Rescue The $700 Billion Bailout

This column was written by Clay Risen.

When corporations are openly gaming the system, city governments don't understand who qualifies for the bailout, no one's watching the watchers, and the well is running dry, clearly something has gone terribly wrong. The Troubled Asset Relief Program has, in no uncertain terms, failed. And, predictably, libertarian and populist opponents of the original bill are dancing with joy. To use one (self-serving) example, Katherine Mangu-Ward, over at Reason's blog, teased me for buying into a big government plan in the first place: "Ah, New Republic. Life holds so many shocking disappointments for you. Like today, when you figured out that the bailout wasn't going to be a smooth transition to economic health guided by a selfless, rational public servant."

But the poor execution of the plan doesn't mean that a bailout, or even the bailout as approved by Congress, was a bad idea. On the contrary, the bailout helped avert a major crisis from becoming cataclysmic. And the case for strong action remains. Consumers, and too many industries, find themselves in free fall without a net. Fortunately, it's not too late to reset--and with $350 billion left in the bag for January 21, there's a lot the next White House can do. Obama's first challenge coming into office won't just be cleaning up the mistakes Bush made over the last eight years. It will be cleaning up the mistakes he and Paulson made in the last four months of their terms.

Let's begin with two important premises, both of which are debatable but also defendable. First, a rescue plan of some sort was necessary. In a matter of days in late September, Lehman Brothers and Washington Mutual had failed, while AIG had gone on government life support. The credit markets dried up. The Dow tanked. The investment banking sector, through a mix of bankruptcies, takeovers, and restructuring, ceased to exist. Most significantly, a mood of cautious optimism was replaced with an impending dread over the next bank failure, with rumors flying about even solid institutions like Goldman Sachs. Fear and confusion were so rampant that the market's usual self-correcting mechanisms--like investors looking for cheap deals--were nowhere to be found.

In this situation, only a shot of confidence from the government could avert further collapse--even most critics of the Paulson plan agreed on that. And with the crisis centered in the banking sector, it made most sense for the government to focus its efforts there. Paulson and Fed Chairman Ben Bernanke insisted that the best way to shore up the sector was to buy complex mortgage-backed securities, the "troubled assets" that gave the Paulson Plan its official name. There was significant debate over that notion, but the real value of the package was psychological, and for a few days it worked: By showing that the government was able and willing to act comprehensively, Wall Street calmed, the Dow rose, and the credit markets began to loosen.

Soon after the plan's passage, however, Paulson and Bernanke decided that, in fact, buying troubled assets was a bad idea, and that a better course was to inject money directly into banks--a strategy that Paulson had explicitly rejected earlier, but that a range of economists, including Paul Krugman, had supported. The problem is that while the shift in strategy was defendable, they never bothered to defend it, or even explain it, and their keeping quiet made the whole program appear rudderless. What's worse, while the original TARP required participating banks to help out homeowners, Paulson's on-the-fly stock-buying plan didn't, making it essentially free money.

Indeed, Paulson has proved surprisingly naïve. He and TARP's interim director, Neel Kashkari, haven't applied much pressure on banks to open the lending spigots, assuming that the banks would do so on their own thanks to market logic or virtue. And they were wholly unprepared for the onslaught of lobbying that came after the bailout, combined with a spate of restructurings and consolidations that repositioned everyone from American Express to Goldman Sachs as bank holding companies, thus qualifying them for bailout funds. These were not the people who needed money, and yet Paulson was apparently unwilling to develop rules to keep them out--or even use his own discretion to do so. The result is a massive government program that to all the world looks like a banker's boondoggle, with little to no positive impact on the economy.

Which brings us to the second premise: that the bailout was not destined to fail; it was just handled terribly. To his credit, Paulson is right to point out, as he has done several times this week, that the bailout was never designed as a panacea. It was designed as a solution for the financial industry, leaving it up to the administration to develop parallel responses for the crises hitting mortgages and state and local coffers. Yet so far it has been the beginning and end of the government's response. There has been no complementary action for credit-starved small businesses or swamped homeowners. And while there's no impending collapse like in September, the economy desperately needs a well-planned, broad-based response from Washington.

What all this recommends is a reboot by the Obama Administration. There are, of course, an unlimited number of approaches to the economic crisis, but any strategy should include a few key steps. The first thing Obama and his people need to do once in office is reboot TARP. Before adding more programs, they need to make sure that the existing, faltering ones are up to par. That means instituting new, more stringent requirements for banks looking to tap the funds--not only higher bars for who can access it, but stronger requirements to force open the lending spigot for those who do. It means putting real teeth into oversight. Paulson has been slow to set up the mandated oversight offices that would force him to explain his sea-changes, a failure that has produced much political, investor, and taxpayer doubt about whether he's improperly benefitting his former Wall Street colleagues. Rebooting TARP also means putting someone outside the "Government Sachs" nexus into the driver's seat--for example, Sheila Bair, head of the Federal Deposit Insurance Corporation, a woman with a track record of fierce independence. Finally, it means implementing a mortgage assistance package, yet another unfulfilled mandate in the original bill. This isn't just a sop to flooded homeowners--until investors see some sort of support under collapsing home prices and shuttering mortgages, they'll continue to be spooked.

None of this is to preclude the other pieces in an economic recovery package. Stimulus measures in the form of tax cuts, expanded health insurance, and infrastructure investments are important pieces, as well as, yes, funds for ailing industries. But the critical element is to present all of this as a unified project. Banks aren't lending because, even though they're getting free money, they don't see anything being done about mortgages. Consumers are cutting back because they aren't seeing anything being done to help them pay off those mortgages or provide tax relief. Obama was right to support the bailout as it was originally approved by Congress. Now he needs to put it back together again, properly finishing the job Bush started.
By Clay Risen
Reprinted with permission from The New Republic