This is the central thesis US President George Bush is applying to the biggest financial crisis to hit the US since the great depression. The problem is, that on both sides of the House there is intense disquiet about the long-term effect on an already troubled economy. Effectively, the US Treasury will buy distressed financial assets in a package worth US$700 billion. Additionally the Treasury will offer guarantees for US$3.2 trillion in money market mutual funds.
The abandonment of free-market principles worries many, as does the decision to bail out Wall Street rather than the roughly four million people facing repossession of their homes. However, it looks like the political wrangling is just beginning. Both presidential candidates are closely watching the outcome. They can sense that the package is a bailout now, pay later formula that will probably limit their own spending plans. Inevitably the devil is in the detail. Whether the bailout works will be largely as a result of cost. Cost to the government, the banks and of course the taxpayer. If the government buys the debt at book value, the banks will have gained. If however, it buys at distressed prices the government stands to gain if the mortgage backed debt market recovers. These are big ifs. Time is short with Congress set to adjourn and a president pushing for a quick agreement.
The other point is that the US economy does not need extra debt. The White House estimates the US will be US$482 billion in debt next year. Any further deterioration in its debt position is likely to impact the already battered US dollar. Foreigners are more reluctant to hold US debt than at any other time. After an unprecedented period of deregulation the pendulum is in peril of swinging in the opposite direction towards overregulation. That would be dangerous. What markets require is the right kind of regulation. The derivatives market, in particular, needs to be a lot more transparent.
It is a risky strategy. If the package is not successful in prompting banks to lend to each other the US economy is headed for uncharted waters, and so is the global economy.
Although there is still a lot to be discussed it looks as if it is a done deal. The risk to the financial system is such that opposition will have to accept that far bigger consequences are at stake.
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