The $750 trillion bailout plan that the Senate approved, and which the House is expected to endorse reluctantly, could give us all a little more breathing room in the current economic crisis, but it wonâ€™t resolve anything. Itâ€™s much the same plan the House voted down a few days ago, with a bushel of tax breaks calculated to draw more votes but unrelated to the turmoil in the capital markets. It should stave off a short-term panic, but it wonâ€™t stabilize the credit or housing markets. Such a little impact seems hardly an effective use of $750 billion.
Itâ€™s hard to know how many members of Congress understand the forces seizing the financial system or how this plan would actually affect it, especially since the Treasuryâ€™s original three-page plan outline has become a highly complicated, 750-page piece of legislation. Most lawmakers know they have to act quickly to at least begin to address a crisis thatâ€™s become a critical focus for the voters most of them will face in five weeks. The truth is, economists donâ€™t agree on the best course, with a broad range of theories and proposals â€” and telling agreement on not much more than the likelihood that the governmentâ€™s plan wonâ€™t do the job. Itâ€™s not even likely to get all of us through the general election on November 4 without further upheaval.
To be fair, most members of Congress are caught between two opposing and very discomforting forces: Pass a bailout plan that will anger many of their constituents, or reject it and be held responsible for the next wave of economic shocks. Itâ€™s a fact that the markets will slide sharply and quickly if they believe that the government cannot pass any response â€” but also that this plan will only modestly soften or delay those consequences.
Why are we all left with these two sorry alternatives? Iâ€™m afraid weâ€™re all prey to what economists call path dependence, when an outcome is heavily influenced by how a development began. A classic example is the ubiquitous success of Microsoft Windows. Itâ€™s arguably not the most efficient, powerful or effective operating system, and a rational market would normally have moved to other systems over time. But personal computing started with DOS, people and institutions became invested in its particular approach to the technology, and it continues to prevail. In this case, the Treasury hadnâ€™t developed a plan even as the crisis unfolded, responding in an ad hoc way to the collapses of Bear Stearns, Merrill Lynch, Freddie Mac and Fannie Mae; bailing out some and not others based on their judgment of the moment about whether a rescue was needed to avoid system-wide panic.
By last week, after letting Lehman Brothers fall and facing a real prospect of multiple major failures and bank runs, the Treasury pulled together a three-page outline which it called a plan. And once that plan was distributed, it became the focus and organizing principle for the congressional debate, and path dependence took hold. The plan is inadequate â€” it doesnâ€™t recapitalize financial institutions nor address the underlying deterioration in the housing market â€” but without a substantial period to bone up and consult experts, most members of Congress donâ€™t have the ability to step back, ask basic questions of the plan, and approach the crisis in a different way.
Ironically, this suggests the same â€˜best case scenarioâ€™ thinking that the Treasury and Federal Reserve have brought to this problem for two years, and which the Bush Administration has used for even longer in Iraq.
For now, this is the only plan we have. It should have some benefits. For $750 billion, or several million dollars per-American, we will place a floor under the losses of financial institutions for their speculations in the market for housing-based securities and derivatives. Our own best-case scenario is that this floor will be enough to attract outside equity investors for these institutions, recapitalizing the system over the next six months or so. But the bill includes only weak and marginal steps to help stem the foreclosures and falling housing values driving this crisis; and if the floor is not enough the attract outside equity investors, we will be right back where we started fairly quickly.
We could face the next phase of this systemic crisis soon, and as the problems spread across Europe and into Asia, intensified by a deepening recession, it could well be a dominant problem well into 2009 and the first great test for the next president of the United States.