Rescue Plan's Critics Offer New Proposal

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The on-again off-again bailout plan has gone through many changes since it was first delivered last weekend. It's now more than a hundred pages long and has many taxpayer protections built in, but critics in Congress aren't happy. Critics are offering a plan of their own.


As members of Congress and the Bush administration struggle to hammer out a rescue plan for the financial system, there's still doubt among some economists that the plan will actually work. The plan's core idea is this, that the government can protect the economy by spending up to $700 billion to buy up distressed mortgage-related securities. NPR's John Ydstie talked to some critics who just aren't buying it.

JOHN YDSTIE: Members of Congress from both sides of the aisle have criticized the central idea of Treasury Secretary Paulson's plan. Yesterday, their concerns were seconded, in a letter from 200 academic economists. They said Paulson's plan was too expensive and risky. Republican Senator Richard Shelby waved the letter before cameras and microphones as talks at the White House collapsed yesterday.

RICHARD SHELBY: I don't know if you have this but I have a five-page- five pages of the leading economists in America, that wrote to me and the leadership saying the Paulson plan is a bad plan. It will not solve problems, it would create more problems. We're rushing to judgment, that we do stress in our financial markets but this is not the best way. We ought to look at alternatives.

YDSTIE: One of the economists who signed that letter is Luigi Zingales of the University of Chicago Graduate School of Business. He argues the Paulson plan is too expensive and gives investors the wrong incentives. He's pushing a plan that would cost taxpayers nothing.

LUIGI ZINGALES: So what I propose is simply that you write a special sort of a chapter of the bankruptcy court, maybe even temporary and just aimed at financial institutions.

YDSTIE: Speaking on his cell phone from Italy, Zingales said his new bankruptcy law would require people who lent money to struggling firms to exchange that debt for an equity stake in the companies. Instead of being lenders to the companies, they'd become shareholders. There would be no cost to taxpayers and he says, it would create the right incentives for inventors going forward.

ZINGALES: Because people who lent and didn't pay attention to where they're lending, now, they're going to take a hit, and so next time, they would pay attention.

YDSTIE: By transforming their debt into equity, says Zingales, these financial firms would be increasing their capital. That would mean they could lend more, which would achieve the basic goal of the Fed and treasury to ease the credit crisis. Zingales says the Federal Reserve could essentially force struggling firms to participate by saying any firm that didn't would not have access to emergency Fed lending for a year or so. Simon Johnson, the former chief economist of the International Monetary Fund, has also been a critic of the Paulson plan for the same reasons as Professor Zingales, it's too expensive and it may not work.

SIMON JOHNSON: I agree the situation is serious. I agree we need to find a comprehensive and decisive solution. I don't think what they're proposing is comprehensive or decisive. They need to have the courage of their convictions and they need to act in the interests of the taxpayer.

YDSTIE: Johnson, now a professor at the Sloan School of Management at MIT, says he would have preferred that instead of buying distressed mortgage securities, Paulson had proposed lending money to firms and taking the securities as collateral. But given the current meltdown in the credit markets, Johnson says officials in Washington have no choice but to pass the package they're working on, warts and all.

JOHNSON: I think this bill has to go forward. It this bill doesn't go forward, then we have a calamity. But I don't think that's enough. I think that Congress shouldn't go home. I think they have to stay and I think they have to put their own proposals on the table to deal with the health, and preserving the health and preserving the existence of the core of the U.S. financial system.

YDSTIE: Johnson is alarmed by the toppling of U.S. financial institutions one by one and he thinks there are more to come. He suggests a two-day bank holiday during which U.S. officials determine which institutions are strong enough to survive and arrange for them to absorb the weaker ones. Dramatic action, he admits, but inaction is not an alternative.

JOHNSON: Look, there was a war that once upon a time was called the Great War, and they stopped calling it the Great War because there was another big war. Then they called them World War I and World War II. At the moment we have just one Great Depression. I think we should try and leave it that way.

YDSTIE: John Ydstie, NPR News Washington.

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