Young offenders could serve their custodial sentences in children's homes, under Home Office plans.
The move could see criminals living with children in care homes
The move, published in the Offender Management Bill, is aimed at cutting re-offending rates.
Ten to 17-year-olds are detained in secure local authority accommodation or young offender institutions at present.
The plan could see criminals living with youngsters in care, but Home Office Minister Gerry Sutcliffe said risk assessments would be carried out.
He said this was a "holistic solution" to put forward.
"And if they can be put into local children's provision - to go on to an educational scheme, to go on to a work scheme, then that should happen," he said.
"But clearly people will be risk assessed and we'll have to look at the effects on the other children in the home and the wider public protection issues."
The Offender Manager Bill will also allow private companies and voluntary groups to take over some of the probation service's work.
And the penalty for helping a prisoner to escape will double to 10 years in prison.
Previous attempts to introduce privatisation were fiercely opposed but Mr Sutcliffe said the present structure was not working.
Liberal Democrat home affairs spokesman Nick Clegg said: "Overcrowding in our prisons must not be allowed to turn children's homes from a place of refuge into semi-penal institutions.
"Secure children's homes are vitally important in reforming young offenders, but open homes do not offer either adequate supervision or rehabilitation.
"This will only increase the risk of pushing more young people towards long-term hardened criminality."
The bill will get rid of existing local probation boards and replace them with probation trusts, with Home Secretary John Reid taking on some of the boards' powers.
Reflecting on the privatisation plans, director of the Prison Reform Trust Juliet Lyon said Mr Reid should beware not to further demoralise staff by "driving competitive wedges between service providers and muffling the independent voice of the voluntary sector".
A better solution was to divert offenders away from prison and instead into drug treatment or mental health care, she said.