Massive Bailout Plan Menaces Economy, Triggering Opposition

by Hans Bader on September 23, 2008 · 4 comments

Treasury Secretary Paulson wants the American people to fork over $700 billion to bail out Wall Street, even though he admits that his prior multibillion dollar bailouts failed to stem the crisis.  Banking expert and law professor Todd Zywicki, a former Bush Administration official, notes that “by exploding the national debt, the bailout plan has ignited inflation fears and threatens to ruin the dollar while gold and oil prices skyrocket.”  The proposed bailout has triggered “bailout envy” and a flood of demands for more bailouts, ranging from insurers to automakers to defaulting mortgage borrowers.

As Zywicki notes, the foolish Paulson got little in return for “giving away the store in his negotiations with Wall Street by basically telling them that the government was desperate to buy up their garbage paper. Did he really think that the Wall Street creeps who caused all these problems and then asked the taxpayers to bail them out were really going to show self-restraint and put their selfishness aside as a show of gratitude for all of us saving their hides? Instead, it appears that the Wall Street billionaires will deign to participate in the bailout only if it doesn’t threaten their house in the Hamptons or private jets.”

Paulson was too blind to see the mortgage crisis coming, let liberal lawmakers block crucial reforms of Fannie Mae, and disregarded both logic and history in shaping his bailout plan.  He has ignored inexpensive methods that might stem the mortgage crisis, like relaxing rigid federal accounting rules that he himself hypocritically refuses to follow.  There is no reason why taxpayers should trust him with $700 billion, given his incompetence and conflicts-of-interest.

Not that everything is Paulson’s fault.  Federal affordable-housing mandates did much to spawn the mortgage crisis.  And as Professor Jonathan Adler notes, “Charles Calomiris of the Columbia Business School and Peter Wallison of AEI have an op-ed in the Wall Street Journal today arguing that the subprime mess is largely due to the actions of Fannie and Freddie (and their Congressional backers), and not due to financial industry deregulation or broader institutional problems. They also suggest the whole mess could have been averted”:

In 2005, the Senate Banking Committee, then under Republican control, adopted a strong reform bill, . . . The bill prohibited the GSEs from holding portfolios, and gave their regulator prudential authority (such as setting capital requirements) roughly equivalent to a bank regulator. In light of the current financial crisis, this bill was probably the most important piece of financial regulation before Congress in 2005 and 2006. All the Republicans on the Committee supported the bill, and all the Democrats voted against it. Mr. McCain endorsed the legislation in a speech on the Senate floor. Mr. Obama, like all other Democrats, remained silent.

Now the Democrats are blaming the financial crisis on “deregulation.” . . . But the primary “deregulation” in the financial world in the last 30 years permitted banks to diversify their risks geographically and across different products, which is one of the things that has kept banks relatively stable in this storm.

As a result, U.S. commercial banks have been able to attract more than $100 billion of new capital in the past year to replace most of their subprime-related write-downs. Deregulation of branching restrictions and limitations on bank product offerings also made possible bank acquisition of Bear Stearns and Merrill Lynch, saving billions in likely resolution costs for taxpayers.

If the Democrats had let the 2005 legislation come to a vote, the huge growth in the subprime and Alt-A loan portfolios of Fannie and Freddie could not have occurred, and the scale of the financial meltdown would have been substantially less. The same politicians who today decry the lack of intervention to stop excess risk taking in 2005-2006 were the ones who blocked the only legislative effort that could have stopped it.

wooD September 23, 2008 at 10:34 am

Frying pan to fire. My latest webcomic series ( is parodying the creation of the Federal Bureau of Bailout. Funny since it even includes a house in the Hamptons (thursday or friday) so we must think alike.

Lisa_P November 17, 2008 at 3:01 am

There was some lingering hope that Treasury Secretary Henry Paulson might use a generous portion of the $700 billion bailout plan’s funds to help out consumers with their devaluing mortgages. It has now been effectively dashed, as it is clear no such thing is going to happen. A good chunk of the remainder is going back into the consumer credit market, such as car loans, student loans, and credit cards. Since it is a form of consumer credit, payday cash loans should be getting a portion, but there will be none made available to that industry, whose usual customers have either no credit or credit difficulty. Paulson wants normal avenues for consumer credit to remain open, such as car loans, student loans, and credit cards; these normally open lines of credit have become far slower or even frozen with “illiquidity.” “This is creating a heavy burden on the American people and reducing the number of jobs in the economy.” Inexorably so, but has anyone else seen what is going on here? Paulson has admitted a mistake with the earlier strategy of the plan, including massive banking bailouts. If only America had a President willing to admit his mistakes. We do have to pick up the pieces and move forward, but certainly some things could have been avoided. However, government officials are doing something right by encouraging investors to return to the market with the bailout. If the investors return, then confidence and jobs could start returning to the world market, and fewer people may have to rely on payday cash in tough times. Sure, it is a good tool to have sometimes, but it isn’t a long term solution.

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