James Hamilton writes

The Fed has been trying to sop up the illiquid assets that nobody else wants. But I think what the Fed should be doing is instead acquiring assets of a type that would allow it to quickly reverse its position if a sudden shift in perceptions causes inflation to come in above the intended 3% target.

What a radical idea! Instead of buying “toxic” assets, why not buy good stuff?

We don’t know what the toxic assets are worth. We don’t know if the more than $7.5 trillion in new government guarantees are going to cost the taxpayer a few billion or a few trillion.

What we do know is that the risk premium on Treasuries is really, really low. We are like the hedge fund of last resort for the world’s investors. Hamilton says the hedge fund should buy TIPS and foreign securities (I assume he means foreign government bonds). That’s fine. The hedge fund should also buy debt from Freddie Mac and Fannie Mae, because that debt still trades at a risk premium relative to Treasuries, even though taxpayers are already on the hook for it.

The hedge fund should buy good stuff. Let the bad stuff sit and rot, or collect it as part of the process of shutting down failed institutions.

I question whether the whole concept of “rescue” plans is the right thing to do. Just let the failures happen and clean up afterwards. You’ll have less of a mess if you do it that way, because you won’t have so many zombie banks to try to manage.