Attention Hobbit & Gnome Lovers!

[Tequila Sunrise]

I'm writing an rpg and can't decide how to handle small races. It annoys me how Small races in D&D have nearly identical mechanics than medium races, so here are my two options:

1. Hobbits, gnomes & company are small, but not Small sized. They're at the bottom end of the Medium size category and therefore have no special modifiers due to their size.

2. Hobbits, gnomes & company are Small sized, and have modifiers that make them decidedly weak in melee. These modifiers wouldn't be crippling, and each small race would have racial traits that make them good at other things, but playing a small melee character would be obviously sup-optimal even to new players.

So as small race lovers, which option would you prefer? If you choose the second, please give me ideas for what other knacks small races might have to make up for their poor melee ability. In other words, what would make you say "wow, hobbits/gnomes/whatever are cool in this game!"?

TS