Memo to the House: Vote “No”

I said on Monday that if I were in the House, I would vote, reluctantly, for the bailout package as negotiated by the Republican leadership over the weekend. This was based on the many warnings from economists and others across the political spectrum to the effect that failure to enact the measure would result in potentially disastrous consequences for the economy.

I’ve changed my mind. The bill failed in the House on Monday, and the sky didn’t fall. Those who predicted doom are a bit like the cartoon characters who don white robes and climb mountains carrying signs that say “the world will end tonight.” They feel silly when the sun comes up the next morning.

There are two separate issues here, and two separate crises. The first crisis afflicts those banks and other institutions who invested too heavily in mortgage-backed securities that turned out to be worth less than they thought, or, in some cases, to be simply incomprehensible. These institutions stand to lose money and would prefer that the taxpayers lose it instead.

The second crisis is the one that policy makers legitimately need to address. Mortgage-backed securities of dubious value have spread so widely through the financial system that they have become a drag on credit generally. We are experiencing a liquidity crisis in which banks find it increasingly difficult to borrow from one another and credit generally is drying up. This is a world-wide phenomenon, not limited to the U.S.

There are a number of measures that can be taken to address the liquidity crisis; some already have been. Revision of the SEC’s mark-to-market rule should help considerably to free up banks’ lending capacities. Likewise, extension of the FDIC limit from $100,000 per account to $250,000 will help prevent runs on banks. Other relatively modest regulatory measures are no doubt available that will also make incremental contributions toward freeing up national and international credit markets.

As far as the broader issue of what to do (if anything) about the hundreds of billions of dollars worth of questionable mortgage-backed instruments is concerned, I have heard no coherent explanation of why the taxpayers need to buy those assets. This is the most expensive, most intrusive, least free-market-friendly solution to the problem. The House Republicans proposed an insurance system, funded by financial institutions themselves, as an alternative. Respected bankers have suggested that the government could lend money to affected institutions with the dubious instruments as collateral. These and other alternatives seem to be better, more modest approaches than the $700 billion blank check bailout that remains the essence of the pending legislation.

In all of the arguments that the administration, Congressional leaders and Presidential candidates have made in favor of the bailout proposal, the consistent theme is that the bailout is better than doing nothing. That could well be true. But I have not yet heard a single word of argument from the bailout’s proponents as to why that plan, which can fairly be described as extreme, is better than an insurance program, or a loan program, or a combination of regulatory initiatives to free up credit, or other alternatives that may be devised by banking experts.

There is only one thing we know for sure about a bailout program, as opposed to those alternatives: it will constitute a massive transfer of wealth from taxpayers to investors in banks and investment houses. I can easily understand why financial institutions that made bad investments would consider this desirable. It is not so clear why Congressmen looking out for the interests of taxpayers would find it so.

The panic of the last week appears to have been overblown. This is reflected in what has happened in the stock market. There is no reason why we need to commit $700 billion of taxpayer money–tomorrow!–without taking a careful look at the consequences of such a program, and at the available alternatives. I’m pretty sure that if we have that debate over the next few weeks, alternatives will emerge that are far better than the legislation that passed the Senate today.

Members of the House should vote “No” tomorrow.

PAUL adds: I’m not really sure how House members should vote — the issues here are complex and well beyond my expertise. However, I don’t believe that House members should be influenced by how the stock market did yesterday and today or whether “the sky fell” this week.

JOHN replies: My point, as I hope I made clear, is not that the merits of the bailout bill are dictated by transient economic indicators, but rather that the House need not act in a panic and should take the next week or two to consider alternatives to the bailout. Such deliberation requires a “no” vote today or, as it now appears, tomorrow.