Alternative Solutions Diverge From Administration's Approach
Wednesday, September 24, 2008
To hear Henry M. Paulson Jr. and Ben S. Bernanke tell it, there is only one plan to save the economy -- use $700 billion in taxpayer money to take the worst of Wall Street's assets off its books.
But leading economists and financial analysts argue that there are a host of alternatives that would reduce taxpayers' liabilities and perhaps more effectively address the urgent crisis in financial markets. Although these experts concede that the clock is ticking, they say other approaches have been dismissed too quickly.
While the government's plan is built around buying troubled assets, other options offer sharply different visions.
One approach seeks to reduce taxpayers' liability by offering collateral-backed loans to troubled banks, leaving them to work out their own solutions. Another idea is to have the government set up a profit-driven investment fund with the aim of infusing the financial system with cash without taking on bad debt. Still others suggest radically different tactics of directly helping homeowners by reducing mortgage principal or bolstering banks by suspending capital gains taxes.
The administration has said it is willing to negotiate key parts of its plan -- including a possible concession allowing the government to take equity stakes in financial firms in exchange for bailing them out -- but senior officials stand by the fundamental approach they have adopted to solve the crisis.
"They presented this as a comprehensive, decisive solution, but it's clearly not comprehensive and probably not decisive," said Simon Johnson, a former chief economist at the International Monetary Fund and a professor at Massachusetts Institute of Technology.
A mistake could result in a catastrophic collapse of the U.S. financial system that could ripple across the world or in a staggering cleanup bill for taxpayers. At the core of the debate is whether Paulson, the former chief executive of Goldman Sachs now charged with rescuing Wall Street as Treasury secretary, and Bernanke, the Federal Reserve chairman and one of the leading academics on financial crises, are serving up the best possible recipe for purging the U.S. financial system of billions of dollars worth of distressed mortgage-related debt.
Under the administration's rescue plan, the Treasury secretary would have broad discretion to buy as much as $700 billion worth of troubled mortgage-backed assets and other securities that Wall Street firms have been struggling to sell. Administration officials hope that once those assets are cleansed, money will flow freely through the financial system again and that the government can hold onto the securities until they recover some of their value.
In testimony on Capitol Hill yesterday, Bernanke and Paulson explained that they formulated their plan after considering past crises, including the U.S. savings-and-loan bailouts of the 1980s and the bursting of Japan's economic bubble a few years later. But they ultimately decided that the response to the current crisis needed to be a fast and massive fix.
"The situation we have now is unique and new," Bernanke said. He later continued, "The firms we're dealing with now are not necessarily failing, but they are contracting. They are de-leveraging. They're pulling back. And they will be unwilling to make credit available as long as these market conditions are in the condition they are."
Many of the alternatives fall under four basic approaches:
Government as Lender
Critics of the administration's plan argue that one alternative could be crafted to minimize the exposure of the government -- and taxpayers -- to risk. Johnson, the MIT professor, suggested that the government, instead of taking on the bad debt, could offer loans to troubled banks, allowing them to put up their compromised portfolios of mortgage-backed debt as collateral.