Paulson, Bernanke, and Congress on the Bailout: Incompetence All Around

Treasury Secretary Henry Paulson and Federal Reserve Board Chairman Ben Bernanke got beaten up pretty badly in the House Financial Services Committee yesterday. And on at least one point, I think, justifiably so. In his opening statement, Paulson acknowledged that at the time the Senate passed its version of the financial rescue package October 1 and the House passed the same version October 3, he had already decided that the Treasury Department would not embark on the program of acquiring toxic securitized mortgage and other paper from financial institutions, as he was telling Congress it would, and that it would instead use powers in the bill to inject capital into banks and other financial institutions. I think members of Congress have standing to complain when they are asked to approve a piece of legislation on the grounds that the administration will do A, but in fact the administration has already decided to use the broad powers in the bill to do B—and hasn't told Congress about its change of mind. Paulson in his opening statement hit back at that by noting that in the two weeks Congress had been considering the legislation—from September 19, when Paulson and Bernanke presented their three-page rescue package outline to members of Congress, until October 3, when Congress passed the bill—the stock market fell 9 percent. In effect, he's blaming Congress for dithering while $2 trillion of wealth was being destroyed. He's got an argument, too.

I think there's something to be said for both sides, as well as against. Congress acted pretty darn quickly by its standards in voting to give the secretary of the treasury powers to deploy $700 billion pretty much as he wished. There was some negligence on the part of Congress, including members of both parties. When Speaker Nancy Pelosi announced on September 23 that she wanted 100 House Republicans to support the bill, all the folks concerned—Paulson and the administration, the House Democratic and Republican leadership, the bipartisan leaders in the Senate supporting the rescue package—should have brought the House Republicans (previously ignored, since Democrats can pass pretty much anything they want in the House under its rules and Pelosi's strong party discipline) into the negotiations. This didn't happen immediately, resulting in the defeat of the rescue package in the House September 29 (when plenty of Democrats with safe seats as well as Republicans voted against it: no party discipline from the Democratic leadership here). The House Republicans got some concessions in the Senate bill (no money for Acorn, etc.), passed in the Senate October 1 and in the House (where the Democratic leadership had lost negotiating leverage) October 3.

Incompetence all around. The general practice when you have a closely divided Senate and a controlled House is to have the Senate pass a bipartisan measure and the House a leadership measure, and then resolve them in conference. But when the speaker announces she must have bipartisan support (in this case so that politically marginal members of her party can vote against the measure), then the House minority must be brought into the discussions. Suddenly, the House minority, which ordinarily has no leverage to produce legislative results, has a great deal—a concession Pelosi in effect made on September 23. But she did not bring in the House Republicans, nor did the House Republican leadership authorize anyone (including Spencer Bachus, ranking minority member on Financial Services) to negotiate for them.

As for Paulson, I've seen no indication that he understood the need to bring House Republicans into the discussion. House Assistant Minority Whip Eric Cantor came forward with a proposal that the treasury should be authorized not only to acquire toxic assets but also to insure them. This is an alternative that Paulson's treasury had already rejected as unworkable (for the same reason that it decided that acquiring toxic assets would be unworkable: because no one could set a value on the toxic assets, and accordingly, no one could set a value on the insurance premium), but which, as Financial Services Chairman Barney Frank pointed out, was already authorized under his draft of the bill and that he had no objection to including as a possible alternative. Intellectually, this was the basis on which the final, Senate-originated bill was passed. All this could have been done, I think, before September 29, if proper negotiations had been conducted. But they weren't; markets plummeted; and some time in there—Paulson hasn't so far as I know been specific about the date—Paulson decided that acquiring toxic assets wouldn't do and that capital injections would work better.

Pollster Scott Rasmussen notes that only 26 percent of Americans are confident that our leaders know how to deal with the economy and that 45 percent are not very confident. They also acknowledge, by larger percentages, that ordinary citizens are culpable by having acquired too much debt. Yet consider. I've been reading Ben Bernanke's Essays on the Great Depression, recently published by my friends at Princeton University Press. These essays, usually written with fellow academics as coauthors, are hard slogging, and I have to say that as a graduate of Harvard College and Yale Law School with a high verbal and even math aptitude, I have had a hard time understanding them. But I bring out of them one conclusion: that Ben Bernanke probably knows more about the Depression of the 1930s, about specific events and economic interpretations, than any other living person on Earth. If that credential is decisive, he is the person we want making these great decisions and wielding vast sums of money in this unprecedented financial crisis. Secretary Paulson in his testimony makes the argument that things would be much worse than they are if the rescue package had not been passed by Congress and if the capital injections to banks had not been made pursuant to it (though not pursuant to the arguments he made to Congress to get it passed). That's a counterfactual that cannot be tested; we can't go back to September 18 and see what would have happened if Paulson and Bernanke, having concluded that credit markets were completely coagulated, that no blood was flowing in the veins and arteries of our financial system, had not determined that something spectacular needed to be done to prevent the patient from dying. My guess is that Paulson is right, and that the economy would be in a much worse downward spiral now. But we'll never know for sure. Our leadership has been suboptimal, perhaps, in the interaction between the financial authorities and Congress, but not nearly as suboptimal, I think, as it might have been.

Footnotes: This is an interesting analysis of General Motors' situation; blogger Francis Cianfroca says that no one will lend to GM in Chapter 11 and that it will be forced into Chapter 7. Politically, the Republicans will be blamed for the collapse of many subcontractors and suppliers (though note that many, like Delphi and Collins-Aikman, are in bankruptcy already). Cianfroca seems to be arguing for what he takes to be the Bush administration solution: free up the $25 billion already approved for financing low-emission cars into a capital infusion, under terms presumably more onerous than GM and the UAW would get from the incoming Obama administration and the more Democratic Congress after January 20.

Polling shows ambivalence on a Detroit Three bailout. Gallup shows 47 percent for a bailout, and 49 percent against, if the companies were threatened with bankruptcy. But if one of the companies were certain to fail, only 18 percent would favor aid, and 79 percent would oppose.