The View From Here . . .

By Bob Morgan, Jr.

In an unwelcome surprise, the American economy has been rocked with a series of shocks and emergency governmental responses.

The reasons for the crisis in confidence are difficult and complex, and few people, inside or out of government, has a grasp on all of factors involved. Nevertheless, a clear root cause is the mortgage debacle, in which borrowers were permitted to obtain "subprime" loans for which they otherwise would have not qualified; these loans were later "securitized" (packaged and sold on Wall Street). Fannie Mae and Freddie Mac, two government sponsored enterprises that became independent entities, both placed the securitized assets on the market (some with Fannie's or Freddie's own loan guarantee) and held them for their own accounts. There were periodic attempts on Capitol Hill to rein in Fannie Mae and Freddie Mac as too ambitious, but the enterprises were very well connected, and not much was done.

So long as the housing market continued to rise, the loans were good investments for all concerned. Even if a homeowner got in financial trouble, he or she could get out of the investment by selling his or her house at a profit and the holder of the mortgage was repaid.

Nothing goes up forever, however, and a downturn in the real estate market led to a wave of defaults and foreclosures and severe ripples in the economy. Demand for the mortgage securities became almost nonexistent and a number of banking and financial corporations involved in these markets were severely damaged. On September 7, Fannie Mae and Freddie Mac, each facing extreme financial difficulty, were in effect taken over by the government. Following that, a number of traditional financial powerhouses were rocked by the financial collapse. Lehman Brothers was forced to declare bankruptcy and AIG had to be saved by massive government intervention. The financial markets were starting to crash with two days last week of losses in the Dow Jones average each exceeding 400 points.

The response of the Bush Administration has been a dramatic proposed bailout with an estimated cost of $700 billion. Under the plan, the Treasury would purchase illiquid mortgage assets from United States companies and some foreign enterprises with a significant presence here. In theory, the securities would eventually be sold at a profit. Also, certain money market funds would be shored up. At least in the initial draft of the plan, Treasury Secretary Henry Paulson and his successors will have a great deal of discretion in administering the program.

While there are many objections to the bailout, from both the left and the right, and very many uncertainties, this is legislation that pretty much has to pass. No politician wants to be blamed for a collapse of the United States economy and there is no competing plan that clearly is a better alternative. Both Senator McCain and Senator Obama have called for greater oversight of the Treasury in going forward with the bailout, which clearly makes sense, but they have been quite unspecific in offering other ideas. The bailout may or may not be the Hail Mary pass suggested by The New York Times economics columnist Joe Nocera, but it is the play that has been called. Everyone will be looking down the field to see if it works.