Last Thursday, the top economic policymakers in the United States told congressional leaders that the financial system was only days away from a catastrophic failure — and that the only hope was an immediate, massive government bailout. Congress agreed in principle, buoying financial markets. But five days later, the specifics of the rescue legislation remain undecided. Two of Monday's market events — a 372-point drop in the Dow Jones Industrial Average and a $16-per-barrel jump in the price of oil — show just how rapidly the clock is ticking.
Congress and the Bush administration generally agree that the government should buy up the toxic mortgage-backed securities that are spreading losses and destroying the confidence essential for debtors and creditors to function. This taxpayer-funded bailout is not necessarily the only conceivable approach or even the most efficient one. Quite possibly, it would have been wiser instead to inject government capital directly into banks so they would be better able to work out problem assets on their own. But for better or worse, that option is off the table, and the question is how Uncle Sam can most effectively take on as much as $700-billion worth of bad debt. The basic trade-off here is between speed and flexibility on one hand and oversight and accountability on the other.
Treasury Secretary Henry M. Paulson Jr. clearly believes that the way to get the maximum number of financial institutions to unload as much distressed paper as possible, as quickly as possible, is to keep it simple: announce that the U.S. Treasury is open for business and let the fire sale begin. That is essentially what he advocated when he asked Congress for the power to purchase troubled mortgage-backed assets from financial institutions at whatever price he and hired experts saw fit, with only minimal congressional supervision and complete immunity from lawsuits.
The problem, of course, is that this raises the risk that the government will get fleeced by the debt-sellers, raising the ultimate cost to taxpayers. It was also politically unrealistic, in that members of Congress were quite properly concerned that financial institutions accept limits on executive compensation in return for their federal lifeline. There was no provision in Paulson's proposal for taxpayers to enjoy any of the profits that financial institutions may enjoy once they have been restored to health. A new proposal by Senate Democrats seeks to correct this by requiring would-be asset-dumpers to give the government equity if Uncle Sam winds up having to sell the paper at a loss. Of course, at the margin, the proposal could deter some firms from ridding themselves of the bad loans in the first place. And that would slow the process. Democrats are also insisting on various forms of mortgage relief for the homeowners who are about to find themselves in debt to Uncle Sam. Mortgage relief might help stabilize home prices, but since the government would now own so many mortgages, taxpayers (most of whose mortgages are not in trouble) would have to foot the bill once again.
A little delay was both inevitable and desirable. Congress cannot write a $700-billion check with no questions asked. But speed and focus are still of the essence, and leaders in both parties must not use this crisis as an opportunity to refight all the political battles of the past year. They should treat it as what it is: a chance, possibly the last chance, to keep the U.S. financial system from collapsing.