Out of Control Policy Blog

Congress to go shopping for bad debt

Stocks have surged over 700 points from yesterday through this morning on news that the federal government is preparing to offer Wall Street a massive bailout package. While the details are yet to be hashed out this weekend, Treasury Secretary Paulson and President Bush both spoke this morning to outline what Congress is considering.

In short, Congress is preparing to create a special fund, on the order of "$100s of billions of dollars" according to Paulson and perhaps nearly $1 trillion dollars. This fund would then buy up the bad mortgages off the books of banks and lending agencies in order to give them fresh capital.

At present, many financial institutions have their capital tied up in "illiquid assets," such as homes that they can't sell and that no one is paying them for. Banks can't lend Americans money because they can't free up the capital to do so. Additionally, these bad assets aren't drawing any money, creating losses for the institutions. Essentially, Congress is going to come in and buy up these homes so banks don't have to worry about them any more. The clouds will be lifted and all their risk will go away.

Well, it will go away from them, and land squarely on the shoulders of the government of the people.

Secretary Paulson believes that stability in the mortgage markets will equal stability in financial markets. He said in today's press conference that the cost to the American taxpayer would be worse if government didn't take these steps.

As Congress prepares to shop for bad debt to add it the government's growing assets (already including an insurance company and two mortgage lenders), the government has taken more steps to chip away at our free market capitalism.

The SEC stopped investors from shorting stocks–betting that firms would fail–until at least October 2nd. President Bush said they wanted to keep investors from "intentionally" trying to destroy firms for "their own personal gain." Of course, all investing is for personal gain on some level, so the judgment here is that certain investors were being malicious in their short selling, but that was already criminal. This act is just limiting the free market.

Furthermore, the Fed and Treasury announced that they would open the $50 billion Exchange Stabilization Fund to support U.S. money-market funds (MMFs). While the FDIC insures checking account deposits, this is a first for the government to insure investments–albeit safe ones. MMFs are intended to be low-risk, low-yield accounts to park your money safely while earning a bit of interest. Yet they are still risks. They are invested in very low-risk opportunities, but could–in theory–lose money if the banking institution collapsed.

MMFs have never lost money in the history of their use as an investment tool, but there has been that threat lately (causing Americans to pull nearly $90 billion out of MMFs). This strips firms of already desperately needed capital so the government has stepped in to insure them, placing more taxpayer money at risk.

Anthony Randazzo is Director of Economic Research


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