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  • The Week on the Hill

Whatever you think of the emergency financial plan presented to Congress by the Treasury Department and the Federal Reserve Board this week, you can no longer accuse the Bush administration of dithering or denial. Although support for a revised measure appears to be coalescing on Capitol Hill, the dithering charge would be better aimed at many in Congress.

The proposal hurriedly put together by Treasury Secretary Henry Paulson Jr. and Federal Reserve Chairman Ben Bernanke last weekend was staggering in its scope, countenancing outlays of $700 billion on impaired mortgage-backed securities, together with an unprecedented freedom of maneuver in the disbursement of that enormous sum. Understandably, and no doubt inevitably, Congress was reluctant to swallow all of this whole. But were its initial skepticism and its demands for changes wise?

The honest answer is that it is impossible for a bystander to say. Even Treasury and the Fed, with all the information at their disposal, are flying blind. An outsider, with so much less to go on, can only guess. But if I were in Congress, I would have been inclined to let the plan go through as drafted, and here is why.

If Paulson and Bernanke are right about the gravity of the situation, then speed is crucial. Every day's delay in bringing support to the country's credit system risks an accelerating, self-reinforcing cycle of financial breakdown and economic decline.

Any proposal, especially one put together as quickly as the Fed-Treasury plan, can be improved. But the benefits of taking time to make the plan better have to be set against the potentially massive costs of delay.

The scheme can be tweaked later, and -- rest assured -- whatever happens, it will be. Responses to financial crises are always improvised. That has been the invariable experience of other countries, including Sweden, whose mostly successful management of its own great housing-related financial crash of the 1990s was described by Bruce Stokes earlier this year.

Successful crisis management is flexible, adaptive, willing to think big -- but, above all, prompt. Congress's instinct to deliberate and complicate, then pass a law that does everything, flies in the face of history. Spending precious time now on a futile search for perfection is a mistake.

The risks of acting too slowly and letting the best be the enemy of the good are further worsened by mission creep. Many in Congress want to put the financial system on a sounder regulatory footing. They are keen to bundle some new rules into the plan.

Many are concerned that the plan should be fair -- with the burden on taxpayers kept to a minimum, and shareholders and executives appropriately punished. And others want to provide more help to distressed homebuyers. All of these are worthy goals, but they have little to do with resolving the immediate crisis.

Such questions are best addressed later. Granted, long-term reform and crisis resolution cannot be neatly separated. Crisis measures shift the context for longer-term reform and may tie the hands of legislators somewhat. But you cannot do everything at once. If you try, you risk failing to do the main and most urgent thing -- which is to keep the credit system up and running. The entire economy depends on it.

Some of the proposals for improvement that surfaced in Congress this week have an overtly political edge, which carries extra dangers. Again, six weeks before a presidential election, politics understandably and inevitably enters in, but that increases the hazards nonetheless. Coming rapidly to consensus on an emergency plan means shelving disagreement and postponing inessential and divisive questions until later. Even though this urgency tramples on normal democratic processes, it likely serves the public interest.

Moreover, the point is not just to act as promptly as possible. If the plan is to have the best chance of working, its core features need ungrudging political support. The suspicion that it might unravel, depending on the result of the election or on shifting congressional opinion, may neutralize its effects on confidence.

At midweek, despite the urgency, deliberations snagged on several inessentials, all of which could be attended to later. Many in Congress (supported by both John McCain and Barack Obama) wanted to see tough restrictions on financial executives' pay woven into the package. Many Democrats wanted new bankruptcy rules, allowing courts to reset the terms of mortgage loans as part of bankruptcy proceedings. Others wanted close congressional oversight of Treasury's proposed transactions in the mortgage-security market. And still others wanted the government to acquire equity stakes in the banks and other financial institutions that would benefit from the plan by selling bad mortgage-based assets to the government.

I support all of these ideas in principle, but there is no reason to let them hold up the emergency package. Supervision of the structure of salaries and bonuses in the finance industry is desirable. I think it's clear that the existing pay systems promoted recklessness and depleted the capital that would otherwise have been available as a cushion against emergencies like the present one. But getting these rules right is a complicated issue that will take time to address--time we do not have. Do it later.

I also favor the change to bankruptcy rules that many are pressing for -- though most likely for a different reason. Advocates see this as a way of easing the stress on households in financial pain. Instead of having their mortgages foreclosed, homeowners would be granted some form of court-directed debt relief. Letting courts restructure mortgage loans in this way would make issuing mortgages less attractive to lenders.

That is all right, in my view, because a root cause of this crisis is too many mortgages that people could not afford. But some of those in Congress now calling for new bankruptcy rules had made the generous supply of mortgages to the less-well-off a priority.

Demands for oversight of Treasury's operations in the mortgage-security market seem reasonable enough -- as long as care is taken to avoid the related hazards of delay and the intrusion of politics. Transparency, yes; periodic reports to Congress, of course.

But if "oversight" takes the form of Congress and the courts second-guessing Treasury's day-to-day transactions in the mortgage-security market, the whole arrangement may be crippled.

As for equity stakes in troubled financial institutions, again this seems fine in principle. The Fed itself set the precedent with its loan to American International Group, which was given in exchange for an 80 percent share of the business. But there are drawbacks as well as advantages to structuring assistance as injected equity rather than purchases of impaired assets. What matters, if the Fed and Treasury are right about how much danger the economy is in, is to increase oversight or deal with equity -- or both -- without delay, rather than spending time and political goodwill on arguing about which is the better basic design.

This brings us back to the main question: Is the government right about the danger? My preference would be to avoid putting this to the test. Some critics of the plan argue that it would be better simply to stand aside than to pile in with vast amounts of taxpayers' money -- that the economy has weathered previous financial storms well enough, and that all will be fine as long as the Fed avoids its great mistake of the 1930s and maintains growth in the money supply. I find this argument unconvincing.

The problem is precisely that the Fed cannot control the "money supply" except in the narrowest technical definition of that term. It can control interest rates, which are already close to zero. But broad measures of money supply ("liquidity," as it is also called) are just another name for the supply of credit -- and that is precisely what is in jeopardy. If the contagion of financial panic causes banks and other financial institutions to stop lending to each other, to households, and to businesses, then "money supply" in that crucial sense will shrink abruptly. The economy will tank regardless of the Fed's conventional monetary policy operations.

The Fed-Treasury plan has many critics, but those who argue that the best policy is hands-off seem to be a small minority. Until now, the argument has been almost entirely among those who agree that drastic action is called for but disagree about exactly what form it should take. In ordinary times, when it comes to bold government interventions, I tend to think: Don't just do something, stand there. When circumstances allow, it is best, of course, to listen to all sides, thrash out the details, and get policy as close as possible to exactly right--all the more so when $700 billion is on the line.

Unfortunately, these are not ordinary times, and circumstances do not allow.