Passing the Rescue Package Isn’t Enough

Oversight and further steps will be key to the rescue bill’s success, write Michael Ettlinger and Andrew Jakabovics.


Congress did what it had to do today in passing the financial rescue package—with understandable reluctance by many of its members. The administration was much too late in moving past stop-gap measures to address the problems in the credit markets and then dumped poorly thought out legislation on Congress under the threat of imminent financial collapse. The legislation improved in the negotiations of last weekend, but still fell far short of ideal. Nevertheless, given the state of credit markets and the threat that their condition poses to the well being of all Americans, passing the bill was the most prudent course.

There is still a chance that the legislation will not achieve its goals and will put a huge cost on taxpayers. Notwithstanding the improvements made by Congress, better, more deliberately crafted, legislation would have made that outcome less likely. More optimistically, in the best case scenario:

1. The government restores lenders’ confidence in their own and others’ financial condition, provides them cash to lend, and lending returns to normal, primarily by virtue of the U.S. Treasury taking assets of uncertain value off the books of banks and other institutions. This in turn allows businesses, individuals, and state and local governments to sustain borrowing again, thus avoiding job losses, missed paychecks, and empty store shelves as businesses face cash shortfalls. It also avoids cutbacks in individual credit such as auto loans, student loans, and credit cards, the consequences of which would have spread around the country.

2. The Treasury uses its authority under the legislation to manage the assets it purchases well, ensure that those on Wall Street don’t get windfalls, and protect taxpayers’ interests. One such step is working to modify as many mortgages as possible leading to mortgage-related assets rising in value.

3. The assets purchased by the government are purchased with care to maximize the effect that the plan has on the credit market and ensure that taxpayers get good value for their $700 billion—eventually recouping it all, or even making a profit, as the assets are sold.

Unfortunately, there is no guarantee this will happen, and even if this does happen, there are other important actions needed to restore the economy.

There are a number of steps that the federal government can take to make sure that the results come as close as possible to the best-case scenario.

First, there must be very close supervision of the Treasury as it buys and manages assets. The bill creates an oversight board that consists of the Treasury secretary, the director of the Federal Housing Finance Agency, the Federal Reserve Bank chairman, the HUD secretary, and the SEC chairman. Congress is also authorized to maintain close oversight with its own five-member oversight panel.

These overseers should pay particular attention to the quality of assets and the way they are being purchased. For $700 billion, the public deserves assets that are worth, or soon will be worth, $700 billion. How the assets are purchased—one-by-one or through an auction process—and who handles the transactions—outside firms with conflicting interests or others—may go a long way in deciding what the assets end up being worth. Keeping a close eye on the process, as well as the actual quality of the assets being purchased, will be vital to ensure that the taxpayers get their $700 billion worth.

Second, Treasury should focus its purchases on mortgage-related assets. The legislation authorizes purchase of a broader array of assets. These other assets are not at the core of the problems in the financial markets, and their value is not subject to the same uncertainty as mortgage-backed assets. Their purchase by the Treasury is therefore less likely to produce the desired effect on the credit markets.

Third, the Treasury is obligated under the law to develop a plan to mitigate foreclosures and encourage servicers to modify mortgages. Modifying mortgages is very important to restoring their value and addressing the underlying problem that generated this crisis—declining home values and mortgage assets.

Fourth, in addition to making necessary modifications to existing mortgages where possible, we must not lose sight of the devastating effects that foreclosures have on neighborhoods. Recognizing that not all homeowners will be able to avoid foreclosure, Treasury must develop an asset disposition plan in short order that seeks to minimize the effect of the sale of foreclosed properties on surrounding home values. To the extent possible, Treasury should work with HUD and its new neighborhood stabilization program to rapidly identify buyers committed to the program’s goal of creating sustainable, affordable homes.

Even if those things are done and the plan is a success, there is more to do:

Even if the Treasury Department acts in completely good faith and does everything it can do to modify mortgages—something we shouldn’t count on—more needs to be done to allow mortgage modification to happen at the scale that is needed. Overall, there remains a serious concern that Treasury will be unable to gain a controlling interest in the individual mortgages that have been pooled for securitization into mortgage backed securities (and for which ownership and decision-making authority regarding the mortgages may be widely dispersed).

Loan servicers who directly manage the mortgages have so far been unwilling to make widespread or substantive long-term modifications, in part because of concerns about investor lawsuits over breach of fiduciary duties. Without legal protections to allow servicers to participate actively by offering individual mortgages or entire pools of mortgages for sale to Treasury, these servicers will likely remain on the sidelines as they’ve done until now. Unless Treasury can gain a controlling interest in any given mortgage pool, they basically can cajole servicers all they want, but have no basis for compelling modifications to be made. Action is needed to address this problem, both to address the liability issues and to create greater incentives for loan modifications. Action outside of the parameters of the rescue package may also be needed.

In addition, the regulatory framework for the securities markets needs to be addressed. While the Bush administration had all the power it needed to stop this crisis from happening and reduce its impact as it developed, once it got to the point of damage control, the lack of authority to take action in some areas of the financial markets became problematic. Expansion of regulatory authority should be addressed as soon as possible. Broader regulatory reform should also be pursued to create an institutional structure that makes a crisis of this sort less likely in the future.

The federal government should address other short- and medium-term issues in the economy through a stimulus package that should include:

  • Creating jobs by jump-starting our transformation to a low-carbon economy. The CAP Green Recovery proposal would create 2 million jobs over two years by investing in six green investment areas.
  • Investing in infrastructure. Investment in highways, roads, and mass transit would be a robust source of jobs.
  • Expanding unemployment insurance. With only 37 percent of jobless workers qualifying for benefits, and periods of unemployment getting longer, Congress should temporarily increase unemployment insurance and extend coverage for those who will not get it otherwise.
  • Increasing energy assistance. With cold weather approaching, Congress should provide expanded funding to the Low Income Home Energy Assistance Program.
  • Expanding Medicaid aid to the states. As more people lose jobs and income, more people qualify for Medicaid, but states have often scaled back on the program because of their budget crises. A proactive Medicaid policy would help preserve health coverage, jobs, and state financial stability—all of which will help to an economic recovery.
  • Boosting food stamp support. Low-income families are particularly vulnerable to a weak job market and boosting food stamps both helps those families and provides a mechanism for quickly boosting spending in the economy.

The economy didn’t turn bad overnight. The fall in housing prices precipitated a financial crisis made inevitable by years of slipshod regulatory oversight. Stagnant incomes and weak job growth have been the norms this entire business cycle. There are fundamental changes that we need to make for our economy to be successful in the 21st century. Transforming to a low-carbon economy, reforming our systems of health care and education, building support for innovation, restoring fairness and adequacy to our tax code ,and other measures outlined in Progressive Growth are the path ahead for the long term.

Note: In addition to the rescue package that was passed, the legislation included the $107 billion “tax extenders” bill, which until now has been bouncing back and forth between the House and Senate. The bulk of the cost of these tax extensions involve some politically essential enactments such as the annual “fix” of the alternative minimum tax to prevent more of the middle class from falling into this non-inflation-adjusted tax net. Other worthy provisions include renewable energy tax credits, and the expansion of the child tax credit to benefit lower-income families. Other less savory business tax breaks were also included.

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Michael Ettlinger

Vice President, Economic Policy