Finding Alternatives To Bailout Proposal

President Bush, the Treasury secretary and the Federal Reserve chairman have all suggested we have no choice: One way or another, they've said, the economy is in danger without a $700 billion bailout of the financial services industry. But the original bailout plan is changing in Congress, and outside economists have suggested different approaches.

Simon Johnson, a former chief economist at the International Monetary Fund, had a note of disbelief in his voice as he described the proposal made by the Bush administration Friday.

"Seven hundred billion dollars of taxpayer money has been put on the table at the express request of a Republican administration to bail out banks, bank managers, bank shareholders, bank creditors," Johnson said.

He doesn't think the administration's idea of taking distressed mortgage securities off the hands of financial institutions is the right approach. He says it's a backdoor way of injecting money into the firms, boosting their capital and making them more willing to lend again.

Johnson and a number of other prominent economists suggest a Warren Buffet approach instead: Buy shares in the company.

"You don't want to do this in a halfhearted, backdoor way," he said. "You gotta be transparent, come all out, go for preferred shares for the government in return for new capital. Wall Street is not going to like it, but that's tough. We're way beyond only doing things that Wall Street likes."

'If It's A Dog, It's Your Problem'

Johnson thinks there's another approach that would be superior to the Treasury's plan — giving government loans to the struggling financial firms and taking their distressed mortgage securities as collateral.

"Think of it like this: If you need some cash, and you have a secondhand car that's in pretty dubious condition, if I buy the car from you and the car turns out to be a complete dog, that's my problem," he explained. "But if I lend you money against the collateral of that car, ultimately you're going to pay back the loan, and it's your car so if it's a dog it's your problem."

So, by not buying the distressed securities that are the equivalent of the used car, taxpayers aren't holding the bag if the securities turn out to be dogs. But the financial firms do get the money they need in the form of a loan to help them get on their feet again.

The Japanese Model

On Wednesday, as he answered questions before the House Financial Services Committee, Treasury Secretary Henry Paulson critiqued some of the alternatives to his approach. He said it's a bad idea to inject capital into banks without removing their troubled assets, calling it "the Japanese solution."

During its financial crisis in the 1990s, Japan propped up its failing banks instead of forcing them to get rid of bad assets, and the country stagnated for a decade.

"They were in a very long recession for many years. You know, you put capital in the banks, and the government is essentially in many ways running them," Paulson said.

There are many other alternatives to Paulson's plan — among them, forcing banks to stop paying out dividends in order to build up their capital, or suspending capital-gains taxes to make financial institutions more profitable, an idea being pushed by Republican lawmakers.

Open To Alternatives

Democrats are supporting other measures, including providing funds to help homeowners facing foreclosure. After all, it's foreclosures that are making those mortgage-backed securities toxic.

Many of the alternatives have made their way into draft legislation, and some will probably make it into the final bill. The administration has softened its all-or-nothing approach. In Wednesday's hearing, Fed Chairman Ben Bernanke seemed open to using some of the alternatives to attack the problem.

"It's the intention of the secretary, certainly I would advise him to be flexible and respond to conditions as they change, and if this process is not working effectively, there are other ways to use this money that will, again, purchase assets or purchase capital and support the banking system," Bernanke said.

Negotiations over the final shape of the rescue plan continue Thursday.

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