The Price of Wall Street's Rescue

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.