RAY SUAREZ: If lawmakers approve the bill tomorrow, the package would be the largest government intervention in history.
The government would be allowed to buy up to $700 billion of bad debt in phases; Congress could deny Treasury’s request for half the money.
It could raise the amount of bank deposits insured by the FDIC from $100,000 a person to $250,000. And the government could allow the FDIC to temporarily borrow money, as much as needed, from the Treasury.
And it could encourage the Treasury secretary to restructure any mortgages bought by government that may be in danger of foreclosure.
To what extent does this plan help solve the problem? We get three perspectives. They come from Scheherazade Rehman, who has written about financial crises and advised a number of institutions, including the World Bank and central banks. She’s a professor of international finance and business at the George Washington University.
John Cochrane is a professor of finance at the University of Chicago. He helped organize a letter signed by 200 economists questioning the design of the Paulson plan.
And Ken Rogoff is a former chief economist for the IMF. He’s now a professor of public policy and economics at Harvard University.
And, Professor Cochrane, in your view, does the modified bill — the one that’s going to head up for a vote tomorrow — address some of the underlying problems in the securities and credit markets?
JOHN COCHRANE, University of Chicago: No. I think the modified bill is, in fact, worse than the original bill. Many of the modifications are either counterproductive, hugely expensive, or a pinata full of ridiculousness.
RAY SUAREZ: And explain that, “a pinata full of ridiculousness”? Are you referring to the things that were added in order to get those extra votes?
JOHN COCHRANE: Yes. For example, deep in there, there’s a subsidy for bicycle commuting. But more importantly, the parts that are going to be counterproductive are very expensive.
A 'full-blown financial crisis'
RAY SUAREZ: Professor Rehman, do you think this gets at the fundamental problems that this bill was meant to solve?
SCHEHERAZADE REHMAN, George Washington University: Well, I think pinata or no pinata, we are in a full-blown financial crisis. There's a panic out there. There is a crisis of confidence.
We are hemorrhaging, not in terms of confidence, but in capital. And we have now a couple nights ago hit the belly of economic America, which is middle-class wealth.
Whether it addresses all the technical details, no, but it does stop the hemorrhaging. And that is the critical aspect right now, to stop the panic.
RAY SUAREZ: Professor Rogoff, where do you come down?
KENNETH ROGOFF, Harvard University: Well, it's a very imperfect bill, but there -- I totally agree, there's a wholesale panic going out there. It's a good old-fashioned bank run on money funds, on commercial paper, on everything.
And I think, if Congress says to the credit markets, "Drop dead," it's just going to be chaos out there.
So as much as I don't like this, I think the bill is better than the one that we had on Friday. I think it sort of pulls back a lot at some of the giveaway to the financial sector and, OK, I wouldn't have written it, but we've got to do it.
RAY SUAREZ: "Imperfect," you say. But what about the biggest part of it, the one that gets the most attention, and that is the up to $700 billion of money made available to the Treasury secretary to stabilize the markets by buying up troubled debt?
KENNETH ROGOFF: Well, first, I say the part I think is the best is the part they've added of raising the deposit insurance, because there's a bank run going on that's driving a lot of the problems on credit markets.
But I certainly agree with John that it's a very complicated financial engineering. They have to have lots of -- legions of investment bankers figure out what these securities are worth, the same investment bankers who, when they were in the private sector, couldn't figure out what the securities are worth.
It's a mess, but I think we have to move forward. There is some take-backs so that the final cost is not as great as it would have been.
Restoring confidence and capital
RAY SUAREZ: Professor Cochrane, you hear your two colleagues talking about having to do something to avoid a full-blown panic. What would you suggest instead?
JOHN COCHRANE: Well, there's lots of things we can do instead, but neither of them said how this is going to work. Every story I've heard involves at some point magic steps in.
This argument so far was, "Well, we have to do something to restore confidence." That's just magic. If this bill is going to pass, let's hear how, in fact, it is going to restore that confidence.
There's plenty we can do instead. Basically, banks need more capital. And before that can happen, the old capital -- stockholders and some long-term debt -- are going to have lose a lot of money. And they're crying that they don't want to do that.
RAY SUAREZ: Restoration of confidence is magic?
SCHEHERAZADE REHMAN: No, but it is absolutely critical. A car accident victimÂ is bleeding, we have to stop the hemorrhaging first and then debate about how to stitch him up, what bandage to use, which hospital to take him, and which specialized doctor to use.
And I think that there is going to be some very technical, detailed discussions following this. But if the panic is not stopped, Middle America gets hit again on Friday, if there is a no vote.
RAY SUAREZ: Well, reassurance is hard to quantify on a balance sheet. What does confidence do that stops that hemorrhaging, that stops that panicking?
SCHEHERAZADE REHMAN: I think, as the previous speaker said, the $250,000 limit now on FDIC has eased fears of banks and their customers that perhaps we are covered a little bit more. And so that builds up confidence.
The amount could be $600 billion or $900 billion. It doesn't matter. It's restoring the confidence that somebody's in there, the federal government, to bail these companies out, rightly or wrongly.
RAY SUAREZ: Professor Cochrane, what about the raise in the FDIC-covered amount in accounts? Do you favor that?
JOHN COCHRANE: I'm all for that, yes. I'm all for that. And your viewers need to understand there is no need for anyone to run to the bank and empty their bank-insured bank accounts. Ordinary depositors are not at risk here, and that's a very good part of this bill, the one good part.
RAY SUAREZ: Well, tepid praise there.
KENNETH ROGOFF: Well, I mean, I certainly don't think this is the end. This is a step. It is not going to work. It is not going to be enough.
Eventually, we have to do something like Professor Cochrane suggests of injecting capital into the banks in return for senior equity, putting the taxpayer first.
We've got to close a lot of the banking system. The banking system is still bloated. They have to get auditors in there to choose which banks close. It's going to take much firmer intervention.
There are other plans. There are some involving helping the homeowners directly.
This is not the last word. The final cost is actually going to be much greater than what's projected from this bill, but we're in paralysis here.
The spreads are exploding. Companies are having trouble meeting their payrolls, if we don't get the credit markets moving. You can't just, you know, talk about theoretically what's the best thing to do. You have to stop the bleeding.
Estimating the final cost
RAY SUAREZ: The CBO, incidentally, the Congressional Budget Office, has scored this as saying it may cost significantly less than the $700 billion. You're saying it's going to cost more?
KENNETH ROGOFF: Oh, no. I think this will cost a lot less than $700 billion, but it won't do the job. This is going to cost maybe a couple hundred billion. We might even make a couple hundred billion.
But the trouble is, I mean, it's a complicated piece of financial engineering, but it just doesn't do enough. The banks don't have enough capital. We have to close the banks that are insolvent.
We have to inject capital into the banks that are going to be strong in return for getting stock equity, something so the taxpayer gets some of their money back.
But there's an important point. You've got to close the insolvent banks. You can't just rain money on everyone. That was really the problem with the first bill, and there are problems in this bill that it could be some of the weaker banks take the money.
But this is a step. This is a process. Every big financial bailout works this way. It's very hard to hit it, you know, in one shot. We've got to show we're moving. It's very painful, but the credit market situation is simply once in a century right now.
RAY SUAREZ: Professor Cochrane, before we move on to what happens down the road, I want to get one more shot at what it is that won't work in your view about this.
We know that you think it's a bad idea. We know that you're very critical of the solution. But why wouldn't the injection of this kind of capital into the system through shoring up some of this debt work?
JOHN COCHRANE: Well, the plan is to try to raise the value of all mortgages in the country so that the assets on banks' books look larger -- are larger than they are right now.
There's some magic about liquidity, but fundamentally you have to buy a lot of mortgages to do that. And the Senate added that, at the same time, we're not going to make people pay back their mortgages.
That's going to -- that may be the right thing to do, but that's going to add tremendously to the cost, along with the Senate said the purchases now have to guarantee the level of retirement savings in 403(b) plans. The cost is going to really explode here.
RAY SUAREZ: Skepticism that raising the value of everyone's mortgage is something that the government can really do?
SCHEHERAZADE REHMAN: You know, I don't know. I think that, hopefully, if they can do it, that'll be great. But I think the $700 billion cost -- no one can predict if it's going to be a little bit less, a little bit more. It has to get done, and the devil is in the details here.
But I think the Treasury secretary has enough confidence in professionals around him that these will be managed, and clearly not by the Treasury itself, but there will be professional help in managing these assets and then deciding what to do with them down the road. And this is a long process.
Repairs down the road
RAY SUAREZ: Professor Rehman talked about stabilizing the patient, in effect, and then perhaps making some fixes down the road. What would you like to see done after this first wave of measures is taken to either refine or repair this bill?
KENNETH ROGOFF: Well, I mean, we come back to the point that a lot of banks have to get closed in order to really let the government move in some way to help the other banks. We have to allow banks to fail. We need some tough love in the banking system to get through this.
And there's no real way around that. There are various ways -- injecting capital is the cheapest. We could go at the outside and help the homeowners directly. That would be a lot more expensive.
There just isn't a pretty way to do this. But understand, this is simply an epic crisis in the damage this will cause. We're in a recession. There's really no bottom to this unless we stop this.
You can't just say, "Well, the market will sort it out." The government's deeply intervened in this market already, and you can't just back off and say it will work out.
They've done a -- we've done a good job of having a lot of banks close. Washington Mutual is gone. Wachovia is gone. There are no more investment banks. I mean, a lot of actions happen.
This has not been a case of soft-pedaling, like Japan, where we hold up the whole system. We've been tough. But, I mean, we have to step in at this point and really stop this full-blown financial panic.
It's not just the insured accounts. It's money funds. It's commercial paper. It's big institutions. They're all pouring their money into treasuries and clearing out of everything. And somebody has to put a stop.
RAY SUAREZ: Professor Cochrane, is this something that can be repaired down the road, if -- can your objections to it be addressed down the road?
JOHN COCHRANE: Well, this plan, I think, will end up just doing nothing and wasting a lot of money, and then down the road we'll be doing exactly the kind of things that Ken was talking about, namely, letting banks close.
And I would remind you the important thing is not to keep individual banks alive. The one thing that counts is that the banking system can continue to make loans.
So if one bank goes under, so long as there's another bank around that can make loans, we'll be OK.
RAY SUAREZ: And you suggested at the outset that this is just a holding measure. What's the top thing that you'd like to see fixed in this, after it gets the stability that you're looking for first?
SCHEHERAZADE REHMAN: I think the sorting out the assets, which assets to actually acquire, because, you know, banks can slide in some pretty nasty assets that you can do nothing with.
And so I think that will be a very critical step, which assets to buy, how long to hold them. And that does require some professional help, in terms of intervening and managing these assets.
I think that, if we do nothing, then we have a much more serious problem down the road because of Middle America.
RAY SUAREZ: Professors Cochrane, Rehman, and Rogoff, thank you all.
SCHEHERAZADE REHMAN: Thank you.
KENNETH ROGOFF: Thank you.
JOHN COCHRANE: Thank you very much.