Congress Weighs Next Move On Financial Bailout

Calm prevailed in the markets and on Capitol Hill on Tuesday, a day after the House rejected the $700 billion financial bailout plan.

The stock market rallied on renewed hopes that Congress would regroup and try again. Most House members took a two-day break for the Jewish New Year. Senators promised that lawmakers would indeed be back with a bill later this week, after they tweaked it to pick up more support.

For the ninth day in a row, President Bush weighed in early from the White House on the need for Congress to deliver a financial rescue package.

"I recognize this is a difficult vote for members of Congress," he said. "Many of them don't like the fact that our economy has reached this point, and I understand that. But the reality is that we're in an urgent situation, and the consequences will grow worse each day if we do not act."

At the Capitol, Senate Majority Leader Harry Reid (D-NV) said he had every intention of acting.

"We're all committed to keeping the progress on this rescue package moving forward," he said.

Senate Minority Leader Mitch McConnell (R-KY) went so far as to set a deadline.

"We will get the job done," he said. "We will get it done this week. And I think, hopefully, that will reassure the American people that Congress can rise to the occasion, act like grown-ups, if you will, and get the job done for all of our people."

Driving the resolve to try again for a bailout package is the fear among many lawmakers that the nation's financial system could soon collapse if nothing is done.

New Hampshire Republican Sen. Judd Gregg, who negotiated the now-rejected bailout on behalf of his caucus, warned that Congress cannot wait any longer.

He said the consequences of not passing the measure are extraordinary "and will be so detrimental to our country and to our people that it would be totally irresponsible of us to not take this action."

Many lawmakers who voted against the bailout, however, did so after being deluged with calls and messages from constituents opposed to the rescue package.

New Mexico Republican Sen. Pete Domenici, who is retiring this year, called on those constituents Tuesday to give his colleagues some peace.

"Citizens, turn some of your members loose who you're holding hostage by telegram and phone call to allegations that are not right, that are untrue," he said.

But other lawmakers continue to oppose the bailout bill on its merits.

Sen. Jim Webb (D-VA) said there is a real need to rethink what's in the bill.

"There are a lot of people who are not playing politics, who do understand the problem, who are doing their job, who still have had grave concerns about the approach that has been taken with this proposed solution," he said.

Presidential candidates John McCain and Barack Obama both urged action Tuesday. They suggested one way to broaden support would be to raise the $100,000 limit for federally insured bank deposits, an action that federal authorities endorsed.

Senate banking committee Chairman Christopher Dodd (D-CT) has been a leader in the effort to come up with a rescue package. Dodd said Tuesday he's fairly confident Congress will be able to have another vote soon.

"I know that those that cast votes yesterday are having some second thoughts about the condition they placed us in and are trying to find a way in which to get back on track again," he said. "And so I'm very optimistic we can do that.

"I know the White House is now engaged much more aggressively than it has been on this issue, which I welcome. I know that the leadership of the House is also working on this, and I don't want to predict things with any great certainty, but I'm quite confident we're moving in the right direction and that we should end up with a very positive result within the next 24 or 48 hours."

Dodd added, however, that no conclusions have been reached about whether the House or Senate will act first.

No Rescue? Economists Explore What's Next

The House of Representatives' defeat Monday of a $700 billion financial rescue package may have come as a surprise to President Bush and top administration officials. But economists who have been watching the process say the package had some shortcomings and these became hurdles to its passage.

As political leaders ponder what to do next, here's a look at what some economists think lies ahead.

Dean Baker
Co-director, Center for Economic and Policy Research

Baker says the rationale for the rescue package — to prevent a "meltdown" in the financial system — remains a viable concern: "We're at risk of that. There's clearly a lot of stress," he says. "I'm sure we will see more upheavals, most likely following bank failures."

His primary concern is not the ups and downs of the stock market but what's happening in the credit markets and financial firms' access to credit. Baker says he wasn't a fan of the proposed legislation because it was a "very indirect way" of addressing problems in this arena — namely, that firms lack the capital they need to support their operations. "It would have made much more sense just to inject capital directly into the financial system," he says.

And the underlying issue, Baker says, is that the U.S. has lost close to $4 trillion in housing equity. The toxic assets at the heart of the financial meltdown are mortgage-backed securities. But with house values plummeting, it's impossible to gauge how much these securities are worth.

"This is the story of the downturn and of course, the bailout does almost nothing to counter this drop in demand," Baker writes in an article published Monday on the Talking Points Memo blog.

Baker says the government should have taken an approach akin to what it did with the insurance giant American International Group, infusing capital in exchange for a large share of the institution. Instead, the bailout package advocated an indirect approach focused on buying troubled assets, he says.

Baker says he would like to see a "qualitatively different proposal" but thinks there will be intense lobbying to get the additional votes needed for the passage of the current bill.

Simon Johnson
Senior fellow, Peterson Institute for International Economics

Johnson, who is a professor at MIT's Sloan School of Management and served as the economic counselor for the International Monetary Fund, says the rescue package wasn't "ideal," but it would have bought time and "stabilized the markets." He expects some form of the legislation to pass later this week.

Like Baker, Johnson says the crux of the problem is declining house prices. Regardless of whether the rescue legislation goes through, Johnson says the two key issues that need to be addressed by any follow-up plan are mortgages and banks' lack of capital.

Johnson also remains concerned about what's on the horizon in Europe. He warns that the "cracks in the financial system" extend beyond the U.S., but European lawmakers have been reluctant to acknowledge that. "In fact, they're saying, 'We don't have a problem. It's an American problem.' ... That is known as sticking your head in the sand."

Michele Gambera
Chief economist, Ibbotson Associates

Given that all 435 House seats are up for re-election, Gambera says he was surprised that House members felt they could afford not to act in favor of a financial rescue plan. "I don't know how they will be able to go back to their electoral district with their hands empty," he says.

The bailout plan proposed by Treasury and modified by Congress was "clearly imperfect," Gambera says, and he acknowledges that voter anger was high over what many saw as "free money" for Wall Street. Still, he says lawmakers failed to make it clear that under the plan, the government would actually be acting like an investment bank or a "bottom feeder," swooping in to buy troubled assets on the cheap, with the potential of making a profit when — and if — prices recover.

Gambera agrees that the priority for banks remains capital — not a path for selling assets. Once banks have capital, they can write off bad assets and "come clean," he says.

The big problem for banks is that they "don't know who will be in business next week," Gambera says. As a result, they are not lending to each other — or to households or small and medium-sized businesses. Instead, they're keeping a lot of cash on their balance sheet to show that they remain solvent.

Ultimately, Gambera thinks the U.S. economy might be stuck in "second gear" for a while. The outlook for the U.S., compared with Europe and Japan, is worrisome, he says, because Americans have low rates of savings and their salaries, on average, have not increased; they've just grown enough to cover inflation. "American households have very little flexibility — they have no elasticity to take any hits."

International spillover is already a factor. Gambera says banks across the world have tightened their lending standards. Because the U.S. remains a huge importer, if the economy here continues to slow down, it will have an adverse effect on companies overseas.

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