The Price of Wall Street's Rescue

By Robert Kuttner, AlterNet. Posted September 19, 2008.

Help must go to the ordinary people who have suffered harm, not just
wealthy insiders. That should be the price of a deal.

Treasury Secretary Paulson and Fed Chairman Ben Bernanke are sending
Congress emergency legislation to put the bailout of Wall Street on a
more systematic footing. They had little choice, since the Federal
Reserve has already used up more than half of its nearly a trillion
dollars of cash.

Last week, Paulson played a very high-stakes game of chicken with the
rest of Wall Street, when he tried to halt the bailouts by declaring
that the private financial community would have to rescue Lehman
Brothers. But nobody blinked. And Lehman went under, setting off
deeper shock waves. Next they tried the same game with A.I.G. -- then
quickly reversed course when they realized that the stakes were too
high.

Now, Paulson is playing same chicken game with the Democrats: Accept
our plan or risk Great Depression II. Grant us sweeping authority to
have taxpayers buy up worthless assets from banks, have the government
hold the securities until financial markets return to normal, and then
gradually sell them back and see what the government can recover.

But the worst possible result would be for financial markets to return
to "normal" -- if normal means the speculative casino of the past
decade, abetted by figures like Paulson. The Democrats would be
foolish to accept the Paulson plan at face value, since this entire
crisis is the result of his view of the economy, which boils down to
deregulate-and-bail.

Superficially, the Administration plan bears similarities to ones
first floated by Democrats Barney Frank, chairman of the House
Financial Services Committee, and New York Senator Chuck Schumer.
Administration leaks have likened the proposed plan to earlier
government rescues -- the Reconstruction Finance Corporation and Home
Owners Loan Corporation of the New Deal, which pumped hundreds of
billions of public money into the private economy; and the Resolution
Trust Corporation of the 1980s, which cleaned up the first savings and
loan meltdown (also the child of deregulation.)

But the similarities are only skin deep. In the cases of the Roosevelt
institutions, public capital went hand in hand with stringent
toughening of public standards. And with the Resolution Trust
Corporation, government sorted out good loans from bad, and sold off
assets at so many cents on the dollar. But the damage was finite.

Today, the scale of the bad assets on the books of financial
institutions dwarfs any previous crisis, and is literally unknowable.
For example, insurance against bad debt, underwritten by companies
such as A.I.G, totals about $42 trillion dollars alone. That's
trillion.

Nobody knows how much of this debt will ultimately be paid back,
because that depends on the health of the broader economy and the
confidence of investors. Paulson's idea of allowing financial
institutions to park questionable securities in a government agency
may not be sufficient to stem the damage -- unless it is coupled with
broader reforms.

In return for taking a lot of bad paper off the books of financial
institutions, we should demand:

Much tougher regulation of all financial institutions going forward.
That can't be done in a week -- so let's strictly limit the new
bailout authority to six months, then have the new administration
enact permanent legislation on both systematic recapitalizing of and
much tougher regulation.

A refinancing of sub-prime mortgages held by homeowners. American
households have already lost something like two trillion dollars in
home equity, thanks to sub-prime. Why use public money to bail out the
wizards of Wall Street who caused the damage, but not the ordinary
Americans who suffered it?

A second, much larger stimulus package, in the range of $300 billion,
to put people back to work rebuilding America's rotting
infrastructure, so that money goes to states, cities, towns, and
families -- and not just to banks and brokers.

Congressional Republicans are all over the map on the Paulson plan.
Some are blasting the bailout; others are in bed with Wall Street.
Hardly any are demanding help for Main Street. This is surely an
opportunity for progressive Democrats.

Nancy Pelosi, Harry Reid, and the rest of Democratic leadership should
not be intimidated by this high-stakes game of chicken. Help must go
to the hundreds millions of ordinary people who have suffered harm,
not just wealthy insiders; and that should be the price of a deal.

And for a couple of years and maybe more, deficit spending is going to
have to rise sharply -- there is no other way to recapitalize banks
and to prevent a cratering of the wider economy. Despite bipartisan
deficit phobia, temporary large deficits are far superior to the
alternative -- a second great depression.

But these deficits shouldn't just help Wall Street. If Democrats hang
tough on that principle and Republicans resist, it tells voters
everything they know about the two parties this election year.

Robert Kuttner's new book is "Obama's Challenge: America's Economic
Crisis and the Power of a Transformative Presidency."