Congress Approves Bailout

Congress has passed the bailout now that the three page bill has expanded in size a hundredfold and it has been larded with some good old pork:

With the economy on the brink and elections looming, Congress approved an unprecedented $700 billion government bailout of the battered financial industry on Friday and sent it to President Bush for his certain signature.

The final vote was 263-171 in the House, a comfortable margin that was 58 more votes than the measure garnered in Monday’s stunning defeat. The vote capped two weeks of tumult in Congress and on Wall Street, punctuated by daily warnings that the country confronted the gravest economic crisis since the Great Depression if lawmakers failed to act.

[…]

The House vote marked a sharp change from Monday, when an earlier measure was sent down to defeat, largely at the hands of angry conservative Republicans.

Senate leaders quickly took custody of the measure, adding on $110 billion in tax and spending provisions designed to attract additional support, then grafting on legislation mandating broader mental health coverage in the insurance industry. The revised measure won Senate approval Wednesday night, 74-25, setting up a furious round of lobbying in the House as the administration, congressional leaders, the major party presidential candidates and outside groups joined forces behind the measure.

It worked — augmented by a sudden switch in public opinion that occurred after the stock market took its largest-ever one-day dive on Monday.

It seems that, this time at least, the Senate was the cup and the House the saucer.

Update (Steve Verdon):

Well this abortion of a bill has passed and I guess the best we can say is, I hope it works. Why might it not work? Well there are lots of problems with this bill. This post over at Greg Mankiw’s blog lists some of the problems (note the bulk of this post is from an e-mail another economist sent to Prof. Mankiw and are not Prof. Mankiw’s own views).

With a theory of the problem, we can now ask whether the Paulson plan would solve it. My understanding is that the $700 billion would be used in a series of reverse auctions. In such an auction, the government would announce its intent to use some amount of money to purchase a particular class of security. Financial institutions would then compete by offering the most securities at the lowest price. I think we can agree that it is implausible that the government would be better than other buyers at determining the current value of the stream of payments from those securities. This gives financial institutions a strong incentive to sell the government their lowest quality securities at the highest possible price. Indeed, the government seems to want sellers to unload their worst assets so as to improve their balance sheet, so there really is no conflict of interest here.

This program does not solve the lemons problem. The government purchases a lot of lemons at an inflated price. This improves the balance sheet of the firms that can sell their worst securities. It also improves the balance sheet of firms that own better securities because the market price of those securities will increase. (Of course, it cannot increase too much, or no one would sell to the government. They would wait to sell at the higher market price. I have not worked out the equilibrium of an auction with an option to resell later. It seems complicated.) But this is fundamentally no different than giving taxpayers’ money to owners, managers, and debt-holders of firms that made the worst decisions.

In other words, this “rescue” plan rewards those who behaved the most irresponsibly during the preceding bubble. And it isn’t clear that these firms are going to be in any shape to start lending again once they shore up their balance sheets by removing these toxic assets. Further are these the idiots we want to start lending again? Why not the firms that behaved more responsibly? This bill is sort of anti-Darwinian solution to the problem. Keep the stupid alive, let the smart die.1 And keep in mind that the smart firms, the healthier ones, are probably the one’s that will be the most likely to engage in new lending which is exactly what the main goal of this bill.

Further, this problem isn’t going to solve the problem with pricing these toxic assets. The government is going to buy that at the “hold-to-maturity” value. Nobody in the market right now wants to pay that. So how is such a purchase going to help reveal the actual market price of these assets?

And all of this on the taxpayers dime, and it might not work. We could still have the very massive credit crunch that people (Megan McArdle included) seem to fear so much. In fact, these people are so scared they ignored the advice of numerous economists who basically said, “Wait a second, there are better ways to do this.” I like the way John Cochrane put it,

There is a storm out on the lake, and some of the boats are in trouble. Commodore Bernanke has been helping to bail water from some boats until they can patch themselves up, encouraging other sound boats to help, and transferring passengers on sinking boats to others. But it’s getting tough and the storm is still raging. Someone has a great idea: let’s blow up the dam and drain the lake! Ok, it might stop the boats from sinking, but there won’t be a lake left when we’re done. That’s the essence of the Treasury plan.

Short of that, it will not work. Suppose a bank is carrying its mortgages at 80 cents on the dollar, but the market value is 40 cents. If the Treasury buys at 40 cents or even 60 cents on the dollar, the bank is in worse trouble than before, since the bank has to recognize the market value. Unless the Treasury pushes prices all the way past 80 cents on the dollar up to 90 or even 100, we haven’t done any good at all. And $700 billion is a drop in the bucket compared what that would take.

And look at the market today. It is down…quite a bit. People got their panties in a bind when stocks dropped about 7.5% a few days ago (Ezra Klein, Megan McArdle) and now we have a bail out and things still look like sh*t as far as the stock market is concerned. Maybe because people figured out $700 billion might not be enough for this plan to work, and that a large enough dollar amount to make the plan work would still be really bad for the economy?
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1This is one reason why I can’t, for the life of me, figure out why Megan McArdle so likes these various bills of this kind. My only conclusion is she got really scared and as a result figured even the stupid solution was better than no solution.

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James Joyner
About James Joyner
James Joyner is Professor and Department Head of Security Studies at Marine Corps University's Command and Staff College and a nonresident senior fellow at the Scowcroft Center for Strategy and Security at the Atlantic Council. He's a former Army officer and Desert Storm vet. Views expressed here are his own. Follow James on Twitter @DrJJoyner.

Comments

  1. Patrick T. McGuire says:

    It seems that, this time at least, the Senate was the cup and the House the saucer.

    Or they are both a toilet, depending on your view.

  2. Wayne says:

    The Stock market had a sharp decline soon after the bill pass.

  3. Web Smith says:

    How does it feel to be owned?

    Did everyone notice the media spin and blackout leading up to this vote? The media reported that more people were now favoring the bill when 90% of the calls were from people still opposing it.

    Bush and crew have now completed their theft of the country’s wealth. The elite are going to be chuckling and shaking their heads at the squalor they have created while Bush retires on the property that he bought in Nicaragua complete with Secret Service to protect him.

    The people who own the Fed are now angry at the American population and they will raise interest rates in an attempt to beat us into submission.

    There are 263 Congress members and 74 Senators that should not be returning to office and the President should not be selected from the major parties.

    http://ewebsmith.com/finance/CPResponse.html

  4. Buy on rumor, sell on news.

    The Bailout was so goddamned important that it had to have 15.7% added to it in pork to get it to pass.

    Nice country we had.

  5. anjin-san says:

    Guess McCain can resume his campaign now…

  6. Beldar says:

    Nothing which was not a crap sandwich would ever have gotten a floor vote in Speaker Pelosi’s House. It’s well and good to talk about what kind of bill you’d rather have seen, but that was never going to happen. Ever. Period. That’s just the political reality.

    This or nothing? I’ll take this, reluctantly.

  7. Steve Verdon says:

    And when it doesn’t work Beldar? Seriously, that $700 billion number was pulled out of someone’s ass, not the result of serious analysis.

    In the end you’ll likely have two shit sandwiches…enjoy.

    Oh, and another reason why democracy sucks. Even when you know something is a crap sandwich your elected officials make you eat it anyways. Lovely.

  8. Steve, FWIW as my company’s 401-1(k) Plan Administrator I sat through a webinar Thursday with our provider. Generally they are doing what they can to dampen fears about volatility, but they did have (perhaps inadvertently) some scary looking charts on credit ratios. My initial thoughts were that it was looking like a liquidity crisis was developing rapidly.

    So, I reluctantly believe something had to be done, but my utter disgust and disdain for Congress and its need to lard it up remains unabated.