This weekend, Treasury Secretary Hank Paulson proposed a bailout plan that can only be called "audacious." The administration is asking for literally unfettered authority to spend up to $700 billion of the taxpayers' money to buy underperforming assets from banks.
In case you were wondering, $700 billion is a lot of money. It's almost a quarter of the entire federal budget for 2007. It's also enough to fund about 51/2 years of the Iraq war. It's $170 billion more than the entire Defense Department budget for 2007. It's more than 5 percent of the entire economic output of the U.S. for last year.
The crisis has its roots in the housing bubble. Financial "innovations" allowed people to buy houses at prices far above what they could afford. Introductory periods of two or three years made the homes look affordable, but it was predictable that the mortgage payments would rise to levels the households couldn't pay, particularly if interest rates rose. The mortgages were repackaged into clever financial instruments that were very profitable as long as borrowers paid on their mortgages but lost value if those payments stopped.
But payments rose (partly because interest rates rose), borrowers defaulted, and assets based on mortgages became questionable, in some cases worthless.
It's important to recognize that there are two distinct problems here. First, we know that many entities in the economy have lost a lot of money. That is everybody's problem, because if there's too much uncertainty, then normal lending seizes up, and businesses that are fundamentally profitable can't get the cash flow they need to keep operating.
Second, we don't know just how big the losses are or who has lost exactly how much. That is everybody's problem too, but for a different reason.
The financial paper based on those fairy-tale mortgages looked great, and so did the stocks of the companies that got rich off of issuing and repackaging them. So they found their way into private and public pension funds and individual retirement accounts. With such seemingly great returns, everyone could save less for retirement and spend more now. Inflated house prices had similar effects on homeowners, as well as making it easier for them to borrow. Governments came to rely on the taxes from all this apparent wealth.
But it was apparent wealth (and here in New York state we're disproportionately affected, having disproportionately benefited from Wall Street when times were flush). We're not as rich as we thought we were, and no government action can make that fact go away.
What government can do is help resolve the uncertainty. It can set up a sort of "safe haven" where financial institutions can figure out their losses without investors punishing them for the mere act of looking honestly at their books.
Just as important as this near-term medicine is basic re-regulation of the financial sector. The industry has now admitted that it needs the backstopping power of the federal government.
But for it to rely on government support while being free of any meaningful government oversight and control is an absurdity. It's a combination that dwarfs the incentive problems of traditional welfare programs. And the regulation needs to come with the bailout "" once the bailout is in place, the banks will fight regulation like crazy.
And we need an above-board process to figure out the losses and assign them in a fair way (though "fair" will always be a contentious idea).
Instead, we've been offered a process where we'll most likely buy banks' assets for far more than they're worth, but we'll never even know that, because Secretary Paulson wants there to be no oversight, no appeal to the courts, and no application of standard contract law.
All that for $700 billion _ $2,300 for every person in the United States. So do you feel confident now? Well do you?
Seeley is an associate professor of economics at Hartwick College in Oneonta.