Warning $700 Billion: Handle with Care

Treasury Secretary Paulson needs help and oversight if U.S. taxpayers are going to help the nation weather the global financial crisis, writes Michael Ettlinger.

Treasury Secretary Henry Paulson, left, and Ben Bernanke, chairman of the Federal Reserve, testify before the Senate Banking Committee on September 23, 2008. (AP/Susan Walsh)
Treasury Secretary Henry Paulson, left, and Ben Bernanke, chairman of the Federal Reserve, testify before the Senate Banking Committee on September 23, 2008. (AP/Susan Walsh)

U.S. Treasury Secretary Henry Paulson’s initial proposal for the giant Wall Street bailout would have given him, as secretary of the Treasury, the personal authority to spend $700 billion of taxpayers’ money to buy troubled financial assets on any terms he saw fit. He would then be authorized to sell these assets, also without limitation. Under his proposal, his actions are explicitly exempted from review by any court or administrative body.

Congress appears to be moving Paulson off these extreme terms, but any final deal should rest meaningful control, true decision-making authority, not in one person and certainly not with the secretary of the Treasury of an administration that, in large part, authored this crisis. Paulson along with the rest of the Bush economic policy apparatus—and in fact all of those who are ideologically resistant to a role for government in the economy—are deeply implicated in the mess we’re in. Whether we call it incompetence, gross negligence or ideology run amok, no action was taken as the economy, and the financial sector in particular, grew more and more dependent on a mass of untenable loans in over-valued assets.

Since that bubble began to burst they have dragged their feet in taking the kind of comprehensive action that’s been needed—resisting congressional attempts to fix the housing market and calls by the Center for American Progress, among others, to jump in to stop the bleeding before it ever reached this stage. More aggressive action has been needed for months to preserve the value of homes for the benefit of homeowners, to protect the value which underlies the mortgage-related assets in the hands of investors, and to prevent the loss of so much value in our overall economy.

Now, Secretary Paulson, after seeing the problems move beyond homeowners to become an impossible-to-miss bloodbath on his home turf of Wall Street, finally recognized the need for action. So, after dawdling for many months, during which a sensible, well-thought out plan could have been devised, he has sprung a plan to put truly gigantic sums at his disposal with virtually no oversight, and told Congress they must pass it in a period of days because the crisis is at hand.

The situation has precedent. The last time the government was run by those who believe that the best route to economic prosperity is to hand the keys of the economy over to the financiers and tell the traffic cops to stay home, we ended up with the savings-and-loan scandal of the Keating 5, a slew of bankrupt banks, and the Resolution Trust Corporation to fix it. As we’ve seen time and again, for markets to work well the rules of the road need to be enforced and adults have to be looking over the market’s shoulder to make sure it’s not heading for a ditch. That’s not over-regulation; that’s responsible supervision of the economy for the benefit of everyone.

Treasury Secretary Paulson must be involved in the solution to the problem he contributed to creating. But giving him carte blanche over $700 billion of taxpayer money is not a solution with which Americans should feel comfortable. A program of this magnitude should have a decision-making board overseeing it.

It is, of course, never a good idea to give any single person this much power over this much money. In fact, outside of dictatorships it’s unclear whether it’s ever been done. Whatever we may think of Secretary Paulson’s integrity this would be a dangerous precedent.

Another concern is Secretary Paulson’s bias toward Wall Street-centered solutions. Paulson is a creature of Wall Street—that’s where he made his estimated $600 million of personal net worth. Throughout this challenging period his focus has been very much on the financial security of large investors. The plan itself is squarely aimed at getting the investment community back on its feet. But our ultimate goal here is presumably to free up the capital and credit markets so businesses and people can again borrow and invest to the benefit of the economy and American families. Accomplishing that requires a broader set of considerations than propping up Wall Street:

  • Valuing the assets the government purchases is going to be a difficult task and, while it is in Wall Street’s interest to overcharge, it is not in the nation’s interest to overpay. If $700 billion is paid for assets that prove to be worth much less than that it will do more harm than good—driving up the deficit and diverting resources from investments that are important to our economic strength.
  • The more assets that are bought the better off Wall Street is. But the $700 billion is not an amount that has been calculated with any precision. Less than $700 billion may suffice to stabilize the markets—no one knows for sure. If the interests of Wall Street are the dominant consideration in the spending of the funds, however, it will certainly be all spent whether it’s the best use of those resources or not.
  • The Center for American Progress has long argued that to be successful the program needs to do more than save investors—it also must boost home values and the value of the mortgages and the securities they underpin. Doing that will require re-writing mortgages. Paulson, while giving lip service to the idea has clearly not embraced it—and it is unlikely that he will give this a high priority even if the legislation calls for him to do so.

A well-constituted board would bring the diversity of interests to the table to ensure that this massive investment best serves the needs of the entire economy and the nation. The board would represent the interests of taxpayers when setting the criteria for the asset purchases and by (as the deals are made) evaluating whether the funds are being well spent—and put the brakes on the program if they are not. A board would weigh the value of further purchases of assets versus the risks of further increasing the national debt and undermining the nation’s ability to make other investments. A board would ensure that the assets, once taken over, are managed in the most effective way for homeowners, to spur an economic recovery, and to bring value to the assets now in public hands.

The Bush administration will argue that the program needs to be nimble and that a board would slow it down. The role of the board, however, won’t be to get into the nitty-gritty of implementation—that must be left to the Treasury. But there is an important role for a small board of people of good judgment with deep knowledge, representing the needs of homeowners, creditors and others that could quickly assess the tradeoffs between speed versus prudence—representatives from the Federal Deposit Insurance Corporation and the Department of Housing and Urban Development are a good place to start. There is a risk that even a well-constituted board will make bad judgments but there is a greater risk that Paulson will be acting on his own.

In addition to a board, there are other accountability provisions needed, among them:

  • Frequent reporting to Congress and the public on the volume of transactions and their nature
  • Disclosure regarding the handling of the transactions. This program will be implemented by outside financial experts and firms, which raises issues of conflict of interest. There should be full disclosure of which individuals or firms are being hired to conduct the transactions, and the terms of the arrangements.
  • Return on investment to the taxpayers. One way to ensure that the purchases of the assets do not end up being a bad deal for taxpayers is to have, as part of the transaction, a continuing relationship with the seller of the assets. One approach, employed in the Chrysler Corporation bailout of the 1970s was for the government to obtain warrants in the corporations involved. This has the effect of allowing the government, and hence taxpayers, to benefit, as would a shareholder from the future success of the corporations involved. Thus, to the extent that any sale of assets to the government is skewed to the benefit of the seller, that benefit would at least in part, redound to the taxpayer in the form of increased value in the warrants.

In terms of the relative importance of these measures, only moving control to a well-selected board and warrants or other form of taxpayer equity offer much more than the chance to point fingers if things go awry. Reporting requirements and transparency are important because they will have some impact on behavior (people behave differently when their conduct is going to be exposed to the light of day). But given how much is at stake, the amounts in play, and the short time period over which much of this is going to happen, more is needed.

Michael Ettlinger is vice president for Economic Policy at the Center for American Progress. To read more about our proposals to cope with the U.S. housing and global credit crisis please go to our Economy and Housing pages on our website.

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Michael Ettlinger

Vice President, Economic Policy