Comment & Debate
In September of 2008, following the failure of several major US financial institutions, U.S. lawmakers proposed an initial bill to bailout the U.S. financial system. This measure, which involved the government acquiring or insuring as much as $700 billion of troubled mortgage-backed securities, was intended to reduce the level of uncertainty regarding these assets and restore confidence in the credit markets. Following several financial crises among major U.S. financial institutions in September 2008, including the federal takeover of Fannie Mae and Freddie Mac, the bankruptcy of Lehman Brothers, an emergency Federal Reserve loan to American International Group, and the merger of Merrill Lynch into Bank of America—events considered part of the on-going financial crisis of 2007–2008—the United States Secretary of the Treasury Henry Paulson proposed a plan under which the U.S. Treasury would acquire up to $700 billion worth of illiquid securities that are backed by troubled housing loans. The plan was immediately backed by President George W. Bush and negotiations began with leaders in the United States Congress to draft appropriate legislation. On September 28th, however, legislation supporting the plan was rejected in the House of Representatives. It is, nevertheless, possible that a similar piece of legislation with a $700 billion bailout will be passed. In any case, the debate regarding the merits of a $700 billion bailout continues. The debate surrounds numerous questions. Is a $700b bailout necessary to avoid financial crisis? Or is the US economy stronger than many believe, and a bailout less important than some have believed? Is an immediate solution necessary? Or, is there time to debate alternatives? Is government intervention in the markets appropriate on principle? Can it help solve the fundamental problems in the US economy, or will it only add to the problem? Does the economy need more regulation or less? Did too little regulation cause the crisis, or was too much regulation to blame? Is there a moral hazard in bailing out reckless risk-takers on Wallstreet? Should they be allowed to fail so that they learn their lesson? Would a $700 billion bailout overly burden taxpayers? Or, is it possible that taxpayers would not lose at all and possibly profit from a bail-out and the re-sale of mortgages that they are essentially buying? If the majority of taxpayers oppose the bailout, should their will be followed? Is a bailout consistent with the balance of powers in the US between the Executive and Legislative branches? Is it Constitutional?
U.S. Treasury Secretary Henry Paulson summarized the rationale for the bailout in testimony before Congress in September, 2008 – “We must…avoid a continuing series of financial institution failures and frozen credit markets that threaten American families’ financial well-being, the viability of businesses both small and large, and the very health of our economy.”[1]
“Job security: Safeguarding jobs across the economy and preventing bankruptcies that ‘threaten American families’ financial well-being’ according to US Treasury Secretary Henry Paulson.”
Treasury Secretary Henry Paulson summarized the rationale for the bailout in Testimony before the US Senate – “This troubled asset relief program has to be properly designed for immediate implementation and be sufficiently large to have maximum impact and restore market confidence.”[2]
“Paulson Plan provides a plan Just as optimism in times of growth encourages an upward trend, pessimism in uncertain times can feed a downward trend. Allowing such a trend to gain strength is our great risk…The proposed rescue legislation accomplishes one simple goal: It provides a buyer (the Treasury) for financial assets that cannot be priced today because the market for such assets has temporarily frozen up, enabling financial institutions to stabilize their balance sheets, regain confidence in the system and one another, and start lending again.”
“The Treasury proposal to rescue the financial system has gotten a lot of grief lately, especially from the community of economics professors. A smart friend, who knows more about this topic than I do, emails me his response to the critics: ‘Academic economists don’t like the Treasury plan, but nearly all of the Wall Street economists are for it. You don’t have to be all that cynical to say that the Wall Street economists are talking their book. But I’d like to think that there is at least in part a sense in which they are more attuned to the reality of the situation in credit markets — that last week we were a day or two away from a breakdown of the financial system.'”
“Global financial stability: the plan is aimed at bringing calm to an extremely volatile global financial system. The world’s richest nations, the Group of Seven (G7) say the package will, ‘protect the integrity of the international financial system’.”
“We are experiencing “the greatest financial crisis since the Great Depression”!…Even if this were true, we aren’t even close to that catastrophic event. At the Great Depression’s nadir, 25% of adults were unemployed, including nearly 50% of urban black adults. Economist David Wheelock of the Federal Reserve Bank of St. Louis says that by the dawn of 1934, nearly half the urban homes with mortgages were in default, and 7.3% of housing structures had been foreclosed. Today, 6.4% of mortgages are delinquent, 2.75% are in the foreclosure process, and 0.6% of all housing units are bank-owned.”
“Proposed $700 Billion Bailout Is Too Little, Too Late to End the Debt Crisis; Too Much, Too Soon for the U.S. Bond Market”. Weiss Research Inc. 25 Sept. 2008 – “New data and analysis demonstrate that the proposal before Congress for a $700 billion financial industry bailout is too little, too late to end the massive U.S. debt crisis…There should be no illusion that the $700 billion estimate proposed by the Administration will be enough to end the debt crisis. It could very well be just a drop in the bucket.”
“Proposed $700 Billion Bailout Is Too Little, Too Late to End the Debt Crisis; Too Much, Too Soon for the U.S. Bond Market”. Weiss Research Inc. 25 Sept. 2008 – “II. Too Much, Too Soon for the U.S. Bond Market. There should also be no illusion that the market for U.S. government securities can absorb the additional burden of a $700 billion bailout without putting dramatic upward pressure on U.S. interest rates. The Office of Management and Budget (OMB) projects the 2009 federal deficit will rise to $482 billion. But adding the cost of announced and proposed bailouts, now approximately $1 trillion, it is undeniable that the federal deficit could double or triple in a short period of time, driving interest rates sharply higher and aggravating the very debt crisis that the bailout plan seeks to alleviate.”
“there’s little stomach for bailing out what essentially turned into a Ponzi scheme backed by the largest players in the financial industry. Yes, they say they need a massive, trillion-dollar influx of cash to patch the crisis they themselves caused via irrational pricings of mortgage-related derivatives. But when someone has proven to be utterly financially incompetent, giving them a trillion dollars in the hopes that they merely don’t blow it all too quickly is not confidence-inspiring.”
Sen. Richard C. Shelby of Alabama – “We have been given no credible assurances that this plan will work. We could very well spend $700 billion, or a trillion, and not resolve the crisis.”[3]
Rep. Spencer Bachus, Republican of Alabama and Ranking member of the House Financial Services Committee – “Our time has run out. We’re going to make a decision. There are no more alternatives. There are no other choices. Just this one choice. And I don’t know about you, I believe every member of this body feels as if there’s an awesome responsibility on our shoulders. This will be the most difficult decision I make in my 16 years in this body. And I have decided that the cost of not acting outweighs the cost of acting…”[4]
Many critics of the $700 billion bailout argue that there are problems with the bill, and that little things here and there should be added. Some argue that there are disadvantages to the plan compared to the relative advantages of certain alternatives. But, as these nuances and alternatives are debates, and the passage of a bill is delayed, the economic crisis will continue its downward spiral. The advantages, therefore, of making a bailout plan perfect are outweighed by the costs of delaying the passage of a solution.
“Isn’t anybody going to stop these people? Many of us bought into the Weapons of Mass Destruction line of bull, and see where that got us. And, oh yes, we were urged to act quickly on that one too, before the mushroom clouds started sprouting over American cities.”
Sen. Richard Shelby, R-Ala., the top Banking Committee Republican – “I am concerned that Treasury’s proposal is neither workable nor comprehensive. In my judgment, it would be foolish to waste massive sums of taxpayer funds testing an idea that has been hastily crafted, and may actually cause the government to revert to an inadequate strategy of ad hoc bailouts.”[5]
“our economy is not a shining example of pure unfettered market forces. It never has been…From the outset, Washington envisioned some government involvement in the commercial system, even as he recognized that commerce should belong to the people…So is the government’s bailout a major departure? Hardly. Today’s federal involvement offers bailouts as a strictly temporary measure to prevent a system-wide financial calamity. This is entirely in keeping with our basic principles — as long as the bailout promotes, rather than hinders, financial democracy.”
“the other lesson [from 1929] was the one “we” forgot — not to let banks and other financial institutions turn themselves into casinos. It is helpful, in the spirit of Tonto’s historic interrogatory to the Lone Ranger — “What you mean, we?” — to unpack that “we.” The “we” who forgot the lessons included first and foremost Republican ideology — deregulate everything and let markets run wild; secondly Bush administration regulatory officials who disdained even the regulations on the books; and third, the Wall Street Democrats who were de-regulation’s willing enablers.”
“Taxpayers could soon be gobsmacked by a $700 billion rescue of the American economy. Yes, it’s galling, yes, it’s humiliating, and, no, it’s not the way capitalism is supposed to work…But a government-assisted rescue is unavoidable.”
“We do not support government bailouts of private institutions. Government interference in the markets exacerbates problems in the marketplace and causes the free market to take longer to correct itself. We believe in the free market as the best tool to sustained prosperity and opportunity for all.”
“while the mortgage crisis convulsing Wall Street has its share of private-sector culprits they weren’t the ones who ‘got us into this mess.’ Barney Frank’s talking points notwithstanding, mortgage lenders didn’t wake up one fine day deciding to junk long-held standards of creditworthiness in order to make ill-advised loans to unqualified borrowers. It would be closer to the truth to say they woke up to find the government twisting their arms and demanding that they do so – or else…The roots of this crisis go back to the Carter administration. That was when government officials, egged on by left-wing activists, began accusing mortgage lenders of racism and ‘redlining’ because urban blacks were being denied mortgages at a higher rate than suburban whites.”
Rep. Jeb Hensarling, Republican of Texas – “I fear that, under this plan, ultimately the federal government will become the guarantor of last resort, and Madam Speaker, that does put us on the slippery slope to socialism.”[6]
“By rescuing Wall Street tycoons who succumbed to the lure of an irrationally exuberant housing bubble, the bailouts today do pose something of a moral-hazard problem. But we can more than repair it by defining a new generation of financial contracts, with a continuation of our evolving thinking about moral hazard, reflecting greater enlightenment, greater understanding of human psychology and the means to deal with financial failure.”
“For 200 years, the ‘business model’ in our country has rested on a simple fact: that while one may reap rewards from taking risks, one should also be prepared to face the consequences of those risks. Some of the proposed actions with regard to the credit market turn that business model on its head — absolving those who took too much risk, or bought too much house, from the weight of their own choices. If Congress passes the proposed bailout, we will be destined to have far greater problems in time, leaving those who are prudent in their finances to foot the bill for those who are not.”
The nature of the $700b bailout does not, by its nature, bailout Wallstreet fat-cats. It is not a cash giveaway to Wallstreet banks. It involves, rather, government and taxpayers purchasing mortgage assets. These assets are then owned by the government and taxpayers and can even later be sold for a profit for taxpayers. This is, therefore, obviously not a cash-giveaway to Wallstreet fat-cats.
“This is not about how to bail out Wall Street. This is about saving the U.S. financial system for the benefit of American businesses, consumers and the economy at large. I believe that Mr. Paulson’s plan will accomplish this goal. Congress should include provisions it feels are necessary to ensure oversight and accountability. And it should then pass the legislation as soon as possible.”
US Secretary of the Treasury Henry Paulson – “The American people are angry about executive compensation and rightfully so. Many of you cite this as a serious problem and I agree. We must find a way to address this in the legislation, but without undermining the effectiveness of this programme.”[7]
Sen. Byron Dorgan’s – “this proposal looks to me like a stampede in the wrong direction…to reward the very people on Wall Street who created this mess, and who pocketed more than $100 billion over the last several years making it.”[8]
“Bankers’ big pay: There are worries about controlling the mega-bucks bosses earn at the very banks being bailed out – given the view that it was Wall Street ‘that got us into this mess in the first place’.”
“CBS News found 21 former staffers from the Senate Banking, Housing and Urban Affairs and House Financial Services Committees are now lobbyists for financial firms. Their job? To lobby those in Congress who will shape the financial bailout. The former staffers now represent hedge funds, private equity firms, investment banks and the failed mortgage giants Fannie Mae and Freddie Mac.”
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