02 October 2008

Policy Researchers Support Financial Plan, with Reservations

They say the only certainty is that doing nothing is unacceptably risky

Washington economists debate the rescue plan and largely favor it, though some aspects are as cloudy as the Washington sky October 1.

By Burton Bollag
Special Correspondent

Washington — The five economics specialists on a panel at the Brookings Institution were not sure how the government’s $700 billion financial rescue package would be used or what it would accomplish. But they all support it because they believe the price of inaction could be even greater.

Could the crisis pass without this massive commitment of government money, as some economists and politicians have argued? It might, said Alice Rivlin, senior fellow at Brookings and former vice chairwoman of the Federal Reserve. But the possibility that the crisis could lead to a financial meltdown and a deep economic recession is too big a gamble to take.

“It’s a little bit like nuclear war,” she said. You don’t know what the result would be, “but you better do everything you can to avoid it.”

She and the others spoke October 1 in a Brookings-hosted discussion billed as “The $700 Billion Question.”  Analysts at several other Washington-based research organizations have taken up the topic, and they too largely come out in favor of the rescue plan.

Several economists with the Peterson Institute for International Economics support the “troubled asset relief program,” which is already referred to by its acronym: TARP.  “There is still time for the U.S. administration and the Congress to make something positive emerge from the delay in passing TARP legislation,” said Morris Goldstein, a Peterson economist.  “A revised and improved TARP bill can … increase the liquidity of mortgage-backed securities, while allocating more resources [than did the original TARP] both to recapitalization of our financial institutions and to mitigation of rising home foreclosure rates.”

Even researchers from the Heritage Foundation, which has “limiting government” among the goals in its mission statement, argue for congressional action.  “Faced with a crisis of this scale, lawmakers need to consider steps that would be out of the question in more normal times,” write Stuart Butler and Edwin Meese III in a recently published paper titled The Bailout Package: Vital and Acceptable.

At the Brookings meeting, William Frenzel, a former Republican congressman from Minnesota, said the initial opposition to the rescue package — the House of Representatives voted it down days earlier — was due to pressure from the “hard left and hard right.” The former did not want taxpayer money used to bail out investors; the latter felt the market was sacrosanct and should not be meddled with.

But after a few days, members of Congress increasingly heard from less ideological and more representative members of their constituencies, he said.  People may not have much faith in the government’s ability to handle the crisis, he said. But “the public knows there’s an emergency” and feels something needs to be done.

The five panelists all appeared optimistic that the rescue package was likely to bring the current crisis under control. But several stressed that Treasury Secretary Henry M. Paulson Jr. may get extraordinary powers to implement the government’s efforts, but he has no detailed road map. Instead, he will be moving without a plan as he tries to remedy a problem that emerged quickly.

Simon Johnson, senior fellow at the Peterson Institute for International Economics, used satirical flair to drive the point home. “I think the reason we’re frightened is [that] the most trusted public servants with regard to economic policy, the secretary of the Treasury and the chairman of the Federal Reserve, two weeks ago were continuing to tell the American people that the economy was … fine; we’re going to avoid a recession. Two days later, they showed up and they asked for 5 percent of [gross domestic product] in small unmarked bills to be placed in a paper bag outside Mr. Paulson’s office, no questions asked.”

Yet Johnson and other panelists seemed to accept that in this extraordinary situation, there was little alternative to giving Paulson the authority to make deals to purchase the so-called “toxic” securities that no one else wants to buy, to get the credit markets functioning again.

William Gale, director of economic studies at Brookings, said Paulson would need a free hand. “You can’t constantly be coming back to some congressional board for oversight or approval,” he said.

Brookings panelists said the Treasury Department should use the rescue funds in a transparent manner. After all, they said, the crisis was brought on in part by a lack of transparency around the widely held mortgage-backed financial instruments, leaving investors unsure of their true value.

The speakers said the government could determine the worth of these financial instruments by quickly re-auctioning a small part of the securities it buys. “We know there are investors out there. ...  They’re waiting to buy,” Johnson said. Economists say that in the best-case scenario, the government could make a profit selling off the securities after the market stabilizes and prices rise.

One way to make the market more transparent in the future, panelists said, is to reform the way the credit-rating agencies operate. Investors from the United States and around the world typically relied on credit ratings to determine the risk of complicated mortgage-based securities. But critics say these agencies did not do their job and often gave such securities higher ratings than they deserved.

“It’s manifestly not working to have the rating agencies paid by people who want to sell the thing that they’re rating,” Rivlin said.

She added that, after the current crisis is remedied, there is an urgent need to regulate financial markets after several decades with little oversight. “A lot of this could have been avoided if we had sensible lending standards on subprime mortgages.”

See “How Will Washington Prevent Another Financial Crisis?”

Staff writer Andrzej Zwaniecki contributed to this article.