Wall Street vs. Main Street: Why the Treasury Bailout Plan Failed

Last week I wrote about the rise of socialist economics in American policy-making, citing the bailouts of Fannie Mae, Freddie Mac, and AIG as examples of this rising socialism. I also addressed the question of whether or not this marked the decline of capitalism in the United States. Since that time, there has been increasing turmoil in the financial markets as well as increased involvement by the government in the economy, most especially the proposed $700 billion bailout plan by the United States Treasury. When this plan was shot down in the House of Representatives on September 29th, it acted as a catalyst for the single largest dollar decline of the Dow Jones Industrial Average (over 777 points) as well as the Standard & Poor’s 500 Index (over 106 points) (see below, right). This reduction in stock values translated into an approximately $1.2 trillion decline in market value of the entire U.S. stock market. Considering the implications of the House of Representatives’ decision, I decided to explore various blogs to answer two questions of mine: why was the bailout plan deemed inadequate, and did the House of Representatives make the right choice in voting against it? After noting how close the vote was in the House of Representatives (228-205), I was surprised to see that most blogs agreed that the bill did not deserve to be passed. Admittedly, this is my own opinion as well, but I imagined there would be more of a counter-argument than there actually was. The question that more blogs disagreed on was why the House of Representatives decided to vote against the proposed bailout. I found two blogs that gave the most interesting insight into this decision and left my feedback on them. In the first blog, Amateur Economists, Evelyn Black addresses the issue in an entry entitled “Why Did Paulson’s Bailout Plan Fail in the Congress?” Black claims that the issues raised were the lack of regulation of CEO pay for companies that choose to receive money from the bailout plan as well as the fact that there is no guarantee the bailout would work. In the second blog, Church of the Customer, Ben McConnell briefly addresses the issue in an entry titled “Why the Bailout Package Failed.” He claims there are three main issues: the concentration of too much authority in the hands of Treasury Secretary Henry Paulson (see below, left), the lack of transparency about the administration, and, like Black, the lack of regulation of Wall Street CEO pay. For your convenience, in addition to posting my comments on their respective blogs, I have copied them below.

“Why Did Paulson’s Bailout Plan Fail in Congress?”
Comment:
Thank you for your useful insight into why Paulson’s bailout plan was voted down in the House of Representatives. It really helped to shed some light on the faults of this $700 billion piece of legislation With the market’s record-setting drop after this news was released, I think many people are wondering why exactly Congress voted against this plan and, had it been passed, whether the economy would have taken the downturn it had on Monday. Your analogy of the lobbying for this plan to an old western film is depressingly fitting, as Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke seem to be convinced that the only way to turn our economy around is by taking money out of the hands of the public and into the hands of the people who started this crisis in the first place.

I liked how you used the comments on New York Times editorials as evidence of a confrontation between Main Street and Wall Street. It adds a tangible aspect to a claim that is otherwise hard to quantify. I also liked your analysis of the analogy between this bailout plan and the Resolution Trust Corporation of 1989. I have seen the link made between the two before, especially in the context of the bailout not costing taxpayers as much as initially thought, but did not know enough about the Resolution Trust Corporation to be able to make the comparison. I agree that the comparison is not valid, for the RTC bought and sold actual assets, while this proposed bailout plan would be buying faulty financial instruments, the mortgage-backed securities.

Though I thought your blog was well researched and informative, I have some questions and comments about it. First, do you think the only reasons for the public outrage were CEO salaries? I don’t see any other reasons in the article other than the lack of a guarantee that the plan would work. Also, while you say that Congress negotiated some governmental oversight and provisions for helping homeowners keep their homes, I think this article would have benefitted by explaining those changes in more detail. The current description is relatively vague.

Thanks again for the helpful insight and I am looking forward to continuing reading your blog as the financial crisis progresses.

“Why the Bailout Package Failed”
Comment:
Thank you for your succinct article on why the bailout package failed to clear Congress. Like most people, I have been following the credit crisis closely over the past year and was especially following the progress of this bailout package. The way you opened the article with five especially gloomy headlines from a single day’s Wall Street Journal (and not even on the front page!) really painted a picture of just how dismal our economy is right now and put the entire bailout package into context perfectly.

In the body of your article, I liked how you very clearly laid out the three reasons why you believe Congress voted against the bailout. It was clear, concise, and eye-opening. I agree that the biggest issue with this bailout package was the lack of transparency in the system, especially given how much power Paulson would have been given. It is as if the government is trying to test the phrase “power corrupts, absolute power corrupts absolutely.” It was heartening to hear how the public became involved in this legislation, and I found your statistic that calls were averaging 100-1 against the bailout especially interesting. It solidified your statement that “vast numbers of citizens” were calling their representatives to reject the bailout and added credence to your argument that this financial crisis might bring about transparency in business and government.

Though I loved the article and I liked the way you started your article, I think you would have benefitted by saying what the front page headlines actually were. I understood your intentions behind what you did, but I believe it is more confusing that it has to be. Also, do you think that some of the outrage came from the fact that the government was giving money to the companies that caused this crisis rather than the people who have been hurt by it? The way you talk about rich fat-cats makes me think that you are one of the people who would rather see the money go into a stimulus package than bailing out Wall Street.

The Red Flag: An Examination of the Social and Economic Implications of the Recent Government Bailouts

Bailout. This one word has inspired more commentary than any other in the past few weeks. However, with every news outlet in the world talking about the bailouts of Fannie Mae, Freddie Mac, and AIG, I find it interesting how the ideological implications of these actions are only now starting to receive some attention. Most media has been focused on the direct, economic impact of Congress's decisions on the stock market now and in the near future, as well as the simple dollar figures for what the bailouts are going to cost taxpayers (see below, left). While this aspect is obviously important, there are deeper, more long-term consequences to the government’s actions. With the most recent buyouts, federal insurance for risky mortgages, economic stimulus packages, and ban on short selling of financial stocks, the government has been taking actions contrary in nature to the free market economy it was founded upon and more in line with the communist, government backed system it has been fighting against for the better part of a century. Is this the end of capitalism as we know it? Did the government take a step in the wrong direction by bailing out this country’s financial system? No, probably not. While the recent government buyouts of Fannie Mae, Freddie Mac, and AIG go against the capitalistic ideals of this country, they were necessary in order to help keep the country out of the depression it was headed towards and will eventually be seen as the right decision by the federal government. Assuming the government does not continue to take over companies or impose its will too much on the companies it already controls, these actions will be seen as temporary socialist interventions like those during the Great Depression and not the beginning of the decline of capitalism in America.

Despite the fact that most of the actions the government has taken in the recent past have be socialist in nature, the United States is not moving down a path away from capitalism; rather, it has simply been following a history of free market capitalism supported by moderately socialist government policy. Capitalism is an economic system characterized by private or corporate ownership of capital goods, by investments that are determined by private decisions and by prices, production, and the distribution of goods that are determined mainly by competition in a free market. Socialism is the opposite. It is composed of a government controlled economy in which the means of production are federally controlled. Today, the American economy cannot be accurately described by either word in itself, but more of a combination of the two. Originally, the it represented the epitome of a capitalist society. People spoke of the “American Dream,” of common men coming to the United States and working their way into fame and fortune. However, the American economy has gradually shifted away from a true free market economy towards a mix between capitalism and socialism. True, the most recent wave of attempts to revitalize the economy by the United States government have been some of the most extreme ever, but regulation of our financial markets has been a critical part of our economy since the Great Depression. In fact, one of the reasons these problems arose was the deregulation of the financial markets that allowed instruments like mortgage-backed securities to exist and subprime loans to be issued. Like it or not, the government has a history of stepping in during times of financial crisis and taking extreme measures to protect the economy (see the New Deal). For the most part, it has always been justified and ended up having a positive influence on the economy. If the United States government had not stepped in and taken the actions it did, the economic fallout would cost taxpayers much more than what it has cost to effectively bail out the housing market. According to Jeanne Sahadi, a senior writer for CNNMoney.com, “If Fannie and Freddie went under…the housing industry could seize up, causing the loss of millions of jobs.” Or, in terms of actual dollars and cents, an article by James Pethokoukis, the money and politics blogger for U.S. News & World Report, claims that the dollar cost of not bailing out Wall Street could range anywhere from $15 trillion over four years to upwards of $30 trillion. The financial markets would crash and credit markets would completely freeze, making it impossible for students to get loans and families to get mortgages. If these estimates are anywhere close to the truth, the government intervention in this financial crisis will prove to be a brilliant move that effectively saved the American economy.

There are those who argue that these bailouts set a poor example for financial institutions, especially how it guarantees money for the larger financial institutions at the expense of everyone else (see below, right). As Andrew Horowitz, founder of Horowitz & Company, says, “In a capitalistic society that relies on a free market system, we should only look to the government to guide and regulate against fraud and the manipulation of the system... it is not to be a business partner and a sugar daddy there to provide a backstop to the bad business practices of the banking system.” True, there is the potential for companies to take these bailouts as a figurative safety net for them, guaranteeing their continued existence despite any risky practices they might engage in. However, given the necessity for a dramatic move by the federal government to turn the economy around, there were not many other options. Ideally the government would not have to come in and financially back the banking system, but in times like today, people have to look past their ideals to what is the most prudent and effective solution for our financial crisis. Like the co-host of CNBC’s “Squawk on the Street” Mark Haines observed on “Morning Joe”, “Nobody really likes this on a philosophical basis, but we live in a real world and we can’t, can’t dither with philosophy when such serious matters are at stake.” Only time will tell whether or not the government made the right decision, but given the situation at the time, it made the best possible move by intervening in our failing economy. Either way, this bailout is only a temporary fix. Unless we do something about the unchecked greed that is at the root of all these problems, we will not be able to fully recover from this recession.