During my daily chronicle of the Panic of 2008, I’ve had occasion once before to say that the fever has broken. That was a week ago Friday, after Secretary Paulson first announced the outlines of his plan to buy up to $700 billion in distressed mortgage-backed paper.
I’ve also had several occasions to tell you that officials at the Fed had taken extraordinary actions in the dead of night to stem an immediate emergency. This morning, it’s Congress’s turn.
Around 12:30am this Sunday, a gaggle of Democratic leaders, joined by Senator Gregg and Representative Blunt, announced that their labors were nearing completion, and the great Augean stables of Wall Street would be cleaned out.
We’ve had many rumors over the past week that Congress had arrived at this point. So the first challenge is to make sure that it’s for real this time. Secretary Paulson thinks it is, and this is the first time he’s said so. That’s an encouraging sign.
Congressional staffers expect to be feverishly writing this legislation throughout the day today, so I can’t tell you what’s going to be in and what’s not.
The whole controversy turns on the great many additions to the basic securities-purchase plan, that were inserted at the insistence of both Democrats and Republicans. The basic idea remains intact.
Whole rafts of ideas for modifications of the proposal have been floated from academic economists, business people, and finance executives all week. None of them benefited from the luxury of time, so although many had merit, some were just plain bizarre and will end up embarrassing the experts who proposed them.
And ultimately, most were beside the point. One basically good idea that will probably stay in is to allow the government to take warrants in financial firms that participate in the bailouts.
One superficially-reasonable but potentially dangerous addition is that Congress will have powerful oversight capability over the implementation of the deal. When you’re trying to install something that’s supposed to act as a defibrillator for a stopped heart, it’s not necessarily a good thing to have someone looking over your shoulder who considers slow action to be a virtue.
One idea that I regarded as ridiculous appears to have hit the cutting room floor, but not before creating at least a fear last night that the negotiations would be derailed yet again: it was proposed to require banks and Wall Street firms to purchase insurance from a new government agency, to protect against defaults in their portfolios of distressed assets.
It’s supposed to be like the FDIC, which is funded by insurance premiums that all banks must pay. The idea was supposed to relieve some of the political pressure by requiring that the firms who receive assistance pay for it themselves.
But how can you provide insurance against an asset class that is showing systemic distress, rather than distress that is caused by isolated failures? It would basically have to cost just about as much as the originally-proposed bailout, if not more.
And if the goal is to work with companies that are undercapitalized, how does it help to make them pay for the aid you give them?
Anyway, this insurance idea is reported to have been changed from mandatory to optional. And another bullet was dodged.
Although world financial markets turned in an outwardly calm performance last Friday, the tension on Wall Street was extreme. Every passing day brings the risk of yet another major bank failure or other disaster, and we’re not out of the woods yet.
This weekend may yet see one or two more failures. JP Morgan Chase, which had been negotiating with Washington Mutual over the last few weeks, set the pattern: don’t negotiate, wait for the distressed institution to hit the wall, then swoop in on the body and pick up the choice cuts for a fraction of what you would have spent before.
Morgan Stanley stopped negotiating with Wachovia a few days ago. I will say no more.
I’m quite confident that Members of Congress finally heard the steadily-increasing rain of warnings from Wall Street, that the system was edging steadily closer to a major shock. Congress has been simply paralyzed with fear over the political risk of passing legislation that the vast majority of Americans are just disgusted with.
They finally understood that they couldn’t wait any longer.
Now what comes next? Well, the markets open the new week in Asia about twelve hours from now, and we’ll see how they react.
After that, we have two discussions, one large and one larger.
The large question is: will the Paulson plan actually improve the economy, in addition to relieving the pressure on Wall Street? We know it will do the latter. The former is much more iffy.
The larger question is: now that we have kicked off the New New Deal and socialized the United States financial system, what if any will be the role of free markets going forward?