. That much money put back into their mortgage would have an initial effect of buying them some extra time to either refinance if possible, or sell at a reasonable price.

The “reasonable price” standard is important here because of housing prices. This sort of move would have a secondary effect of at least stopping the free fall, if not pushing prices back up. There are a lot of folks out there that are watching closely, and will probably buy the second prices start trending up (I should know…I’m one of them). The expectation when this policy goes into effect is that prices will start to go up, which will cause an initial flood of purchases (on good loans, rather than subprimes). Demand will go up, and supply might drop (since those that are getting the tax break might pull houses off the market), which would have the effect of boosting prices. If prices raise enough, those with subprimes might be able to get out of their houses without getting taken to the woodshed.

So in theory, over a two year period, the following would happen:
1) an initial purchase of houses on the market based on good loans (likely from some of the holders of the worst subprimes out there since they just need out – one’s on the edge will probably pull theirs from the market to see if they can recover).
2) prices propped up over that period of time to the point that other subprime holders can get near even value (again, based on good loans).

Now, at the end of the 2 year period, values on anything left out there will crash, and crash HARD. But ideally, that’s a fraction of the subprime loans out there, and that crash should be a lot softer than this crash.

Now for the objections, which I think are all related:

• How the heck can we pay for this?
• Why should those that were responsible about their mortgages get hosed on taxes?

Which brings me to the next parts of the policy suggestion:

2) The Bush tax cuts are made permanent
3) Anyone entering this program will pay a few percents more in taxes for the following 2,5,10,however many years.
4) At least one, if not two federal departments will be completely eliminated.

In making the suggestion in point 1, I do so with a number of additional assumptions. While some deficit spending is OK, going completely deficit on this is something nobody wants to do. At which point, there’s only a few options – raise taxes on those not in the program (completely unacceptable), or drastically cut spending so that the deficit spending is limited.

This is where we can win some major support from fiscal conservatives (who might initially object to the 100% tax refund idea). We’ve been talking forever about eliminating federal largess, so here’s the opportunity. Saying we’re going to bail out subprimes might be an easy sell, but the tradeoff would be eliminating selected department(s). And once gone, they’re GONE. Obvious target, Education. Others may suggest others. Whatever it takes…if citizens want a federal bailout of homeowners, the trade is other programs they support.

I expect folks would jump at that idea. At which point, at the end of the two years, everyone comes back on the tax rolls (including the former subprime holders at higher rates), but the departments are still gone. This at least makes it easy to make the Bush tax cuts permanent, if not opening the door for further cuts in the future. So the positive result for those that didn’t get themselves into a mortgage mess is lower taxes once the 2 years are out, and federal government has gotten smaller. If the end result includes a stable housing market, we’ve come out at the end of this mess in a much better position.

5) Legislation must include a complete poison pill that makes it next to impossible to extend at the end of the 2 years
6)Major loan regulations are put in place over the 2 years to prevent this mess from coming back.

If we don’t include a poison pill (like, 90% approval to extend or something else that’s next to impossible), we create an incentive for subprime mortgages, as well as allowing people to drag it out until they get the price they want. The theory here should be the same theory with AIG – a life preserver so that you can get out of the mess at a loss, but not nearly as big of a loss. And the regulations are obvious – lax lending standards cannot continue. If that means that not everyone can own a house, so be it. The policy of a housing bubble propped up by subprime mortgages cannot be allowed to return.

If we can stabilize the housing market, then the street will stabilize…at least enough to let the AIGs and others get out of their mess. They might still die, but it’ll be an organized death rather than a panicked crash. The street is allowed to reorganize, the federal government shrinks drastically, and a fraction of the people in bad loans are left at the end of the time period. It requires some sacrifices on all sides, but in theory the economy as a whole comes out much stronger in the end.

Like I said, this is the thought process of a total novice. It’s admittedly very general, and makes some broad assumptions. But I think it makes a reasonable starting point. I believe we need to come up with a solid policy proposal that has a chance at fixing the problem, that the American people can accept, and that we can find a good deal of support on. We can keep wringing our hands, or we can use our collective conservative intelligence and come up with something other than the same old same old.