The $700 Billion Question

It is too urgent a decision for congress to delay. We must act now or face certain disaster. Extreme times call for extreme measures. Come on, do-nothing Congress - let's move!

No, this isn't a recap of the hasty congressional putsch that whipped and shamed the legislative branch into authorizing the Iraq War. This is what's going on right now in Washington in an effort to get Congress to sign off on the proposed $700 federal toxic mortgage buyout proposed by Ben Bernanke and Henry Paulson before the legislative session ends. Once again, the Congress - and the American people, by proxy - are being asked to sign away unprecedented powers to the administration with little to no oversight on the way our money is being put to use. Back in 2002, we were bamboozled into a disasterous war; now, we might just be bamboozled into a bailout plan that will cost just as much as another Iraq War.

There is something deeply wrong about a plan that socializes all risk associated with these bad mortgages while not giving taxpayers a stake in the potential profits brought in by major commercial banks, insurance companies, and investment banks. But, contrary to the run-up to our Iraq fiasco, there may just be some congressional opposition this time around. Today in Washington, Paulson and Bernanke held a hearing to pitch their 3-page plan, and leaders in Congress - from both sides of the political spectrum - voiced overwhelming concern. Chris Dodd called the plan "stunning and unprecedented in its scope and lack of detail"; Republican Jim Bunning commented: "It's financial socialism, and it's un-American." In The Nation yesterday, William Greider wrote: “If Wall Street gets away with this, it will represent an historic swindle of the American public — all sugar for the villains, lasting pain and damage for the victims.” Bernanke and Paulson received quite a grilling indeed.

Hopefully our elected officials (as opposed to the Bush-appointed heads of the Treasury and the Fed) continue to put the pressure on. We can all acknowledge that we are in dire times right now, but rushing into an ill-conceived and extravagantly expensive bailout plan is a reckless way to spend public funds. (And Alan Greenspan thinks it will cost a lot more than $700 billion.) Add to this the fact that Treasury will have virtually unfettered power to do with our money as they see fit, and you have a recipe for a disaster. This plan is somehow being framed as the only way to avert catastrophe, but is that really the case?

The fundamental problem here is that firms have too much debt relative to their assets. Credit is frozen because an institute can't go out and make big promises when they don't have the assets/collateral to back up their loans. Therefore, in order to avoid a seizure of credit, either the bad assets need to disappear or the firms need to acquire new capital to invest. (A great, simple explanation of this can be found here.) The Paulson plan follows the first idea: we buy up bad mortgages to relieve firms of their toxic assets so they can go out and start lending again. Many economists, however, suggest the second option: through major government investments in the firms themselves, taxpayers won't simply be saddled with subprime mortgages - we will in essence be given a piece of the companies that invested stupidly in the first place. Profits down the road, therefore, would be shared with the investors (us).

Firms now need capital, that much is not in doubt. But there are more ways for them to recapitalize than simply having all their bad paper bought up (so-called "cash for trash"). Firms could seek money from sovereign wealth funds. They could ask their shareholders to pony up additional money to get the capital flowing through their veins again. A government bailout should be the last possible option, reserved in case all other plans fail. Yet this is essentially the first solution we're running to.

(Warren Buffett's recently announced $5 billion investment in Goldman Sachs is a case in point: funds don't have to come from the taxpayer.)

When many readers see the $700 billion pricetag, their eyes glaze over. This is a truly abstract amount of money. But let's put this into a little perspective here: 700 billion is roughly the same as the entire US defense budget; it represents 5% of our GDP; it is approximately the same size as the entire economy of Brazil, India, Russia, or South Korea. It makes you want to cry when you see the Earth Policy Institute's projected costs for sweeping global warming-related social programs and earth restoration goals - $190 billion. For less than 1/3 of these bailout expenses, we could achieve global universal primary education, universal health care, adult literacy, protection of forested land, stabilization of our water tables, restoration of fisheries and biological diversity, etc. etc. Think how significantly we could bite into global carbon emissions with $700 billion.

Yes, we're in the middle of a crisis. But we need to think long and hard before ceding so much money and such sweeping powers to Mr. Paulson (who was Goldman Sachs's CEO before taking this gov't gig, as the revolving door has it). From what I understand of the situation right now, this bailout is a disastrous idea.

To be continued...

[Please join the point-counterpoint of economic posts by Ben Batchelder and I by contributing your comments and impressions about this mess.]