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The Wrong Emergency

What Washington doesn't understand about the financial crisis.

Congress should think long and hard before giving Hank Paulson $700 billion to buy fallen mortgage securities. Paulson has draped his bailout plan in the cloak of a national emergency. Much as George W. Bush demanded expedited action from Congress to help fight terrorism, the treasury secretary wants his war-chest pronto. And just as Dick Cheney and his minions argued that the terrorism threat was too grave for the White House to submit to the customary checks and balances, so Paulson wants an appropriation with no conditions, no terms--nothing written down about how he would spend the money.

All Paulson has said is that the Treasury (and not an independent agency, as was the case during the 1980s savings and loan crisis) needs the money to buy distressed mortgage paper. Since almost no restrictions govern the use of the bailout, money could be used to buy securities held by strong institutions as well as weak ones. What price they would pay, how that price would be set, and for what assets--all to be determined later. The Treasury’s charter would turn every bank into the equivalent of the former Fannie Mae and Freddie Mac--a government sponsored (but now quite government owned) enterprise, a half-man, half-beast Centaur seeking profit for their shareholders and distributing their losses to taxpayers.

Paulson, the former Goldman Sachs banker, whose stock when he cashed out in 2006 was worth half billion dollars, is sure to argue that the appropriations are necessary because the market is illiquid. Yet a market for mortgage paper still exists. “Sellers just don’t like the bids,” a hedge fund manager told me. A manager with a big money management company confirmed that if Citigroup, Goldman, and the rest want to unload their securities, his firm has money to spend. “We just can’t spend as much as Paulson,” he noted.

The only conceivable purpose of Treasury intervention is to buoy the market (using taxpayer funds) by paying higher-than-market prices. After all, if the government merely intended to match the market, what would be the point?

The sums involved are staggering. As a comment that Greg Mankiw, the former White House economic adviser, posted on his blog asked, “Has more money ever been given with fewer restrictions on how it is used? Ever?”

In 1932, at the height of the Great Depression, the government created the Reconstruction Finance Corp. to make loans to banks, railroads and others. President Hoover asked for $2 billion--equivalent in today’s money to $30 billion--and spent just under that amount in the RFC’s first year. The country then was in the midst of an economic catastrophe. Economic output had dropped 45 percent. Production of steel and autos were each down by three-quarters. Unemployment was 24 percent, and so on.

The allocation sought by Paulson is 23 times bigger. And it is in addition to the tens of billions pledged to back loans to Bear Stearns, Fannie, Freddie and A.I.G.

America’s economy does not face an emergency--only its financial system does. This is a distinction lost on the bankers in Washington, but it is one worth remembering. On Main Street, unemployment is 6.1 percent. Home prices are down close to 20 percent and presumably headed lower. These numbers are not pretty, but they do not add up to an economic Pearl Harbor or even close.

Of course, potentially several million Americans face home foreclosure. That is a crisis, but it is a slow-developing one, for which the normal legislative process--as distinct from a shotgun corralling of Congress--will suffice. And the Paulson plan does not help homeowners.

The only emergency is on Wall Street, and that is entirely of Wall Street’s making. It was the banks that made the loans, the banks that bought the paper, the banks that dumbly believed the models that said that housing prices wouldn’t collapse. The pinstriped bankers who leveraged their institutions’ capital thirty-to-one so as to inflate their profits (and their personal take) now complain they were done in by those nasty short-sellers. How touching to see executives from the likes of Lehman Brothers, not normally an institution associated with widows and orphans, squawk about cutthroat tactics. Regardless, had they not borrowed so much, they would not have been vulnerable.

Ultimately, the issue of blame is less important than is the question of whether markets will eventually right without a federalization of losses. After a lifetime as a champion of free markets, Paulson should carefully explain why he no longer thinks they will. And Congress should listen with just as much care.

Roger Lowensten is a contributing editor at The New York Times Magazine and author, most recently, of While America Aged: How Pension Debts Ruined General Motors, Stopped the NYC Subways, Bankrupted San Diego, and Loom as the Next Financial Crisis (2008).

By Roger Lowenstein