Carolyn Lochhead, Chronicle Washington Bureau
Sep. 26, 2008
Washington performed an astonishing high-wire act on Thursday, wobbling toward and then away from an unprecedented $700 billion emergency debt bailout that no one can say for certain will work. A long, frenetic day on Capitol Hill and at the White House produced much action but no result.
Congress faced on one side the possibility of economic calamity and on the other angry and baffled constituents and rebellions on the flanks of both parties. At the White House five weeks before the election, the two presidential candidates, Democrat Barack Obama and Republican John McCain, met to hash out the plan with a deeply unpopular president who soon will hand over to one of them the responsibility for carrying out a rescue of the world's biggest financial system.
In a panicked atmosphere and amid flaring tempers, Democrats and some Republicans announced before the White House meeting that they had the outline of an agreement, but GOP leaders refused to sign off on it. Liberal and conservative interest groups railed against the bailout, while business groups insisted that Congress pass the plan with all speed, warning that tight credit already is sharply slowing business activity.
At the White House, House Republican leader John Boehner of Ohio expressed misgivings about the plan, and McCain would not commit to supporting it, people from both parties who were briefed on the exchange told the Associated Press. In the Roosevelt Room after the session, Treasury Secretary Henry Paulson literally bent down on one knee as he pleaded with House Speaker Nancy Pelosi not to withdraw her party's support for the package over what Pelosi derided as a Republican betrayal, according to the New York Times.
Congressional negotiators, joined by Paulson, went back at the proposal in nighttime meetings. Talks were to resume this morning.
There is little doubt among economists that a recession has begun. The question is how deep and long it will be, and that depends on whether the bailout plan, if it passes Congress, works. Another possibility is a long stagnation like Japan's "lost decade" of the 1990s, which followed a similar real estate market collapse in that country.
Either way, the nation faces what Berkeley economist Barry Eichengreen, an expert in financial panics, calls unavoidable consequences.
Senate Majority Leader Sen. Harry Reid, D-Nev., left, and Senate Banking, Housing and Urban Affairs Chairman Sen. Christopher Dodd, D-Conn., speak to reporters before a meeting with Secretary of the Treasury Henry Paulson on the financial crisis Thursday, Sept. 25, 2008 on Capitol Hill in Washington. Lauren Victoria Burke/AP
These could include big budget deficits, higher taxes to service that debt, higher interest rates and more strictly regulated banks that will lend more cautiously. "We've had a decade of relatively successful economic growth and have been living beyond our means," Eichengreen said. "Now we'll have a decade of the opposite. It's payback time."
Maybe credit markets would recover on their own, as some believe, or maybe they wouldn't. But few in Washington really want to find out.
Little to gain politically
"We don't get to run this experiment very often," said Darrell Duffie, a professor of finance at Stanford University. "How would you like it if I told you the probability of a Great Depression were only 10 percent? Looking at even a small probability of something calamitous is not that appetizing."
At the same time, there is zero political gain in voting for a huge bank bailout as demanded by President Bush, however modified to protect taxpayers and require oversight. With liberal activists organizing protests and conservative activists denouncing the advent of American socialism, the safest place to be is to vote no while the rescue is approved with votes from someone else.
"There is no upside for voting for a bill like this," said a pained-looking Sen. Bob Corker, a Tennessee Republican working with Democrats to craft a plan.
McCain, who said he had suspended his campaign to work on a bipartisan solution, met with Boehner before going to the White House. Boehner, a day after joining Pelosi, D-San Francisco, to urge unity, said Republicans were not on board.
Yet no unity within the GOP was evident. Some Senate Republicans called for action with Democrats, while others called the bailout hopelessly flawed. Conservative House Republicans floated their own ideas to provide insurance for mortgage securities rather than buying them outright. Democrats said they were stunned because the markets want a plan by Monday.
Details were in short supply. Democrats insisted on substantial changes in the plan Paulson proposed last weekend, which they and many economists described as a $700 billion blank check.
Changes could include doling out the money in installments: $250 billion, then $100 billion and maybe later the other $350 billion. Government equity shares in companies seem likely in return for buying their bad debt, so taxpayers have some chance for gain and companies pay a cost. Limits on executive pay are certain, although how exactly to do that remains murky. Aid to homeowners facing foreclosure is likely, as is bipartisan oversight.
Economists weigh in
James Angel, a Georgetown University finance professor, said the Treasury might have precipitated the crisis by clumsy handling in its early stages. "When they said they found themselves in uncharted territory, which is code speak for 'We don't know what we're doing,' that gives me very little confidence in their plan," Angel said.
"There are plenty of things that can be done without having the government own 3 million foreclosed houses," he said. "The plan says the government can buy mortgages and mortgage-backed securities. If they buy a mortgage and it gets foreclosed, guess what? We've got the foreclosed house. Who's going to manage that house in the Las Vegas desert in the empty housing project where the vandals are tearing it apart? Do we really want the U.S. government to be the landlord?"
But other economists looked at alternatives and found them wanting. "This particular proposal isn't the only way to attack the problem," said Richard Sylla, a financial historian at New York University. "But I think it's actually one of the better ones."
In the history of banking panics, Sylla said, "the ones that turn out to be bad ones - in the 1840s, when nine states defaulted, in the 1890s, and the 1930s, which was the worst of all - show that crises get really bad when nobody takes bold action like Paulson and (Federal Reserve Chairman Ben) Bernanke are taking."
Other economists fear that the plan may miss the underlying problem of bank insolvency. UC Davis economist Alan Taylor pointed to Japan's "zombie banks" that lingered for years, stifling economic growth. "If they've made loans that are just garbage, backed by unsellable McMansions rotting in the fields of the Central Valley or Florida or wherever, that can't be sold anywhere approaching the value of the mortgage," he said, a jolt of taxpayer liquidity to restore confidence may not be the last step.
Carolyn Lochhead was the Washington correspondent for the San Francisco Chronicle, where she covered national politics and policy for 27 years. She grew up in Paso Robles (San Luis Obispo County) and graduated from UC Berkeley cum laude in rhetoric and economics. She has a masters of journalism degree from Columbia University. Twitter: @carolynlochhead