Just one week ago, Treasury Secretary Henry Paulson was demanding that Congress grant him unprecedented, unreviewable authority to spend $700 billion or more to bail-out Wall Street. But in a major rebuke to the administration and to both the Republican and Democratic congressional leadership, the House voted down the 110-page plan that emerged from last weekend´s frenzied — if not unseemly — effort by Mr. Paulson to salvage a bailout deal.
The Dow dropped some 10 percentage points in reaction to the House vote and, while that was less than a third of the massive percentage drop it suffered in 1987, it shouldn´t surprise anyone that Wall Street was upset at being denied at least $700 billion of taxpayer´s money to practice more of what got it into trouble in the first place — buying up over-valued mortgage-based securities. A majority of members of Congress correctly concluded that the leadership-backed bailout bill was, to put it mildly, bad and that the closed-door sessions that spawned it were deeply flawed as well.
Perhaps at long last, some basic understanding of economics is seeping into the Capitol. Dare we hope that some members now understand the fact that Congress can only redistribute, not eliminate, the pain of an economic downturn? At a minimum now, as a result of the House “no” vote, Congress has time to seriously consider alternative strategies and it needs to press its advantage.
The starting point should be private market adjustment. With the knowledge that an easy government bailout is no longer around the corner, the markets can get serious about working through the mountain of bad debt that imperils homeowners, banks and companies alike.
Unfortunately, artificial booms inevitably lead to painful busts, but these can be productively addressed. Today, this means a mix of bankruptcies, company workouts, and takeovers as we are seeing in the banking sector and outside investors buying large pieces of companies, such as Warren Buffett´s $5 billion investment in Goldman Sachs. This process will reward more responsible firms and encourage them to move early to correct past mistakes.
Many companies also will have to sell mortgage-backed securities. Obviously, companies holding over-valued mortgage-based securities (MBS) prefer to dump bad securities on the government than sell them in a down market. But there is a market even though asset values are uncertain. Merrill Lynch liquidated its MBSs in July.
Bailout advocates simultaneously tell us that these assets are “toxic” and are destroying firms, but which magically at the same time are possessed of value that will ultimately make money for the government if it is allowed to buy them with taxpayer funds. However, good business leaders know that private investors are better able than government officials to dig out that hidden value. Private buyers, too, could participate in reverse auctions and hire asset managers on their dime, not the taxpayer´s. This adjustment process should be carried out in the marketplace — not behind closed doors in Washington.
Both Congress and the administration should focus on cleaning up the mess, not making it potentially far worse. Federal and state authorities need to begin to aggressively prosecute fraud in private markets; fraud that has resulted in trillions of dollars of grossly and deliberately, if not criminally negligently, overvalued mortgage paper. The goal is not to create scapegoats, but to keep markets clean. At the same time, we need a thorough investigation of the misbehavior of public officials in spurring Fannie Mae and Freddie Mac, for instance, to engage in reckless lending. Many of the politicians leading the attack on Wall Street for its failures worked overtime to create the subprime lending debacle.
Congress should rein in the Federal Reserve System. Over the last decade the Fed has followed an easy money policy designed to spur economic growth. But this encouraged irresponsible lending and inflated property values. Increasing the money supply is a bit like mainlining heroin — it´s pleasant while you´re doing it, but it´s extremely painful when you finally stop. Yet as currently configured, the Fed is neither transparent nor accountable.
Congress must say never again with Fannie Mae and Freddie Mac, which lowered mortgage standards and pushed people into new or larger homes than they could afford. These government-sponsored enterprises must be privatized; there must be no more implicit or explicit public guarantees for mortgage lending.
Congress needs to repeal the Community Reinvestment Act. The CRA effectively forces banks to lend to poorer communities irrespective of the creditworthiness of borrowers. Many of the same legislators who demanded increased bank lending in the inner-city now criticize banks for making “predatory loans.” Agencies such as the Securities and Exchange Commission need to suspend the mark-to-market accounting standard and reconsider its application. The rule makes sense for trading assets, especially where values are well established; however, the standard has a perverse impact when applied to long-term income-producing assets in a volatile market. A single major, bad sale can force a major corporate write-down, artificially crippling an otherwise creditworthy firm.
We need better, more streamlined regulation, not more regulation. There are a multitude of government financial regulators, leaving us with expensive controls, but without the transparency most needed by customers and investors.
Finally, we must control federal spending. Where is the $700 billion or more for a bailout supposed to come from, in a government already drowning in deficit spending and a spiraling national debt? Who will bail-out the federal government when investors at home and abroad refuse to buy its paper Instead of attempting to ram through a new version of this bad bill, the president and congressional leaders should announce that a government bailout is off the table. Companies and institutions must focus on systematically working through their problems, in a transparent, focused effort, utilizing the tools in the government´s already-massive quiver of tools.
We must learn from today´s economic disaster lest, to paraphrase George Santayana, we repeat this painful experience in the years ahead.
Bob Barr, a former Republican congressman from Georgia, is the official candidate for president of the Libertarian Party.