Will U.S. bailout work?
The Treasury's $700 billion rescue would push US into uncharted territory.
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Ms. Reinhart, who has studied the history of financial crises around the world, says one lesson of history is to act quickly. "The longer crises last, the bigger the bailout," she says. "Asset prices continue to decline, wealth continues to be destroyed, and … economic activity begins to reflect these developments."Skip to next paragraph
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Concerns stall plan
Still, the rush to pass a plan ran into hurdles starting Tuesday, as lawmakers and others raised concerns.
The Treasury plan does not necessarily preclude some of the alternatives proposed by experts, such as forcing banks to stop paying dividends (to raise capital) or for the government to inject capital in return for equity in banks. Paulson and Bernanke defend the asset-purchase plan as the best idea available, since doubts about the value of these assets lie at the heart of recent chaos.
Credit markets seemed to amplify the urgency, showing signs of continued and extreme stress. Banks are reluctant to lend to one another – normally a routine part of their business.
Against this climate of fear, a positive sign in recent days has been the arrival of some willing investors in financial firms. Mr. Buffett's move Tuesday made the biggest splash. Private equity investor J. Christopher Flowers got clearance from bank regulators to buy a Missouri bank. Mitsubishi UFJ is buying a 20 percent stake in Morgan Stanley. And Barclays bought parts of the failed Lehman Brothers investment bank.
To some economists, this raises questions of whether a big rescue is needed. Yet Barclays didn't move in for Lehman until the bad assets had been removed. Describing the conditions as an "economic Pearl Harbor," Buffett said, according to a Bloomberg news report Wednesday that his investment in Goldman is a vote of confidence in the Treasury's plan.
The Treasury's program must find prices for the assets it wants to buy. It has to pay a high enough price that banks come forward to sell them. But overpaying imposes high costs on the taxpayer.
And the assets are complex, which makes a fair price hard to determine. Paulson said he'll pursue "reverse auctions" in which sellers provide offer prices for the securities.
Brian Battle, vice president of Performance Trust Capital Partners, a bond trading firm based in Chicago, says the Treasury plan intends to gather up bad assets, and it will pay high enough prices to do so. "They're going to succeed" on that front, Mr. Battle says. But "does this cure the disease?"
The question, he says, is to what extent that will resolve the underlying problem of sagging home prices. The further home prices fall, the less the complex mortgage securities are worth.
Some bond experts are optimistic that the Treasury's plan will not only ease financial stress but also make a profit for taxpayers. A team of bond analysts led by Laurie Goodman at the investment firm UBS, says the program "has a good chance of making money for the government."
But banks will still need to raise new capital. UBS analysts say the plan may "remove one major hurdle … [and] stop the downward spiral in the credit markets."