Schumer's Bailout Proposal Divides Economists, Interests Obama

One of the more interesting moments of this morning's Senate Banking Committee hearing with Hank Paulson and Ben Bernanke came when Sen. Chuck Schumer offered an alternative to handing over a $700 billion bailout check to Wall Street.

Why not, the Senator asked, appropriate a portion of the money now -- say, $150 billion -- reassess where the markets are in a few months, and decide then whether more is needed?

"Could you live with less?" Schumer asked.

"I think that would be grave mistake," Paulson responded. "This is about market confidence and the tools to do the job."

Despite Paulson's dire words, Schumer's suggestion immediately became one of the main topics of conversation among the economic and political chatting classes. Indeed, later in the day, Sen. Barack Obama suggested that he supported the financial prudence behind Schumer's idea and thought it was worth exploring.

"When it comes to phasing in the bailout, I do think it is important to recognize we have a short term problem of keeping the markets functioning," he told reporters. "How much of the request that Secretary Paulson has made that deals with that short term problem, hasn't been made clear and it is something that Sec. Paulson should answer. If it is enough for us to look at $150 billion to $200 billion to cover that emergency, and there is an understanding that we have to set up some institutional structures in the long term, then I think that is something worth exploring. The key is that we are actually dealing with the immediate crisis. I think it is important for Congress to recognize that we don't do something too small that gets us back into this fix.... We have a leaky boat. We need to make sure that boat gets into the harbor and then we have to make repairs."

Over the week ahead the questions are likely to persist. If the $700 billion check would be there for the Treasury Secretary if he needed it, what is the need to fork it over in one swap? If Congress wanted to build oversight into the process, what better way to do it then holding the power of the checkbook over the administration's head? And how wise is it to saddle the next president with what could be an avoidable debt?

Among economists, the Schumer proposal provoked some interesting debate.

"Unless Hank Paulson knows something really terrifying that we (and by that I include members of Congress) don't, I lean very strongly in the direction of Chuck Schumer's suggestion to give the Secretary of the Treasury a portion of the money he's asking for now, and then see how it works out before handing over any additional funds," said Steven M. Teles, an associate professor of public policy at John Hopkins University.

"I have extremely low confidence in the ability of a few smart people to concoct a perfect system from the center, in a week, in their first try. The odds that this will turn out to have some weird unintended consequences are almost 1:1," Teles added. "The real purpose of trying to get all the money upfront is, my gut tells me, to temporally extend the power of the current administration and to keep Congress out of the process. That is, if Congress passes a bailout now and hands all the cash over, the ability to do oversight is considerably limited. Basically, Schumer's plan puts Congress in the driver's seat, since whoever the Treasury Secretary is will know that his ability to get the next tranche of funds will be dependent on following Congress' will (as expressed through oversight hearings)."

Others, however, saw the logic in Paulson's point. After all, brief injections of capital into the market have been tried before, including the takeover of Fannie Mae and Freddie Mac as well as AIG. And the success of those transactions was limited at best. Moreover, the point of the bailout is not, necessarily, to keep the market from failing, but to infuse banks with a sense of confidence (both that there is money to play with and that the bad assets will be taken off the books) to begin lending once again.

"I think there are a lot of problems with this plan," said Jeffrey Frankel, an economics professor at Harvard University. "The basic logic is that they have been trying smaller measures and that hasn't done it. It is the Powell doctrine for financial markets, something so big that it impresses the markets... As such, I am tempted to not go along with Schumer on that one."

Added Brad DeLong, a professor of economics at U.C. Berkeley: "There is a big difference between being the biggest gorilla in the jungle and being the second biggest. Paulson wants everybody to think that he is the biggest gorilla -- and there is good reason for him to do so... Nobody knows [how Schumer's plan would work]. It might have significantly less effect, though, if at each stage people thought that there was unlikely to be a next one..."

Despite the concern, Schumer's plan may have legs, especially with Obama's relatively enthusiastic take on it. Certainly, the main thrusts that underline the New York Democrat's proposal are bound to be debated vigorously in the days ahead. Will Congress act with haste or prudence? Can they fix the problem by overwhelming it or should they take a more fine-tuned approach? And how significant can the power of the purse be in securing oversight?

"The real question -- which Schumer asked directly and Paulson responded to unimpressively -- is what is the least Congress can do now to stop the bleeding, in order to provide enough time to really figure out what makes sense here, both substantively (that is, what policy approach would work) and institutionally (how to design the organization to implement it)," remarked Teles. "No one with any sense really believes that we can figure out a tolerably effective answer to a policy problem this complicated right now. Unless we absolutely do not have any choice, we shouldn't try."

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