Five Questions

As much as I continue to pore over news stories, blogs, and academic papers, at least five fundamental questions regarding the so-called bailout remain unanswered.

● First, why was everyone so sure that credit markets would seize without immediate action from Congress? In other words, what was the rush?

● Second, and related to the first, if credit dried up from banks, why wouldn’t substitutes quickly emerge to meet that demand and, thereby, profit from higher interest rates?

● Third, when the oil-for-food program in Iraq couldn’t keep track of $65 billion used to buy oil—a commodity with a set price—how can anyone reasonably expect to oversee a $700 billion program used to buy bundles of junk mortgages that the smartest investment bankers can’t properly value?

● Fourth, the bailout intends to pay fair market value for mortgage-backed securities, which means a bank’s balance sheet remains the same as before. If a bank’s asset levels remain the same, is this really the most effective way to expand credit?

● Fifth, won’t the bailout encourage riskier behavior in the future by establishing a precedent that the government will bail out bad investment decisions?

Normally when I can’t find answers for myself, I start looking or asking around for advice from people with more expertise on the matter. Unfortunately, those whom I normally tap for sound economic advice do not see eye to eye. The Heritage Foundation (a conservative think tank in DC), the Wall Street Journal editorial board, Steve Forbes, and even Jack Kemp all supported the bailout while the Cato Institute (a libertarian think tank in DC), a slew of academic economists, and Newt Gingrich opposed it.

Though conservative supporters all expressed grave reservations, many accepted the immediacy of the crisis and believed the bill would be far better than no bill. In contrast, the academics agreed a crisis exists that needed “bold action,” but they were highly critical of the bailout and charged that it was an unfair subsidy to investors, ambiguous in its mission and oversight, and damaging to the long-term health of capital markets.

So, what is a free marketeer to think?

The answer seems to be that a free marketeer can think quite broadly on the topic.

Unable to find satisfying answers and with no consensus among my advisory council, I’m left to decide with my gut, with instinct, with feelings.

At the outset of the crisis, my gut resounded with a clear no. Let’s just say my gut had a trust deficit when it came to Paulson, Congress, the president, and Wall Street.

Without knowing many facts, it was clear Treasury Secretary Paulson could not be trusted after he proposed removing the bailout from judicial review, as if constitutionally guaranteed oversight would be too meddlesome for his unprecedented socialization of private debt. Moreover, the biggest cheerleaders for this bailout came from Wall Street types like William Gross, the chief investment officer at PIMCO, and Kenneth Lewis, the CEO and president of Bank of America. Forgive me if I don’t trust Wall Street at this juncture.

Initially, the number of free market believers—people I’ve long trusted—who were out lobbying for the bailout mitigated my trust deficit.

But today, my gut is again shifting to a trust deficit. You see, the New York Times just reported that the bailout, on top of giving Paulson the power to buy toxic securities, gave Paulson the power to buy a stake in troubled banks.

What? Since when did the government’s direct purchase of stock in banks become part of the deal?

The option was certainly discussed, and it was actually the preferred option among many academic economists. Injecting banks with capital by buying newly issued stock gets to my point in the fourth question above: the bailout as sold does nothing to change a bank’s balance sheet. Buying an ownership stake does.

But as Justin Fox, Time Magazine’s business and economics columnist, states in his blog: “That wasn’t how Treasury initially advertised its Troubled Asset Relief Program. It was sold as a way to get the market for mortgage securities moving (or, to use the jargon, ‘liquid’).”

To say the least, it’s unsettling that the most significant and most debated counter proposal to the bailout ended up in the final bill without anyone taking notice. The Secretary of the Treasury now holds even more discretion over $700 billion than even the closest observers thought possible.

My gut now rumbles with the worrisome notion that America might be giving way to a new era: one that more broadly accepts government’s heavy hand as a backstop to people and corporations that make foolish bets and precludes the kind of prosperity that can only exist under the discipline of free markets.

Peter J. Nelson is a policy fellow with Center of the American Experiment.

This commentary originally appeared in Volume 8 of “What’s a Free Marketeer to Think?” Click here to read the entire volume.