To hear Henry Paulson and Ben Bernanke tell it, there is only one plan to save the economy – use $700billion in taxpayer money to take the worst of Wall Street's assets off its books.
But leading economists and financial thinkers argue there are a host of alternatives that would reduce taxpayers' liabilities and perhaps better address the crisis in financial markets. These experts concede the clock is ticking, but say different approaches have been dismissed too quickly.
One approach seeks to reduce taxpayers' liability by offering collateral-backed loans to troubled banks, leaving them to work out their own solutions. Another idea is to have the government set up a profit-driven investment fund with the aim of infusing the financial system with cash without taking on bad debt. Still others suggest radically different tactics of directly helping homeowners by reducing mortgage principal or bolstering banks by suspending capital gains taxes.
The administration has said it is willing to negotiate key parts of its plan – including a possible concession allowing the government to take equity stakes in financial firms in exchange for bailing them out. But senior officials stand by the fundamental approach they have adopted.
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“They presented this as a comprehensive, decisive solution, but it's clearly not comprehensive and probably not decisive,” said Simon Johnson, a former chief economist at the International Monetary Fund and a professor at Massachusetts Institute of Technology.
A mistake could result in a catastrophic collapse of the U.S. financial system that could ripple across the world, or in a staggering cleanup bill for taxpayers.
At the core of the debate is whether Paulson, the former CEO of Goldman Sachs now charged with rescuing Wall Street as Treasury secretary, and Bernanke, the Federal Reserve chairman and one of the leading academics on financial crises, are serving up the best recipe for purging the U.S. financial system of billions of dollars in distressed mortgage-related debt.
Under the administration's plan, the Treasury secretary would have broad discretion to buy up to $700 billion in troubled mortgage-backed assets and other securities that Wall Street firms have been struggling to sell. Administration officials hope that once those assets are cleansed, money will flow freely through the financial system once again and that the government can keep the securities until they recover some of their value.
On Capitol Hill Tuesday, Bernanke and Paulson testified that they formed their plan after considering past crises, from the U.S. savings-and-loan bailouts of the 1980s to the bursting of Japan's economic bubble a few years later. But they ultimately decided that the response to the current crisis needed to be a fast and massive fix.
“The situation we have now is unique and new,” Bernanke said. He later continued, “The firms we're dealing with now are not necessarily failing, but they are contracting. They are de-leveraging. They're pulling back. And they will be unwilling to make credit available as long as these market conditions are in the condition they are.”
Many alternatives fall under four basic approaches:
Government as lender:
The government could offer loans to troubled banks, letting them put up sickened portfolios of mortgage-backed debt as collateral.
Government as hedge fund:
Instead of letting Wall Street dump the worst kind of mortgage securities on the federal government, the government could establish a fund that limits its purchases to profitable mortgage securities and other assets.
The government could buy some mortgage-backed securities and restructure the underlying loans into something homeowners could afford. The value of the securities, both those bought by the government and those in private hands, could improve as foreclosures and late payments drop.
Tax breaks for Wall Street:
Repeal the capital gains tax for two years, which would provide Wall Street a stimulus to reinvigorate the financial system.