we are heading into unknown territory. If prices fall at a rate of 1 percent, could they fall at a rate of 10 percent?

TO BE NOTED: Via the Economist's View:

---

Published on Taipei Times
http://www.taipeitimes.com/News/editorials/archives/2009/04/29/2003442273

Deflation raises questions about global recovery

By Martin Feldstein

Wednesday, Apr 29, 2009, Page 9

The rate of inflation is now close to zero in the US and several other major countries. The Economist recently reported that economists it had surveyed predict that consumer prices in the US and Japan will actually fall this year as a whole, while inflation in the euro zone will be only 0.6 percent. South Korea, Taiwan and Thailand will also see declines in consumer price levels.

The prospect of falling prices reflects the collapse of industrial production, the resulting high level of unemployment, and the dramatic decline in commodity prices. Industrial production is falling at double-digit rates in the negative-inflation countries, and the price index for all commodities is down more than 30 percent over the past year.

Deflation is potentially a very serious problem, because falling prices — and the expectation that prices will continue to fall — would make the current economic downturn worse in three distinct ways.

The most direct adverse impact of deflation is to increase the real value of debt. Just as inflation helps debtors by eroding the real value of their debts, deflation hurts them by increasing the real value of what they owe. While the very modest extent of current deflation does not create a significant problem, if it continues, the price level could conceivably fall by a cumulative 10 percent over the next few years.

If that happens, a homeowner with a mortgage would see the real value of his debt rise by 10 percent. Since price declines would bring with them wage declines, the ratio of monthly mortgage payments to wage income would rise.

In addition to this increase in the real cost of debt service, deflation would mean higher loan-to-value ratios for homeowners, leading to increased mortgage defaults, especially in the US. A lower price level would also increase the real value of business debt, weakening balance sheets and thus making it harder for companies to get additional credit.

The second adverse effect of deflation is to raise the real interest rate, that is, the difference between the nominal interest rate and the rate of “inflation.” When prices are rising, the real interest rate is less than the nominal rate since the borrower repays with dollars that are worth less. But when prices are falling, the real interest rate exceeds the nominal rate. This is exacerbated by the fact that borrowers can deduct only nominal interest payments when calculating their taxable income.

Because the US Federal Reserve and other central banks have driven their short-term interest rates close to zero, they cannot lower rates further in order to prevent deflation from raising the real rate of interest. Higher real interest rates discourage credit-financed purchases by households and businesses. This weakens overall demand, leading to steeper declines in prices.

The resulting unusual economic environment of falling prices and wages can also have a damaging psychological impact on households and businesses. With deflation, we are heading into unknown territory. If prices fall at a rate of 1 percent, could they fall at a rate of 10 percent? If the central bank cannot lower interest rates further to stimulate the economy, what will stop a potential downward spiral of prices? Such worries undermine confidence and make it harder to boost economic activity.

Some economists have said that the best way to deal with deflation is for the central bank to flood the economy with money in order to persuade the public that inflation will rise in the future, thereby reducing expected real long-term interest rates. That advice would lead central banks to keep expanding the money supply and bank reserves even after doing so no longer lowers interest rates. In fact, the Federal Reserve, the Bank of England, and the Bank of Japan are doing just that under the name of “quantitative easing.”

Not surprisingly, central bankers who are committed to a formal or informal inflation target of about 2 percent per year are unwilling to abandon their mandates openly and to assert that they are pursuing a high rate of inflation. Nevertheless, their expansionary actions have helped to raise long-term inflation expectations toward the target levels.

In the US, the interest rate on government bonds now rises from 1.80 percent at five years to 2.86 percent for 10-year bonds and 3.70 percent for 30-year bonds. Comparing these interest rates with the yields on government inflation-protected bonds shows that the corresponding implied inflation rates are 0.9 percent for five years, 1.3 percent for 10 years and 1.7 percent for 30 years.

Ironically, although central banks are now focused on the problem of deflation, the more serious risk for the longer term is that inflation will rise rapidly as their economies recover and banks use the large volumes of recently accumulated reserves to create loans that expand spending and demand.



Martin Feldstein, a professor of economics at Harvard, was formerly chairman of US president Ronald Reagan’s Council of Economic Advisors and president of the National Bureau for Economic Research.Copyright: Project Syndicate "

Feldstein Says U.S. `Right in the Middle' of Recession

TO BE NOTED: From Bloomberg:

Feldstein Says U.S. `Right in the Middle' of Recession

It is surprising that the long-term interest rates do not yet reflect the resulting risk of future inflation.

TO BE NOTED: From the FT:

"Inflation is looming on America’s horizon

By Martin Feldstein

Published: April 19 2009 18:54 | Last updated: April 19 2009 18:54

The US last week showed its first signs of deflation for 55 years, prompting inevitable fears of further deflation in the future. Yet the primary reason for the negative rate of US inflation is the dramatic 30 per cent fall of commodity prices. That will not happen again. Moreover, excluding food and energy, consumer prices are up 1.8 per cent from a year ago. That is the good news: the outlook for the longer term is more ominous.

The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president’s budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years.

There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions.

The key fact is that inflation rises when demand exceeds supply. A fiscal deficit raises demand when the government increases its purchase of goods and services or, by lowering taxes, induces households to increase their spending. Whether this larger fiscal deficit leads to an increase in prices depends on monetary conditions. If the fiscal deficit is not accompanied by an increase in the money supply, the fiscal stimulus will raise short-term interest rates, blocking the increase in demand and preventing a sustained rise in inflation.

So the potential inflationary danger is that the large US fiscal deficit will lead to an increase in the supply of money. This inevitably happens in developing countries that do not have the ability to issue interest-bearing debt and must therefore finance their deficits by printing money. In contrast, when deficits do not lead to an increased supply of money, the evidence shows that they do not cause sustained price increases.

A primary example of this was the sharp fall in inflation in the US in the early 1980s at the same time that fiscal deficits were rising rapidly. Inflation fell because the Federal Reserve tightened monetary conditions and allowed short-term interest rates to rise sharply.

But now the large US fiscal deficits are being accompanied by rapid increases in the money supply and by even more ominous increases in commercial bank reserves that could later be converted into faster money growth. The broad money supply (M2) is already increasing at an annual rate of nearly 15 per cent. The excess reserves of the banking system have ballooned from less than $3bn a year ago to more than $700bn (€536bn, £474bn) now.

The money supply consists largely of government-insured bank deposits that households and businesses are holding because of a concern about the liquidity and safety of other forms of investment. But this could change when conditions improve, turning these money balances into sources of inflation.

The link between fiscal deficits and money growth is about to be exacerbated by “quantitative easing”, in which the Fed will buy long-dated government bonds. While this may look like just a modified form of the Fed’s traditional open market operations, it cannot be distinguished from a policy of directly monetising some of the government’s newly created debt. Fortunately, the amount of debt being purchased in this way is still small relative to the total government borrowing.

The Fed is also creating a massive increase in liquidity by its policy of supplying credit directly to private borrowers. Although these credit transactions do not add to the measured fiscal deficit, the unprecedented Fed purchases of more than $1,000bn of private securities have led to the enormous $700bn increase in the excess reserves of the commercial banks. The banks now hold these as interest-bearing deposits at the Fed. But when the economy begins to recover, these reserves can be converted into new loans and faster money growth.

The deep recession means that there is no immediate risk of inflation. The aggregate demand for labour and goods and services is much less than the potential supply. But when the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit.

This will not be an easy task since the commercial banks may not want to exchange their reserves for the mountain of private debt that the Fed is holding and the Fed lacks enough Treasury bonds with which to conduct ordinary open market operations. It is surprising that the long-term interest rates do not yet reflect the resulting risk of future inflation.

The writer is professor of economics at Harvard and president emeritus of the National Bureau of Economic Research. He chaired the Council of Economic Advisers under President Reagan and is a member of President Obama’s Economic Recovery Advisory Board"

It's almost as if Feldstein hasn't been paying attention. Very odd.

TO BE NOTED: From The Economics Of Contempt:

"Martin Feldstein on the Geithner Plan

Martin Feldstein is generally supportive of the Geithner plan, but he says it needs to be expanded in three ways to ultimately succeed. The odd thing is, the Treasury has already announced two of his three proposed expansions.

Feldstein writes:

First, the Treasury must be prepared to inject capital into the banks that agree to sell mortgages. Without additional capital, the banks may not be willing to sell the mortgages that are causing their lack of confidence.

Umm, providing the banks with additional capital is exactly what the Treasury's Capital Assistance Program (CAP) is for:

Should [the bank stress test] indicate that an additional capital buffer is warranted, banks will have an opportunity to turn first to private sources of capital. In light of the current challenging market environment, the Treasury is making government capital available immediately through the CAP to eligible banking institutions to provide this buffer.

Feldstein continues:

Second, cleansing the banks' balance sheets will also require much more Treasury money for equity investments and loans. The current plan to remove $500 billion of impaired assets will not be enough to cleanse the banks' balance sheets to a point where they can be confident enough about the remaining assets to resume lending.

The Treasury has already stated that the PPIP "will generate $500 billion in purchasing power to buy legacy assets – with the potential to expand to $1 trillion over time."

It's almost as if Feldstein hasn't been paying attention. Very odd."

will do so at market-determined (albeit artificially enhanced) prices

TO BE NOTED: From the WSJ:

"By MARTIN FELDSTEIN

The Treasury's new Public-Private Investment Plan should be regarded as a pilot study to see if this approach can remove impaired assets from the nation's banks. If it works, Treasury will have to go back to Congress for substantially more funding to remove enough impaired assets to get the banks lending again.

AP

Increased bank lending is the key to a sustained recovery. Households and businesses that cannot obtain credit are now unable to spend and to invest, dragging down total demand and GDP. The banks are unwilling to lend because they lack confidence in the value of the loans and other assets they already carry on their books, and therefore lack confidence in whether they have enough capital to avoid insolvency. Removing these high-risk assets is a prerequisite to get the lending mechanism in gear again.

The problem of uncertain asset values is particularly acute with respect to residential mortgages. An unprecedented one-third of all such mortgages now exceed the value of the houses that serve as their collateral. Because residential mortgages are generally "nonrecourse" loans (i.e., secured only by the underlying property), homeowners with negative equity have an incentive to default, leaving the banks with net losses. The frequency of defaults is increasing as house prices continue to fall.

The Treasury's primary plan is to induce private investors to buy pools of such high-risk mortgages from the banks. Individual banks will offer pools of mortgages for sale. Private investors -- including pension funds, insurance companies, hedge funds and sovereign wealth funds -- will bid for each mortgage pool in an auction. The total purchase price for each pool will be financed by a combination of the private investor's equity, an equal amount of Treasury equity, and private loans guaranteed by the Federal Deposit Insurance Corporation (FDIC).

Because the FDIC will guarantee six dollars of loans for every dollar of equity, the auction process is expected to produce prices high enough to induce the banks to sell their impaired assets. Because the mortgage loans will be priced in a competitive auction, there will be no windfall profits for the private-equity investors.

The private-equity investors will be responsible for managing the pool of mortgage loans acquired, modifying interest rates, and reducing loan principals in ways that they believe will decrease defaults and increase the value of the loans. If the process produces a gain relative to the initial purchase cost, the private investors and the Treasury will share equally in the profit. If the result is a loss, the private investors and the Treasury can lose up to their entire equity investments. Losses higher than the initial investments would be absorbed by the FDIC as the guarantor of the loans.

A similar structure will be used to finance the purchase of securities backed by residential mortgages, commercial mortgages and credit-card debt. Private investors will buy those securities from the banks at auction and the Treasury will co-invest an equal amount of equity. The Treasury will then match the equity investment with a nonrecourse loan. The entire amount will then be eligible for additional credit from the Federal Reserve. This process will again give the private investors and the Treasury equal profits or losses, depending on the investors' success in managing the securities. Losses beyond the equity investment would be absorbed first by the Treasury and then by the Fed.

If it succeeds, this plan will remove some $500 billion of impaired mortgages and securities from the banks, will do so at market-determined (albeit artificially enhanced) prices, and will give taxpayers a possibility to gain along with the private investors who manage the assets. It will do all of this without nationalizing any of the major banks.

Although the Treasury's plan is aimed in the right direction, it needs to be substantially expanded in three ways if it is to succeed. First, the Treasury must be prepared to inject capital into the banks that agree to sell mortgages. Without additional capital, the banks may not be willing to sell the mortgages that are causing their lack of confidence.

Here's why. Although mortgages with high loan-to-value ratios have a high probability of imposing substantial losses through default, they are carried on the banks' books at their full nominal value as long as the borrowers are making their monthly payments. Selling these mortgages would require the banks to recognize losses that would reduce their capital, pushing them toward insolvency. To remedy this problem, the Treasury should offer to provide enough replacement capital in the form of either preferred shares or perpetual debt to offset the loss of capital caused by selling the impaired loans.

Second, cleansing the banks' balance sheets will also require much more Treasury money for equity investments and loans. The current plan to remove $500 billion of impaired assets will not be enough to cleanse the banks' balance sheets to a point where they can be confident enough about the remaining assets to resume lending. The banks now own $3 trillion of residential mortgages, $1.5 trillion of corporate real-estate loans, and $1 trillion of consumer debt. While not all of these loans are impaired, the banks will have to sell much more than $500 billion of loans to regain confidence in their solvency.

Third, even if all of the existing impaired assets are removed from a bank's balance sheet, the remaining mortgages that now have positive equity are in danger of sliding into negative equity as house prices continue to fall. That risk can be reduced or eliminated if the government offers "mortgage replacement loans" (along the lines that I suggested on this page, March 7, 2008) equal to 20% of the existing mortgage.

Such loans would have a very low interest rate but the borrower would have to personally be liable for them, and could not discharge the debt in bankruptcy. Because the new mortgage would have a lower principal, it would provide a firewall -- even an additional 20% decline in a house's value would still leave the homeowner with positive equity and no incentive to default.

It's critical that we get the banks lending again and providing the kind of back-up credit lines that facilitate the commercial-paper market. The Treasury plan appears well-designed in principle to do that. If the Treasury shows that it can use the available $500 billion to buy mortgages and asset-backed securities, it will then need to scale up to induce the banks to sell a larger amount of their impaired loans and to prevent a damaging deterioration of healthy mortgages as home prices decline.

Mr. Feldstein, chairman of the Council of Economic Advisers under President Reagan, is a professor at Harvard and a member of The Wall Street Journal's board of contributors."

"conversion, whereby, for example, all existing mortgage debts could be wholly or partly converted into long-term, low and fixed-interest loans"

Niall Ferguson on FT talks about Leviticus:

"In the Old Testament Book of Leviticus, God commands the children of Israel to observe a jubilee every 50 years. Nowadays we tend to associate the word with celebrations of royal anniversaries such as Queen Elizabeth’s golden jubilee in 2002. But the biblical conception of a jubilee was more precise: that of a general cancellation of debts.

This point is spelt out in Deuteronomy: “Every creditor that lendeth ought unto his neighbour shall release it; he shall not exact it of his neighbour, or of his brother; because it is called the Lord’s release.” ( I BELIEVE THAT THIS WAS ALSO TO ENSURE THE LAND REMAINED IN THE POSSESSION OF EACH TRIBE )

Such injunctions may strike the modern reader as utopian. How could any sophisticated society function if all debts were cancelled twice a century – much less, as Deuteronomy seems to suggest, every seven years? Yet we know that such general cancellations of debt really did happen in the ancient world. In 1788 BC, for example, about 500 years before the time of Moses, King Rim-Sin of Ur issued a royal edict declaring all loans null and void, wiping out some of history’s earliest known moneylenders. ( WHY NOT HAVE SAVER NATIONS LIKE CHINA AND GERMANY CANCEL DEBT, AND THEN THE SPENDER NATIONS CAN START SPENDING AGAIN AND EVERYONE IS HAPPY AND DOING WHAT COMES NATURALLY TO THEM? )

The idea of a generalised debt cancellation is not wholly unknown in modern times. The late Gerald Feldman, the world’s leading authority on the German hyperinflation of 1923, drew a parallel between the ancient Hebrew yovel and the wiping out of all paper mark-denominated debts as a result of the collapse of the German currency (though, as he was quick to point out, those whose savings were wiped out were far from jubilant).

In the hope of avoiding the mark’s meltdown, the economist John Maynard Keynes had repeatedly called for a general cancellation of the war debts and reparations arising from the first world war. Though no such intergovernmental jubilee was ever proclaimed, debt cancellation was effectively what happened after 1931, beginning with President Herbert Hoover’s one-year moratorium on both war debts and reparations.

As 2008 draws to a close, there are many people on both sides of the Atlantic who yearn for such a simple solution to the problem of excessive indebtedness. Parallels with the interwar period are not inappropriate. It is all but inevitable that we shall see serious political and geopolitical upheavals in 2009, as the recession takes its toll on weak governments (Thailand and Greece are already reeling) and raises the stakes in inter-state rivalries (India-Pakistan). In the words of Hank Paulson, the US Treasury secretary: “We are dealing with a historic situation that happens once or twice in 100 years.” The stakes are high indeed. Has the time arrived for a once-in-50-years biblical jubilee?

Excessive debt is the key to this crisis ( BUT WHAT CAUSED IT? ); it is the reason we are confronting no ordinary recession, curable by a simple downward adjustment of interest rates. It is the reason we still have to fear, if not a second Great Depression, then very likely the biggest recession since the 1930s. We are living through the painful end of an age of leverage which saw total private and public debt in the US rise from about 155 per cent of gross domestic product in the early 1980s to something like 342 per cent by the middle of this year.

With average household debt rising from about 75 per cent of annual disposable income in 1990 to very nearly 130 per cent on the eve of the crisis, a large proportion of American families are submerging under the weight of their accumulated borrowings. British households are in even worse shape.

Looking back, we now see just how big a proportion of US growth since 2001 was financed by mortgage equity withdrawals. Without that as a means of financing consumption, the economy would barely have grown at 1 per cent a year under President George W. Bush. Looking forward, we see just how hard it will be to stabilise property prices and the prices of the securities based on them. Already, at the end of September, one in 10 American home owners with a mortgage was either at least a month in arrears or in foreclosure. One in five mortgages exceeds the value of the home it was used to purchase.

The financial sector’s debts grew even faster as banks sought to bolster their returns on equity by “levering up” ( THIS IS TRUE ). According to one recent estimate, the total leverage ratios (on- and off-book assets and exposure divided by tangible equity) for the two biggest US banks were 88:1 for Citibank and 134:1 for Bank of America. The bursting of the property bubble caused such ratios, which were already too high on the eve of the crisis, to explode as off-balance-sheet commitments and pre-arranged credit lines came home to roost. Only by borrowing from the Federal Reserve on an unprecedented scale have the banks been able to stay in business( THE BANKS CONSIDER IT INSURANCE AND WERE COUNTING ON IT ).

With estimates of total losses on risky assets now ranging from $2,800bn (£1,850bn, €1,960bn) to $6,000bn, a chain reaction is under way that will leave no sector of the world economy untouched. The American economy is contracting at an annualised rate of 5 per cent ( WE NEED TO WAIT ON THAT ). Commercial property is following the residential market into freefall. The Standard & Poor’s 500 index is down 43 per cent since its peak in October last year. The market for credit default swaps is pointing to a surge in defaults on corporate bonds( I BELIEVE THIS IS OVERDONE ). The automotive industry is already (against the will of Congress and the original intention of the Treasury) on life support. The US is at the centre of the crisis but Europe and Japan may suffer even larger aftershocks. As for the much feted emerging market “Brics” – Brazil, Russia, India and China – their stock markets have been dropping like, well, bricks.

What makes this crisis of burning interest to financial historians is the knowledge that we are witnessing a real-time experiment with not one but two theories( THEY'RE NOT MUCH HELP ) about the Depression.

On one side, Ben Bernanke, Fed chairman, is applying the lesson of Milton Friedman’s and Anna Schwartz’s A Monetary History of the United States, which argued that the Depression was in large measure the fault of the central bank for failing to inject liquidity into an imploding financial system. Mr Bernanke has not merely slashed the federal funds rate to below 0.25 per cent. He has lent freely to the banks against undisclosed but probably toxic collateral. Now he is buying securities in the open market. ( HE'S DOING WHAT LOOKS LIKE THE LEAST AWFUL ALTERNATIVE )

The result has been an explosion of the Fed’s balance sheet and of the monetary base. With assets approaching $2,263bn and capital of less than $40bn, the Fed increasingly resembles a public hedge fund, leveraged at more than 50:1. ( THE ASSETS OF THE AMERICAN PEOPLE BACK THIS )

On the other side, Mr Paulson has emerged as an unwitting disciple of Keynes, running a huge government deficit in an effort not merely to bail out the financial sector but also to provide a public sector substitute for sharply falling private sector consumption. Even before President-elect Barack Obama launches his promised infrastructure investment programme, estimates of next year’s deficit run as high as 12.5 per cent.

Once, monetarism and Keynesianism were considered mutually exclusive economic theories. So severe is this crisis that governments all over the world are trying both simultaneously ( THAT'S BECAUSE WE'RE NOT SURE WHAT TO DO ).

Although commentators like to draw parallels with Franklin Roosevelt’s New Deal, in truth the measures taken since the crisis began in August 2007 more closely resemble those taken during the world wars ( AND? ). After 1914, and again after 1939, there was massive government intervention in the financial system. Banks and bond markets were reduced to mere channels for the financing of huge public sector deficits. That is what is happening today, but without the stimulus to manufacturing that the world wars provided. We are having war finance without the war itself.( THANK GOD )

Yet the effect of these policies is essentially to add a new layer of public debt to the existing debt mountain. Added together, the loans, investments and guarantees made by the Fed and the Treasury in the past year total about $7,800bn, compared with a pre-crisis federal debt of about $10,000bn. The Treasury may have to issue as much as $2,200bn in new debt in the coming year. ( IT'S A PROBLEM, BUT NOT INSURMOUNTABLE )

For the time being, the distress-driven demand for dollars and risk-free assets is pushing down the cost of all this borrowing. Treasury yields are at historic lows. But it is not without significance that the cost of insuring against a US government default has risen 25-fold in little over a year ( THIS MIGHT WELL BE OVERDONE ). At some point ( WHAT POINT? ), with most big economies adopting the same fiscal policy, global bond markets are going to start choking.

Is it really plausible that the cure for excessive leverage in the private sector is excessive leverage in the public sector ( YES IT IS. IT'S PARADOXICAL, BUT MUCH OF LIFE IS ) Might there not be a simpler way forward? When economists talk about “deleveraging” they usually have in mind a rather slow process whereby companies and households increase their savings in order to pay off debt. But the paradox of thrift means that a concerted effort along these lines will drive an economy such as that of the US deeper into recession, raising debt-to-income ratios.

The alternative must surely be a more radical reduction of debt. Historically, such reductions have been done in one of four ways:( 1 ) outright default,( 2 ) restructuring (for instance, bankruptcy), ( 3 )inflation or ( 4 ) conversion. At the moment, more and more American households are choosing the first as a way of dealing with the problem of negative equity, while more and more companies are being driven towards bankruptcy. But mass foreclosures and bankruptcies are not a pretty prospect.( BUT THEY MIGHT HELP )

Inflation, by contrast, is hard to worry about in the short term, not least because the Fed’s expansion of the monetary base is leading to no commensurate expansion of the broad money supply; the banks would rather shrink than expand their balance sheets.( SO WHY NOT USE IT? )

That leaves conversion, whereby, for example, all existing mortgage debts could be wholly or partly converted into long-term, low and fixed-interest loans, as recently suggested by Harvard’s Martin Feldstein. (In his scheme, the government would offer any homeowner with a mortgage the option to replace 20 per cent of the mortgage with a low-interest loan from the government, subject to a maximum of $80,000. The annual interest rate could be as low as 2 per cent and the loan would be amortised over 30 years ( THEY DO HAVE TO PAY THE MONEY BACK ).

At the very least, this would rescue many homeowners from the nightmare of negative equity. A similar operation might also be contemplated for the debts of those banks that have been partially or wholly recapitalised by the state. This would not add to the federal debt in net terms and would reduce the interest burden, if not the absolute debt burden, of households.

Such radical steps would naturally represent a haircut for creditors ( FINE WITH ME, SINCE THE HOUSES THEY WOULD FORECLOSE ON WOULD BE WORTH LESS ), notably the holders of mortgage-backed securities and bank bonds. Yet they would surely be preferable to the alternatives ( NOT IF THEY FEEL THAT THEY CAN GET A BETTER DEAL FROM THE GOVERNMENT. ALSO, ARE YOU GOING TO MANDATE THIS? ). And they would certainly be a less extreme solution than the general debt cancellation envisaged in the Old Testament.

Financially, 2008 has been an annus horribilis. The answer may be to make 2009 a true jubilee year.

To be honest, I don't think he made a case for any of the four alternatives. It's an interesting plan, but it is dubious that it can be made to work in practice, due to a number of factors leaving lenders and borrowers to prefer other alternatives.

How fallow years led to a golden jubilee

Every seven years, God told Moses, the children of Israel should neither sow their fields nor prune their vineyards – a kind of self-imposed recession. After seven such sabbatical years, the trumpet of jubilee should be sounded: “And ye shall hallow the fiftieth year, and proclaim liberty throughout all the land unto all the inhabitants thereof: it shall be a jubilee unto you; and ye shall return every man unto his possession.”

Land that had been sold was to be redeemed or returned to the original seller and the poor were to be relieved: “If thy brother be waxen poor, and hath sold away some of his possession, and if any of his kin come to redeem it, then shall he redeem that which his brother sold ... If thy brother be waxen poor ... then shalt thou relieve him: yea, though he be a stranger ... Take thou no usury of him ...” In addition, Jews who were slaves were to be set free.

To modern eyes, however, the most striking of these divine injunctions was that debts were to be cancelled as part of “the Lord’s release”.

An Inflationary Universe Of Plans

Tyler Cowen lists a bunch of plans. Plow through them. I did. This isn't a good sign:

"Plans, plans, plans

Tyler Cowen

There is the O'Neill plan:

His plan to deal with the crisis would start with a "discounted cash-flow analysis'' of distressed instruments that are clogging the financial system. The government would guarantee the assets, paring back the support as principal and interest payments were made, he said. "That should take care of the liquidity problem because if they have a government guarantee at a specified level they should trade just like cash,'' O'Neill said.

Or the Soros plan. And here is a "SuperBond" plan to recapitalize the banking system.

And then there is the Phelps plan for capital injection in return for warrants. Not to mention the French plan.

Or how about the Wright plan:

...to let any American with a mortgage swap it out for a government one at 7% for up to 50 years (to get the monthly payment down to where the borrower can handle it). The Treasury will pay off the existing mortgage with bonds (which it can sell cheap right now). If a borrower wants to default instead s/he can do so, and then the lender can mortgage the property on the above terms.

So many plans!

Here are some solar greenhouse plans. And here are Silly Billy's World's Elementary Lesson Plans."

Also, Greg Mankiw has been listing responses:

"More Commentary on the Financial Mess

1. Nouriel Roubini
2. Martin Feldstein
3. Glenn Hubbard and Chris Mayer
4. Richard Epstein
5. Steve Kaplan"

At some point, this isn't funny anymore.