It occurred to me, while I was listening to the congressional hearings, that the government could stop most of this by just seizing houses in default and continuing to make the mortgage payments. It turns out someone else is thinking the same way:
True just sending money is not incentive compatible. But there is no reason to bail out homeowners. Just intervene in any mortgage default. Seize the property and continue making the mortgage payments. In the short run rent the property back to the homeowner.
This is what I have been advocating to my colleagues. I don't know why it is not under discussion. Before going with the arbitrary implememtation that Paulson is proposing now there should be some convincing argument that it's more efficient than this alternative. It is clearly the most direct approach and therefore should be the default (so to speak.)
There are inherent issues here: at what rate do we rent to the current occupants? How do we make the banks pay for their folly? Also, the government is not a notoriously effective landlord. On the other hand, it punishes the homeowners without putting them on the street, and eventually the houses will be worth something.