Day of reckoning

For more than a year, the U.S. government, led by Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Henry M. Paulson Jr. — with episodic input from Congress — has tried to contain the financial crisis triggered by the collapse of the subprime mortgage market. At every step, the government has faced "moral hazard": the fear that bailouts reward those who took foolish risks. So officials tried to minimize both short-term harm and long-term taxpayer cost. First, there was a modest program to encourage subprime mortgage workouts. That gave way to a plan (still not yet in effect) to refinance and guarantee up to $300 billion worth of mortgages. Then came bigger and bigger bailouts of Bear Stearns, Fannie Mae and Freddie Mac, and American International Group (AIG). And still the panic grew. When a run threatened supposedly rock-solid money-market mutual funds this week, the government had to step in to insure those.

Now, it's moral hazard be damned. The Fed, the Bush administration and Congress promise to quit nibbling around the edges and attack the central problem: the buildup of unmarketable mortgage-backed securities and other assets that are tied to the declining value of U.S. housing. In some as-yet-unspecified way, the government will spend hundreds of billions of dollars to acquire these assets, taking them off the private sector's hands and freeing financial institutions to resume borrowing and lending, unafraid of getting stuck with worthless paper. The U.S. Treasury, or some other agency, will become a vast owner of bad debts and the real estate that underlies them.

We cannot quarrel with the notion of drastic action. The piecemeal, reactive approach taken thus far has not worked; as a bipartisan consensus in Washington has concluded, the U.S. government has a duty to stabilize the nation's financial system, even if this means creating winners and losers who don't necessarily deserve their fates. And action has to come swiftly, before Congress adjourns Friday.

But there are many difficult questions, such as: How will the government decide which assets to buy and what to pay for them, given that market prices do not exist? How will it even figure out what these dizzyingly complex instruments represent? Is the program going to be all risk for taxpayers, with limited potential profit (unlike the AIG and Fannie-Freddie bailouts, which at least gave the feds an equity stake)? Presumably, as the prospective owners of so much distressed real estate, taxpayers will often have an interest in foreclosing; does that set up a conflict with Treasury's loan-modification program? Last but not least, will this latest rescue work?

The government will finance the operation with borrowed money — on top of a federal budget deficit already projected at more than $400 billion for the next fiscal year. Like the trade deficit, the budget deficit reflects recent economic sluggishness. But it is also structural — a result of this country's failure to reform entitlement programs, curtail wasteful spending and tax at a reasonable level.

It is both satisfying and partly justified to blame this disaster on greedy Wall Street executives and the inattentive Washington regulators who enabled them to build what we now know was a financial house of cards. Wall Street has lived beyond its means, but so has Washington. Both did so, in part, because consumers and voters on Main Street wanted it that way. They craved cheap credit to spend on imported goods, and they resisted tough tax and spending decisions. That, too, must change, lest this generation's costly excesses end up crushing opportunities for its children and grandchildren.

— The Washington Post

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