Overview
Wall Street has been on a roller coaster ride over the last few weeks so wild that it would make any Six Flags amusement park jealous. The salvaging of Fannie Mae and Freddie Mac earlier this month was only the first in several steps enacted in hopes of stabilizing the U.S. economy in hopes of staving off a total collapse of the financial sector. This week, Congress will debate a $700 billion dollar package meant to shore up the rest of the industry. That sum is most certainly more than pocket money. The cost of the war in Iraq to date. 12 Bill Gateses. $2300 for every American citizen. Any way you write the check, the additional sum would once again raise the national debt to staggering heights. Thus, the great financial bailout of 2008 is certainly worthy of our analysis.
Key Terms and Figures
Henry Paulson, Jr.: President George W. Bush nominated Henry M. Paulson, Jr. to be the 74th Secretary of the Treasury on June 19, 2006. Before coming to Treasury, Paulson was Chairman and Chief Executive Officer of Goldman Sachs since the firm’s initial public offering in 1999. He joined Goldman Sachs Chicago Office in 1974 and rose through the ranks holding several positions including, Managing Partner of the firm’s Chicago office, Co-head of the firm’s investment Banking Division, President and Chief Operating Officer, and Co-Senior partner. His ties to Goldman Sachs have been of great interest to skeptics of the plan.
Ben Bernanke: Ben S. Bernanke was sworn in on February 1, 2006, as Chairman and a member of the Board of Governors of the Federal Reserve System. Bernanke is the successor to the legacy of former Fed Alan Greenspan. Critics have claimed that Dr. Bernanke’s forecasts had been too sunny over past several months preceding the collapse of Bear Stearns earlier this year. In 2006, he resisted calls for further interest rate increases because he thought the economy might be weakening. Had he listened to his critics at the point, the current financial crisis could be worse. On March 16, 2008, JPMorgan Chase announced its intention to acquire Wall Street investment bank Bear Stearns Inc. The proposed purchase is controversial due to the unprecedented involvement of Bernanke’s Federal Reserve System.
The Democratic Congress: Senior Democrats admitted there was little option but to go along with the biggest government bid to buy up bad debts and rescue blitzed financial firms in decades. Democratic House of Representatives speaker Nancy Pelosi said she told President George W. Bush she was committed to “quick, bipartisan action.” But she said care must be taken to insulate normal Americans — “Main Street” — from the meltdown in the Wall Street financial sector, and to reduce mortgage foreclosures. Senate Majority leader Harry Reid also seemed to be eyeing November’s congressional elections, in which Democrats hope to swell majorities racked up in the 2006 elections when they captured both the House and Senate. While blaming “failed” Bush administration policies for the turmoil, Democrats have pledged to work with the White House, Treasury and Federal Reserve to put it right. Senate Banking Committee Chairman Chris Dodd described the meeting between Treasury Secretary Henry Paulson, Bernanke and top congressional leaders last Thursday night as “about as sobering a meeting as any of us have ever attended in our careers here.”
Major Issues
This Isn’t the First Check Written: Consider the spree of actions that have the potential—directly and indirectly—to cost taxpayers money: the government accepting $30 billion of Bear Stearns’ sketchy collateral for a $29 billion loan to JPMorgan, giving investment banks access to the discount window, assuming responsibility for Fannie Mae and Freddie Mac, guaranteeing money market funds (up to $50 billion), making a big loan to AIG (up to $85 billion), and now proposing the mother of all bailouts—up to $700 billion.
What’s the Cost?: It’s difficult to quantify the costs of these activities for a few reasons. Even though the government has now formally agreed to guarantee the debt of Fannie and Freddie, the White House says it doesn’t see the necessity to include the cost of doing so in the budget. In theory, Paulson could drive a good bargain in buying hundreds of billions of dollars of distressed assets. As a result, the government could recoup a lot of the costs of the latest bailout proposal. And most of the other efforts are loans, which are designed to be paid back. Until it all shakes out, though, the lack of firm numbers and an unclear future of the economy could make for risky business.
Too Much Power to Paulson: The common denominator to many reactions is a visceral discomfort with giving Treasury Secretary Henry Paulson Jr. — himself a product of Wall Street — carte blanche to relieve major financial institutions of bad loans choking their balance sheets, all on the taxpayer’s bill. An underlying source of doubt about the bailout stems from who is asking for it. The rescue is being sold as a must-have emergency measure by an administration with a controversial record when it comes to asking Congress for special authority in time of duress. Paulson has argued that the powers he seeks are necessary to chase away the wolf howling at the door: a potentially swift shredding of the American financial system. That would be catastrophic for everyone, he argues, not only banks, but also ordinary Americans who depend on their finances to buy homes and cars, and to pay for college.
Socialism is the New Capitalism: It’s safe to say that Paulson and Bernanke did not get a warm reception during their testimony. One after another, senators from both parties said that, while they were prepared to move fast, they were far from ready to give the administration of President George W. Bush everything it wanted. Senator Christopher Dodd, Democrat of Connecticut and chairman of the Banking Committee, called the Treasury proposal “stunning and unprecedented in its scope and lack of detail.” Asserting that the plan would allow Paulson to act with “absolute impunity,” Dodd said, “After reading this proposal, I can only conclude that it is not only our economy that is at risk, Mr. Secretary, but our Constitution, as well.” Another expression of disgust came from Senator Jim Bunning, Republican of Kentucky, who said the plan would “take Wall Street’s pain and spread it to the taxpayers.” He added, “It’s financial socialism, and it’s un-American.”
Details of the Bailout
Bush Administration Proposal:
1) Give the Treasury secretary broad authority to buy up to $700 billion in troubled assets from any financial institution if he decides, in consultation with the chairman of the Federal Reserve, that it’s necessary for market stability.
2) Raise the $10.6 trillion statutory limit on the national debt to $11.3 trillion.
3) Allow the Treasury secretary to buy, hold and sell the assets in any way he sees fit. That includes the ability to go outside normal government contracting practices to hire private companies to manage them.
4) Require the government to report to congressional budget, tax-writing and financial services committees within three months of using the authority and every six months thereafter.
5) Shield rescue program from judicial review.
6) Expire two years after enactment.
House Democrats’ Proposed Changes:
1) Require that companies benefiting from the bailout don’t give so-called “golden parachutes” to executives and have rules to revoke bonuses awarded based on bogus claims.
2) Allow the government to take an equity stake in participating companies to share in future profits.
3) Require that the government draft a plan to renegotiate the mortgages it purchases to help homeowners avoid foreclosure.
4) Allow judges to rewrite the terms of bankrupt homeowners’ mortgages so they can afford to stay in their homes.
5) Create a congressional oversight panel to scrutinize the rescue program and subject it to court review.
6) Limit the program to financial institutions with “significant operations” in the United States and exclude foreign central banks and companies owned by foreign governments.
Sample Questions
What concessions must be made in order for Congress to pass the financial bailout?
Can the U.S. shoulder an additional $700 billion in national debt?
Should Congress fail to pass the financial bailout, what will be the residual effects?
Is Henry Paulson gaining too much power?
What is the greatest risk involved in the government’s bailout of Wall Street?