The $700 Billion Question: What Is the Fate of the Economic Rescue Package?

On October 1, Brookings experts in finance, monetary and fiscal policy, and Congress explored what ails the U.S. economy, the diagnosis and treatment, and how difficult it is to legislate during an election year. Brookings Senior Fellow Thomas Mann moderated the discussion that included Brookings Guest Scholar William Frenzel; Brookings Vice President and Director of Economic Studies William Gale; and Simon Johnson, professor at the Sloan School of Management at the Massachusetts Institute of Technology.

Transcript excerpts:

The Hon. William Frenzel, guest scholar at Brookings and a former member of the House of Representatives (R-Minn., 1971-91)

[Debate on the bailout package offered] one of the very few times where you have the White House and the joint managements of the Congress endorsing a bill with great vigor [and with] a lot of press attention to it, that leadership was not followed. I don’t fault the leadership, quite as much as the followership. We don’t have much of that around here anymore. We have an awful lot of independent actors, working each on his, or her own stage.

[Those in opposition are] ideologues who do not care for their leadership, do not care for a lot of things, other than maintaining ideological purity. Whether Rome burns or not, is a much less concern to them, then to whether their extreme philosophies prevail.

I would not rely ever on congressional oversight to save the world. Congressional oversight is almost oxymoronic on its face. It’s either a witch hunt or a white wash.

Alice Rivlin, senior fellow at Brookings and former vice chair of the Federal Reserve

[The package will not] solve the whole problem. We will still probably have some financial institutions failing. We’re probably still going to have some kind of a recession, but if it succeeds in getting the credit flowing again to ordinary businesses with good credit ratings, and ordinary people with good credit ratings, that’s a lot.

And the only thing you can say is, it might have been a lot worse, we don’t know for sure. If we didn’t do something to weigh in on a big scale that we would have a financial meltdown around the world, and subsequent really devastating effects on the real economy. So it’s a little bit like nuclear war or something. You don’t know what the chance is, but you better do everything you can to avoid it.

[On implementation of the legislation] It’ll start very fast. I assume that in some backroom of the Treasury there is a group of people who have been designing the first move. They have said that they will use some kind of a reverse auction. There are lots of different designs that you could do for that and they would have different effects. But some very smart people have presumably been working on this. So the first thing you’ll see is the Treasury moving to buy a substantial slug of the so-called toxic assets, through some kind of procedure. They’re winging it. They’ve never done this before. I think they will see how the first auction goes, and maybe redesign it a little bit. But you’ll see action very fast.

If we can stave off financial meltdown, I think there’s no real reason to think there’s something fundamentally wrong with the U.S. economy. John McCain got into terrible trouble, saying the fundamentals were strong, but if he meant that we have a highly productive economy, our exports are doing well, because the dollar has come down. American workers are quite skilled and ingenious. We have a lot of entrepreneurs, there’s no reason that those positives won’t reassert themselves.

[Long-Term outlook] There are serious problems with the U.S. federal government’s balance sheet in the long run, and the long run isn’t that long. And we have to do something about the fact that we’ve put our federal budget on an unsustainable track for the next several decades because we’ve made promises under entitlement programs that we cannot fulfill on any sensible set of taxes, and we’re going to need tax reform.

That said, and I think it’s important to say it first, yes, I think we can do this. It’s partly because we do have a very productive economy, that’s what this is all based on. And our securities are, perhaps a little strangely, regarded as better than gold. It’s a curious thing with this kind of looming federal debt crisis out there in the next couple of decades
that when anything happens, everybody around the world wants to buy treasuries, and the interest rates go to zero because there is the confidence that this instrument is the safest thing in the whole world. And we’ve got to use that credibility right now, but then make it true later, make sure that after we get past this crisis, which will escalate the deficit, but probably not off the charts in terms of the percent of GDP. After we get through this crisis, then we’ve got to worry about the long run.

William Gale, vice president and director of Economic Studies at Brookings

It’s important to understand, there’s no plan. What the legislation would do, would say to Paulson, “you deal with this, we don’t know how you’re going to do it, but we’re giving you some money to deal with it.”

It’s not like we’re saying we’re going to do this, we’re going to pass this law, we’re going to change this regulation, we’re going to change this tax, et cetera. All we’re debating is whether we just hand over the authority to Paulson or whether something else ought to happen… That’s not a bad thing, it’s just different from other debates that we’ve had.

The risk of under reacting here is much bigger than the risk of over reacting, and the risk of not giving the Secretary [Paulson] enough authority is much bigger than the risk of giving him too much authority.

I think its right to think about [oversight], but I think it’s also a fact that whatever happens, the oversight is not going to be very strong.

[On the bailout package] There is no guarantee that this is the last thing we have to do.
… It might not solve the current issues in the mortgage market. …There [also] are other issues looming … student loans, credit card debt, auto loans are all out there and all sort of are headed in the same way that the mortgage market is … Even within the mortgage market, there are these negative amortizing loans that don’t really kick in until 2009 or 2010 that are basically time bombs waiting to happen.

It’s not clear to me that the government is going to be a better investment bank than investment bankers are, but that’s the model; maybe Paulson will be.

This is a really bad way to form an investment bank or a hedge fund, it’s only buying one type of asset, and it’s a bad asset to begin with, so it’s not diversified. … If a hedge fund were going to do this, they would buy a whole bunch of assets, one of which might be bad housing loans.

When physicists get to some data pattern that doesn’t make sense, they say, this would make sense if only this new element existed or this new quark or dark matter and it had the following features, and they define all the features, and then it all works, and then they go out and look for that element. So if you do that here, what’s that element? Let’s call it Paulsonite.

[Long-term outlook] When we say there have been massive capital inflows into the country, that’s saying the same thing as we are living beyond our means, we are consuming way more — and it’s the government has an issue, but I don’t see that turning around anytime. It seems to me we’re utterly dependent right now on the willingness of foreign capital to come in and we need it because if we don’t our capital markets would really dry up. Which means that the terms of trade, the interest rates that need to get paid not on U.S. government securities but on private market securities, could actually go up a lot. Again we’re in unchartered waters, but over the next five-year horizon, I worry a lot more about that than about the fiscal situation.

Simon Johnson, MIT

I think we are facing an extremely grave international situation, in part because while you may have differing opinions about the response and the delayed response of American officials, I can assure you that the Executive Branch and the legislature in the United States is way ahead of their counterparts in any other industrialized country in terms of both understanding what is going on and in terms of really getting their teeth into sensible suggestions.

I think their suggestions are not yet sufficient; I don’t think the right issues are yet on the table in the United States. There are probably 12 steps to recovery from any addiction, including the one in the United States. I think the U.S. is probably on step two or step three. I think the Europeans are struggling … struggling on step one, they’re in total denial.

Do not, please, make the mistake of Japan in the 1990’s, of throwing in fiscal resource here, a fiscal resource there, dribs and drabs. I’m a very firm believer in at least one version of the Powell Doctrine, which is that when you show up, you show up with overwhelming force, and you do it all and you do it right, and that’s the time when we use the fiscal stimulus.

Well, the rough bottom line way to think about this is, when you throw the kind of party that the U.S. has had in the past five – ten years, it usually ends up costing you five – ten percent of GDP one way or another. Now, that’s not a disaster, the U.S. can easily afford that. My point would be that if you go in with a piecemeal – and I want to say stop – measures, the point of putting your finger in the dike is to wait for the other people to come with the big bulldozers and fix the dike, okay, I’m all in favor of that, don’t get me wrong. But that’s not the solution to the problem. And I think, you know, a piecemeal approach will end up costing you a lot more than coming in with decisive force and a comprehensive solution.