The words that have come out of Washington this week about the state of the U.S. financial system have been frightening. So frightening that a skeptical Congress is considering — despite public outrage — sending as much as $700 billion of the taxpayer money to Wall Street.
As the Bush administration warns of dire consequences without the bailout, some accuse it of fear-mongering to gin up support for the plan. Still, many economists have bought the prognosis, even while arguing over the appropriate prescription, concluding that some form of intervention is required to dispel the fear paralyzing the financial system.
While the debate is going on in Washington, in many corporate offices, in company cafeterias, and around dining room tables, the financial crisis is impinging on plans.
“Loans are basically frozen due to the credit crisis,” said Vicki Sanger, who is now leaning on personal credit cards bearing double-digit interest rates to finance building roads and sidewalks for a residential real estate development in Fruita, Colo. “The banks just are not lending.”
With the economy already suffering the strains of plunging housing prices, growing joblessness and the new-found austerity of debt-saturated consumers, many experts fear the unraveling of the financial system could cause pain for years.
Without a mechanism to shed the bad loans on their books, financial institutions may continue to hoard their dollars and starve the economy of capital. Americans would be deprived of financing to buy houses, send children to college and launch businesses. That would slow economic activity further, souring more loans, and making banks tighter still. A downward spiral.
Fear of this outcome has become self-fulfilling, prompting a stampede toward safer investments. Investors continued to pile into Treasury bills on Thursday despite rates of interest near zero, making less capital available for businesses and consumers. Stock markets rallied exuberantly for much of Thursday as a bailout deal appeared in hand. Then the deal stalled, leaving the markets vulnerable to a pullback.
“Without trust and confidence, business can't go on, and we can easily fall into a deeper recession and eventually a depression,” said Andrew Lo, a finance professor at MIT's Sloan School of Management. The Bush administration has hit this message relentlessly. On Capitol Hill, Treasury Secretary Henry Paulson warned of a potential financial seizure without a swift bailout. Federal Reserve Chairman Ben Bernanke used words generally eschewed by people whose utterances move markets, speaking of a “grave threat.”
The pushback to the bailout reflects discomfort with the people sounding the alarm.
In the aftermath of the war in Iraq, President Bush carries a reputation in some quarters as someone who warns of deadly threats — real or not — when it suits his agenda. Paulson asked Congress for extraordinary powers to take bad loans off the hands of major financial institutions with a proposal that ran all of three pages. Subprime mortgages have been issued with more paperwork than Paulson filled out in asking for $700 billion.
Suddenly, people who have spent their careers arguing that government is in the way of progress — that its role must be pared to allow market forces to flourish — are calling for the biggest government bailout in U.S. history.
“We are in a very serious place,” said William Beach, an economist at the conservative Heritage Foundation in Washington. “There is risk of contagion to the entire economy.”