Will the Bailout Help You?
It's the $700 billion question on everyone's mind -- and nobody has a real answer. To understand whether the money will start flowing again, it's important to understand how we got here, what the plan contains, and where it falls short.
One question that was scarcely taken up in the debate over the bailout was whether it would even work in the first place -- that is, would banks, freed from the consequences of their poor decisions, resume lending to each other and to the nation's consumers and businesses? At the time, there was no consensus that this intervention, in which the Treasury could spend up to $700 billion to buy bad assets based on home mortgages, would actually loosen up credit. And even now, there is no way to know. If taking these assets off the banks' books restores confidence and liquidity, then the benefits of the bailout will trickle down to small firms and everyone else in the economy. If it doesn't, it won't. The Treasury Department is weeks away from actually purchasing anything, but so far, the prospects look grim.
So how did we get stuck with this bill? What changed in the four days between when the House of Representatives first considered -- and rejected -- the bailout bill, and last Friday, when it finally passed? Frantic supporters marshaled increasingly alarming anecdotal evidence that consumer and commercial loans are more expensive and harder to get, but it's hard to believe that the facts on the ground could have changed so drastically so quickly.1 In any event, there was no way to know for certain what precisely was happening on Main Street -- and the numbers, when they're finally available, often contradict the prevailing sentiment.
What we do know for sure is that the bailout generated its own momentum, like a boulder rolling down hill. Wall Street was expecting the help -- if it hadn't come, the markets seemed ready to will confidence away. "You've had the president go on TV and say, 'The world is coming to an end.' You've had both houses of Congress over the weekend promise they're going to do something," economist Anil Kashyap told the radio program To The Point in the middle of last week. "To not act at this point would be pretty irresponsible."
Kashyap was something of a bellwether because he was one of the 200 or so economists who had initially signed an open letter to Congress opposing the bailout. But by last week the University of Chicago professor had come around to supporting it because, he said, his concerns about the lack of specificity and oversight were addressed in the legislation Congress drafted. Although the letter raised other issues, including fairness and the long-term effects of the bailout, which do not seem to have been clearly resolved, Kashyap believes that "a huge fraction" of the other signatories likewise changed their mind.2
Now the bailout is law, and markets around the world are bleeding confidence anyway. So far this week, the Dow Jones Industrial Average has closed down 1,067 points, dropping below 10,000 for the first time since 2004. The Federal Reserve has stepped in to loan money directly to companies, and on Tuesday cut interest rates by half a point.
It's possible, then, that Congress will have to revisit the bailout with new legislation. In the interregnum, legislators have an opportunity to get the bailout right. The next iteration of the bailout should include provisions that make it both more effective and fairer.
The next round of legislation should be straightforward in its intent. When it comes to intervening in the economy, in ways large and small, Washington likes to pretend that it is not doing what it is, in fact, doing. Tax credits are the perennial example. They're often meant to encourage new industries -- like, for example, renewable fuels -- but by nature they are an inefficient way to deliver the benefits. In many cases a direct subsidy is a more efficient to accomplish the same goal, but subsidies are ideologically suspect.
This obfuscation is why the present bailout is structured as an asset sale, and not as a simple capital injection, which is what the banks really need. The government would take equity in exchange for the cash. "With this approach, the government would not need to determine the appropriate prices and quantities of individual mortgage-related securities, it would not be providing a greater reward to companies that have made the worst investments, and it would gain the opportunity for taxpayers to receive a higher return if the financial system recovers more strongly," writes Brookings Institution economist Douglas Elmendorf. Some University of Chicago economists, including Kashyap, have suggested that government could simply mandate that banks go to the private sector for equity infusions, though the Treasury Department might still have to provide "partial support."
The bailout should acknowledge that in the 21st century, "the free market" is a fiction, or at best a theory. We should reject the hypocrisy that demands government "get out of the way and let the private sector and our families grow and thrive and prosper" (as Sarah Palin put it when she debated Joe Biden) until times get tough. Congress should tie further outlays to passing a comprehensive regulatory reform that puts most investment activity under some kind of oversight.
There's also an antitrust dimension: we need to be thinking about market-share limits in banking and finance that define just how big "too big to fail" really is. One thing that has been scarcely acknowledged is that the failures so far have consolidated market share at a handful of very large, yet fragile, institutions -- like, say, Bank of America. On Monday, Bank of America reported that its third-quarter income fell 68 percent over last year. But at least it's still a profit. (Also on Monday, coincidentally, Bank of America agreed to settle claims by customers of BofA acquisition Countrywide Financial, with measures that could keep nearly 400,000 borrowers in their homes.)
The legislation should make those who profited from this fiasco pay for it. Let's be honest: this effort to limit executive compensation misses the point. For one thing, it's certain not to work. The legislation's compensation provisions are only in effect while the company participates in the program; there appears to be nothing that prohibits a firm from leaving the program, rehabilitated with taxpayer investment, and then renegotiating sweetheart employment contracts with its executives. The bigger problem, as conservative economist Gary Becker points out, "there develops a war between the government's closing of loopholes, and the ingenuity of accountants and lawyers in finding new ones." Besides, these guys are not the ones who steered these firms into the ditch in the first place; those folks have long gone.
