Note to Paulson: The Key to Passing the $700 Billion Bailout Is Insurance

Contrary to widespread expectations in Washington and on Wall Street, Treasury Secretary Henry Paulson's financial bailout/rescue package was not agreed to at the White House meeting that started at 4 p.m. Thursday. The meeting included the congressional and committee leaders of both parties and the administration's top financial officials, plus two presidents—George W. Bush and either Barack Obama or John McCain.

What's the problem? An agreement modifying the Paulson plan in significant ways seems to have been reached on the Senate side, between Banking Committee Chairman Christopher Dodd and the committee's second-ranking Republican, Bob Bennett (the ranking Republican, Richard Shelby, is against the whole thing). Barney Frank, chairman of the House Financial Services Committee, expressed confidence that an agreement was reachable. But the word on Capitol Hill is that Speaker Nancy Pelosi is insisting that some substantial number of House Republicans—I've heard the number 110—vote for the measure.

Obviously, Pelosi is looking out for the political fortunes of her Democratic colleagues. The bailout/rescue package has been getting middling to poor responses in polls and furious responses from constituents who don't want their tax dollars sent to Wall Street. House Republicans like Thaddeus McCotter of Michigan have been making populist noises. This would be the second issue this year on which Democrats have found their position suddenly unpopular, the other being oil drilling offshore and in the Arctic National Wildlife Refuge. House Appropriations Committee Chairman David Obey just capitulated on the latter, dropping the language banning offshore drilling from the appropriations bill before the House.

Pelosi's move is not unprecedented. In 1993, when the House was considering the North America Free Trade Agreement, which the Clinton administration and most House Republicans supported and most House Democrats favored, Minority Whip Newt Gingrich insisted that 100 House Democrats vote for it before House Republicans would put their votes on the board. Gingrich then, like Pelosi today, wanted to give his members shelter against what some would consider demagogic attacks. The minority party in the House ordinarily has little power; on much legislation, it is no more than a bystander. But in situations like this, when the majority party in the House needs cover for its members, the minority party in the House can suddenly have more power than the majority party and both sides of the Senate put together.

What do House Republicans want? A senior House Republican gave me and some other reporters a look yesterday at what a working group headed by Assistant Minority Whip Eric Cantor is demanding. The senior House Republican (hereinafter SHR) has what sounded to me like an ingenious approach. He cited Ginnie Mae loans to low-income borrowers, which the government can insure. He proposed that the government (presumably through the entity envisioned by the Paulson plan) offer to sell insurance to financial institutions that hold mortgage-backed securities (hereinafter MBS). Premiums would be determined by the rates of foreclosure on each class of securities so far. Under this plan, the government would be taking in money, not paying it out. Of course, if the premiums are not enough to cover losses, the government might eventually take losses, as it did when the savings and loan industry collapsed. But losses don't seem inevitable and in any case will mostly occur in out-years, not now.

One of the big problems of the Paulson plan is determining the price the government would pay for MBS. If it pays too little, it doesn't help financial institutions very much; if it pays too much, the government will be shelling out a lot of money and won't get back nearly as much when the MBS become liquid and it sells them. And who is qualified to make such evaluations? Many of them are people who have been working for the very financial institutions that are in trouble (although I should think the Treasury Department and Federal Reserve have some people who are very sophisticated in this, too).

The SHR calls this an insurance program and the original Paulson plan a purchase program. He says Treasury Department people have told him that they considered an insurance program but decided that a purchase program would be better. But he also added that in the draft legislation Paulson has advanced, the Treasury would have the authority to set up such an insurance plan without congressional authorization. From what he said, it struck me that both courses could be followed. After all, neither purchases nor insurance is contemplated to take place unless and until a financial institution comes forward and requests one or the other.

So I asked the SHR whether a commitment by Paulson to consider an insurance program would be enough to win over a significant number of House Republicans. He said that a hazy commitment would not be enough, with the implication that the bill would still seem to House Republicans to be a Wall Street bailout with the implication that the government would be shelling out $700 billion of taxpayer money. I followed up by asking whether House Republicans would go along if Paulson pledged to use authority in the statute to set up an insurance program within a month of passage. "That would go far toward convincing [Republican] members," the SHR said. In other words, the insurance option may be the way to save this legislation.

Over to you, Secretary Paulson.