"How Much Will It Cost and Will It Come Soon Enough?"

Here's Jamie Galbraith's view of the bailout plan (the Senate may try to revive the plan tomorrow):

How Much Will It Cost and Will It Come Soon Enough?, by James K. Galbraith, TNR: There is no question that the current bailout bill represents an enormous improvement over the original Treasury proposal. ...

The question now is could the purposes of this bill be met with a smaller appropriation. In my view, the best way to answer that question is to ask: What problem does $700 billion solve? The answer to that is, we do not really know. On the face of it, the exposure to bad mortgage-backed securities is considerably larger; the purchase plan in the bill would inevitably bail out some inessential as well as essential investors and institutions, thus wasting a fraction of the resources; and we do not know the full extent to which banks need new capitalization in order to remain solvent. The reasonable presumption, therefore, is that TARP would buy time; one hears estimates that the authority would be used at a rate of $50 billion a month, though the basis for that estimate is not clear. A smaller appropriation would buy less time.

How much time is needed? There is in my view very little prospect that economic recovery will restore housing prices and personal incomes within a reasonable time -- that is, before the $700 billion runs out. Therefore, it seems to me unlikely that this issue will finish here; more will be needed at a later date. However, on the assumption that one can trust and monitor the actions of the Treasury to assure that it carries out its mandate in good faith, there is an argument for appropriating the full sum now: It will help ensure that the system will hold into next year. A smaller appropriation increases the risk of a major crisis in the relatively near term. By how much and when? No one can say. ...

Many are concerned with the fiscal implications of this bill, so let me turn to that question.

Despite the common use of language, the capital cost of this bill does not involve "taxpayer dollars." It authorizes a financial transaction, exchanging good debt (U.S. Treasury bills and bonds) for bad debt (the "troubled assets"). Many of those troubled assets will continue to earn income for some time, perhaps a long time. The U.S. Treasury commits itself to paying the interest on the debts it issues. The net fiscal cost -- which is also the net fiscal stimulus -- of this bill is the difference between those two revenue streams. Given the very low rate of interest presently prevailing on Treasury bills, this is likely to be somewhere between $20 billion per year..., even if the Treasury were to issue all $700 billion in new debt at once. It is a mistake, in short, to count the capital cost as a "cost to the taxpayer." ...

In the longer run, of course the Treasury will incur capital losses on the assets it acquires. The entire purpose of the bill is to overpay for bad assets, so as to give financial institutions a chance to recapitalize themselves. The proposal to recoup that capital at a later date through a fee on the same institutions strikes me as being somewhat defeating of the very purpose of the bill. If it is desirable to raise tax revenues to cover the running cost, a turnover tax in the stock market is an attractive alternative -- if it could be passed. ...

Whatever happens, if my analysis is correct, even if the bill is passed the issues will not go away. The $700 billion will permit parts of the banking system to be reorganized. I doubt it will cure an underlying problem of illiquid securities many times larger than that. ...

A larger issue concerns the relationship of this bill to the overlying economic situation. Will this bill "unblock the channels of credit" and restore the economy to normal? I would answer in two parts. First, if it is the case that runs on money market funds are threatening the liquidity of the corporate financial system, urgent measures including the Treasury's insurance facility should be put in place to prevent that. Here the TARP plays a somewhat tangential role. Think of it as a slush fund with which Treasury can recapitalize banks as needed, for a time. But even though it is tangential, it may be a useful and perhaps necessary part of a program to prevent, or defer, a disaster.

Second,... this program ... will [not] prove sufficient to restore economic growth and high employment. For that purpose, resolution of the underlying housing problem, of the revenue problem of state and local governments, and of the wealth and income problems of retirees and other asset-dependent parts of the population are all essential. Those measures lie ahead; they will not be part of this bill. ...

In short, as I said at the beginning, the bill is a vast improvement over the original Treasury proposal. Given the choice between approving or defeating the bill as it stands, I would urge supporting the bill. I do so without illusions. There need be no pretense that it will solve our underlying financial and economic problems. It will not. The purpose, in my view, is to get the financial system and the economy through the year, and into the hands of the next administration. That is a limited purpose, but a legitimate purpose. And it may be the most that can be accomplished for the time being.