A Main Street Rescue

Congress passed this ‘bailout’ a long time ago.

The $700 billion financial rescue that Congress votes on today must surely rank as the least popular legislation in modern times. Most Members want it to pass, though not with their vote after it has been trashed so relentlessly in the press as a Wall Street “bailout.” And yet it deserves to pass because in reality it is an attempt to shield middle America from further harm caused by the mistakes of Wall Street and Washington.

[A Main Street Rescue] AP

From left: Nancy Pelosi, Henry Paulson and Harry Reid.

For 13 months, the U.S. economy has held up remarkably well despite the implosion in financial markets. But that has recently changed, as market strains have become a global panic that threatens to trigger a deep recession and perhaps a crash. It is hard to sell voters on insurance against damage that hasn’t occurred. (See Fannie Mae, 30-year history of.) But as Michael Darda argues, the current seizure in the credit markets is real and will do far more harm if not repaired soon. The weekend runs on Fortis in Europe and Wachovia in the U.S. should concentrate Congressional minds about what could happen if the bill fails.

Today’s vote is essentially a pledge of public capital to defend and rebuild the financial system. Some of that capital has already been committed via the Federal Reserve, albeit with politicians preferring not to notice. With this vote, Congress is at last taking some ownership for the mess its policies helped to create by fueling the credit housing mania earlier this decade.

Congress long ago committed taxpayers when it let Fannie Mae and Freddie Mac run wild risks with a public subsidy. It’s a little rich to see some of Fannie’s most devoted GOP patrons now invoking “free-market” principles to oppose cleaning up their mess. More than one Republican opponent also seems to be angling for a leadership challenge next year, even at the risk of causing a bigger GOP defeat if the bill fails.

Background on a Crisis

  • The Washington Panic 09/27/08 — The Paulson plan is a tool to avoid a deeper downturn.
  • The Paulson Sale 09/24/08 — Taxpayers are going to put up capital one way or another.
  • A Mortgage Fable 09/22/08 — Beltway trilogy: the Fed, Fannie Mae, and Bear Stearns.
  • Stopping the Panic 09/20/08 – Now the task is to protect taxpayers and restore markets.
  • Be It Resolved 09/19/08 – Paulson and Bernanke ask Congress for a resolution agency.
  • The Fed and AIG 09/18/08 – Nationalizations aren’t stopping the financial panic.
  • McCain and the Markets 09/17/08 – Denouncing ‘greed’ and Wall Street isn’t a growth agenda.
  • The Fed’s Epic Day 09/17/08 – It’s only fair to praise the central bank when it does the right thing.
  • Surviving the Panic 09/16/08 – A resolution agency, steady monetary policy, and a big tax cut.
  • Wall Street Reckoning 09/15/08 – Treasury Secretary Hank Paulson’s refusal to blink won’t get any second guessing from us.

We agree with those who say there are better ways to provide this public capital, but Treasury Secretary Hank Paulson’s plan should do some good, and if executed properly shouldn’t cost taxpayers anything close to its $700 billion showroom price.

The minute he gets his money, Mr. Paulson should seek a prominent financial pro to supervise the auctions for dodgy mortgage securities — someone who isn’t out to make a killing himself (as is Bill Gross of Pimco). If Mr. Paulson fails to do so, he or his successor will be whipsawed on Capitol Hill as the Members fly-speck every transaction. There was never any danger of too little “oversight”; the real danger is too much political interference that blocks the rapid creation of a market for this paper.

Thanks to the House GOP’s intervention, the Paulson plan is also better than it would have been. Republicans helped to eliminate the Barney Frank-Chris Dodd slush fund for liberal housing lobbies; a plank to let judges shield deadbeat homeowners from bankruptcy laws; and a ploy to stack bank boards with union members.

The details of the taxpayer “protections” in the bill also seem workable, at least based on what we had heard by deadline yesterday evening. Banks that sell more than $300 million in securities to Treasury will only be able to deduct from their taxes $500,000 in compensation for their five most senior executives.

Something like this was inevitable as political cover, and it’s hard to argue that the Italian suits at Goldman Sachs or Morgan Stanley don’t deserve everything they won’t get if they dump their mistakes on the feds. But one unintended consequence will be to drive the most talented financial managers away from these banks and into hedge funds and private equity, where they won’t be subject to such compensation caps. Revenge is overrated as a policy design.

We’re also told the government ownership provisions in the bill are narrow enough not to ruin the securities auctions. The government will get warrants to benefit from any market upside in return for buying the securities, and this will probably be reflected in the price the feds pay for the debt. Our Treasury sources say the warrant provision is de minimis enough that it shouldn’t interfere with price discovery, which is one of the major goals of this exercise.

Even if the Paulson plan passes today, more public capital will be needed to protect depositors at banks that fail — and there will be more such failures. Done right, the Paulson plan should at least reduce the number, while also lessening the damage from the mortgage mania that Congress did so much to promote.

Post a comment or leave a trackback: Trackback URL.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: