“Lemon Socialism” is the failed policy of nationalizing failed firms, pioneered by France and the UK. The Paulson-Bernanke takeover of the failed AIG outdid previous examples in the US. I almost wrote “the federal government’s takeover,” but the legislative branch has been completely passive as the Fed and Treasury have stepped well beyond any reasonable interpretation of the scope of their statutory authorities. (Will anyone challenge them in court?)

This morning comes news that at 10am EST Treasury Secretary Paulson will announce two further steps down the road to Financial Lemon Socialism: a “one-year” guarantee fund for Money-Market Mutual Funds, and a proposal described as “moving troubled assets from the balance sheets of American financial companies into a new institution”.

The idea of a guarantee fund for Money-Market Mutual Funds is baffling. Exactly one money-market fund has suffered losses this week large enough to “break the buck”, i.e. impose losses on its shareholders. That little-known fund got into trouble because it was holding too much Lehman Bros. debt. There were large withdrawals from some other funds, but by construction (all equity shares, no debt) withdrawals cannot cause mutual funds to fail. The guarantees are therefore completely without benefit. They will carry a cost, however, if they come with taxes on MMMFs to finance the guarantee fund or binding restrictions on how MMMFs may invest.

The new institution for “cleansing” the balance sheets of financial firms would buy assets that nobody in the market will buy, or that will nobody will buy at the price the seller hopes for. One portfolio manager has aptly described it as “a giant dumpster for illiquid assets”. Proponents suggest that it would be (kinda, sorta) like the Resolution Trust Corporation that liquidated failed savings and loans after 1989. But the RTC only acquired assets from closed thrift institutions in liquidation. It did not subsidize ongoing institutions, and did not buy dubious assets. Once the assets were sold for whatever they would fetch, the RTC closed up shop. The newly proposed institution is a very different animal. It is hard to imagine how that institution -- given its mission --could be designed so as not to subsidize Wall St. imprudence at taxpayer expense, and thereby foster rent-seeking and moral hazard on a colossal scale.

ADDENDUM: Arnold Kling at EconLog has nicely explained one of the in-built problems facing a federal illiquid-asset purchaser.