WASHINGTON — The Bush administration proposed a historic $500-billion bailout of financial firms Friday that would let the government rather than the cold judgment of the marketplace decide the winners and losers from the crisis that has shaken the U.S. economy for the past year.
The plan, which would be the most sweeping government intervention in the markets since the Great Depression, calls for the Treasury to buy the troubled mortgage securities that have been toppling major financial firms and are at the heart of Wall Street's turmoil. Outside experts predicted that the cost could reach $1-trillion.
Millions of Americans could also benefit from other dramatic stopgap measures. Regulators announced efforts to stabilize the mortgage market; curb stock speculation; and insure money market mutual funds with government funds, seeking to protect ordinary investors and preserve a vital source of corporate finance.
The initiatives were precipitated in part by concern that investors would race to withdraw holdings from money market funds, which hold $3.5-trillion in investments, depleting a key source of short-term corporate funding.
President Bush, who had remained largely silent as the crisis broadened this week, said it is a "pivotal moment for America's economy." In a Rose Garden speech remarkable for its ominous tone, Bush said: "This action does entail risk. But we expect that this money will eventually be paid back. … The risk of not acting would be far higher."
Treasury Secretary Henry Paulson acknowledged that the government's previous policy of addressing corporate failures on a case-by-case basis had not stemmed the crisis. He said the new comprehensive strategy has a better chance of calming the turmoil that froze critical segments of credit markets and sent stocks into a tailspin earlier this week.
"I am convinced that this bold approach will cost American families far less than the alternative — a continuing series of financial institution failures and frozen credit markets," Paulson said.
On new of the impending rescue plan, the Dow Jones industrial average, which jumped between massive losses and gains this week, rose 3.3 percent Friday to close at 11,388.44. Combined with a 410-point gain Thursday, the index ended near break-even for the week — sweeping away Monday's 504-point loss.
Paulson's proposal needs the approval of Congress, and the Bush administration, Federal Reserve Chairman Ben Bernanke and congressional allies began a major offensive Friday to persuade lawmakers to support it. Treasury and the Fed officials are worried that delay would spark fresh market anxiety and are working with congressional leaders to pass the plan by the end of next week, which would be extraordinarily quick for Capitol Hill.
Democratic leaders immediately pledged to work closely with Paulson to pass a plan by that deadline, but they also demanded that the measure include relief for deeply indebted homeowners, and not just for the banks and Wall Street firms. Some lawmakers, including Sen. Richard Shelby, Ala., the ranking Republican on the Senate Banking Committee, have expressed concerns about the plan's cost. Such opposition could delay passage.
Paulson and Bernanke held a morning conference call with more than 100 House Republicans. According to notes taken by one participant, Paulson said that the failure to pass a broad rescue plan would lead to nothing short of disaster. Bernanke said that Wall Street had plunged into a full-scale panic, and warned lawmakers that their own constituents were in danger of losing money on holdings in ultraconservative money market funds.
There are many unknowns about the plan. The outlines of the bailout include buying only from U.S. financial institutions — not hedge funds — and hiring outside advisers who would work for the Treasury, rather than creating a separate agency. Paulson said the Treasury would hire professional investment managers to oversee what could be an enormous portfolio of mortgage-backed securities, according to people involved in the discussions.
The Treasury would hold several rounds of buying, first purchasing securities from the banks that request the lowest prices, to limit the cost to taxpayers. The plan could be broadened to include securities based on other kinds of loans, such as student loans and commercial real estate.
The U.S. government could end up holding the securities for years or even decades, depending on whether they recover value.
Scores of basic questions remained unanswered as of Friday evening, including how much of the mortgage market the administration hoped to buy up.
The broader economic questions are even more daunting, such as assessing the dangers of letting the government borrow another $500-billion — which ultimately might have to come from foreign investors — while the deficit is already skyrocketing.
Information from the Washington Post and New York Times was used.