Ask an Expert: Economic Conundrum

As bailout focus shifts, government tackles a tough dilemma

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Roderick Harrison

News of the fiscal fallout continues to paint a bleaker picture of the U.S. and global economies. On Saturday, leaders of G20 nations, the largest economies in the world, ended a two-day meeting where they discussed the global financial crisis and worked to figure out a way forward. But as President George W. Bush prepares to hand over power to President-elect Barack Obama, little was expected to get done at the meeting. Moreover, last week’s reorganization of the $700 billion economic bailout by Treasury Secretary Henry Paulson, a push by Congressional Democrats for an auto industry bailout, and a flurry of other issues compounded to make the economic situation seem more dire and complex. spoke with Julian Morris, an economist and founder of London-based International Policy Network based with more of a free market approach, and Roderick Harrison, director at the Joint Center for Political and Economic Studies in Washington, D.C., who sees government intervention as necessary. Morris and Harrison discuss how the change in the bailout effort, a beleaguered auto industry, and additional government aid will affect each citizen, and what global governments plan to do about the crisis. Treasury Secretary Henry Paulson announced he was reorganizing the $700 billion financial sector rescue effort, instead focusing on credit cards, auto, and student loans. Why the shift?

Julian Morris: One reason could be that the original bailout was entirely misconceived.
A fundamental problem pertains to the prices the government would have paid for the “troubled assets.” If it had bought the troubled assets at market prices, it would have caused crippling mark to market adjustments across the market (the opposite of what was intended); on the other hand, paying elevated “hold to maturity” prices would be an unjustifiable use of taxpayer funds, given that such valuations would entail a fairly substantial (but difficult to quantify) premium to market prices.

Roderick Harrison: What he abandoned was the plan to buy through a “reverse auction” —-the troubled mortgage instruments that have threatened the survival of the banks and security firms that brought them heavily. The argument was that the great difficulty of knowing what might be on an institution’s books is what has prevented banks from lending to one another, causing the credit freeze. The strategy here is to give the banks sufficient reserves/funds so that they could begin lending again. This has already happened rather quickly —- about $300 billion has already been committed to financial institutions.

Where do the plans on purchasing toxic mortgages stand?

Harrison: This is what was shifted away from. The institutions will simply write these off as total losses and/or hold them in the hope that they will regain some of their value when the housing market recovers.

What provisions in the troubled asset relief program give Paulson the ability to do this?

The program gave him broad powers to purchase assets without specifying particular mechanisms that he would have to use. He originally asked for

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