Can America afford it?

Some see cost over $1 trillion; others predict much less

President Bush discussed the government's bailout proposal yesterday during a news conference at the White House. (Jonathan Ernst/Reuters)

The Bush administration is seeking sweeping powers for what could become the biggest private sector bailout in the nation's history, as economic policy makers try to end the gravest threats to the financial system since the Great Depression.

In a proposal sent to Congress yesterday, Treasury Secretary Henry M. Paulson Jr. sought authority to spend up to $700 billion to buy troubled mortgage-related assets to restore confidence in stock and credit markets, which have lurched from crisis to crisis. Some analysts estimate the cost could top $1 trillion.

In the long run, analysts said, the bailout should cost taxpayers far less than the initial outlay as the federal government resells assets once panicked financial markets return to normal. The upfront costs of the savings and loan crisis of the 1980s, for example, totaled more than $500 billion, but the price eventually fell to about $125 billion after bank assets, primarily real estate, were sold.

Mark Zandi, chief economist of Moody's Economy.com, estimates the final cost to taxpayers for this bailout at $100 billion to $200 billion. Representative Barney Frank, the Newton Democrat who serves as chairman of the House Fi nancial Services Committee, said he would be disappointed if the final cost is much more than 10 percent of initial spending.

"Something like this is necessary," Frank said. "It's a measure of how much the private sector screwed things up because of a lack of regulation."

Many analysts say it is difficult to project the ultimate cost because no one knows the future value of mortgage-related assets, which panicked investors have all but stopped buying. Under the Bush administration proposal, the United States would borrow the $700 billion to finance the bailout and raise the limit on the national debt to $11.3 trillion from $10.6 trillion.

The nation would take on this added debt as it faces huge obligations in Social Security and Medicare, with more than 75 million baby boomers beginning to retire. Over the long term, growing budget deficits can hurt the economy by increasing interest rates, squeezing out private investment, and slowing productivity, which in turn undermines living standards, according to economists.

It also makes the nation more dependent on foreign nations and investors to finance the debt, and squeezes out spending on programs such as education and healthcare. The proposed bailout makes it more likely taxes will increase, some analysts said.

"Eventually, we have to pay these debts back," said Nariman Behravesh, chief economist at Global Insight, a Waltham forecasting firm. "Nobody wants to say it, but taxes are going up in the next five to 10 years."

Most economists agree, however, that the cost of inaction would be far greater. The crisis, which began in the nation's housing bust and spread into credit and stock markets, is pushing the global financial system to the brink of collapse, which in turn would plunge the world into a deep and prolonged economic downturn.

Lawmakers from both parties agreed the government needed to act. Senator John Sununu, Republican of New Hampshire, said that bolstering confidence in financial markets is key to maintaining access to student loans, home loans, and other credit on which American families depend.

"Treasury does need to take steps to ensure liquidity and capital for the credit markets," he said.

Senator Charles Schumer, Democrat of New York, called Paulson's proposal "a good foundation that can stabilize markets quickly" but added that Congress needs to do more to protect taxpayers and help homeowners. House Speaker Nancy Pelosi, a California Democrat, said Democrats would strengthen oversight of the bailout and establish authority for Congress to act quickly to improve regulations.

She added Democrats would push to enact another stimulus package to boost the economy.

The administration's bailout proposal came at the end of an extraordinary week that saw the failure of investment firm Lehman Brothers Holdings Inc.; the $85 billion government takeover of insurance giant American International Group Inc.; and a run on money market funds reminiscent of Depression-era bank runs. Credit markets nearly ground to a halt, and panic selling spread across global stock markets.

The goal of the bailout plan is to restore confidence. Financial firms stopped lending to one another out of fear their partners might have large holdings of mortgage-related assets, similar to those that pulled down Lehman Brothers and AIG, as well as investment firm Bear Stearns Cos. By buying these assets from the financial institutions, federal officials hope to get credit and financial markets operating normally.

The administration proposal, a scant three pages, would give the Treasury secretary broad discretion and authority in buying and selling mortgage-backed assets. It would require the Treasury to consider the stability of the financial system and the protection of taxpayers, and to report to Congress at least every six months.

The proposal is just a starting point, and certain to change as it moves through Congress. The staff of the House Financial Services Committee began drafting legislation almost immediately after receiving the administration plan. The House could act on the bill as soon as this week, with the Senate to follow.

Frank said his committee will add provisions, including restrictions on executive compensation. For example, he said, firms that accept the government bailout might have to eliminate so-called golden parachutes, the multimillion-dollar compensation packages top executives receive when they are ousted by boards or in corporate takeovers. In addition, the legislation is likely to require the Treasury to seek contributions from foreign central banks, which also have a stake in the stability of the financial system and have benefited from the tens of billions of dollars the Federal Reserve has pumped into the global banking system.

Finally, it will include authority to adjust mortgages of struggling homeowners to make them more affordable and prevent foreclosures. Millions of homeowners have become trapped in mortgages as falling home prices made it impossible to refinance their loans or sell their homes for enough to pay off their debt. The result: a downward spiral of foreclosures, further price declines, and more foreclosures.

Many economists say stabilizing the housing market needs to be a component of the bailout plan, since the housing bust is the underlying cause of the financial crisis. Millions of adjustable rate mortgages are slated to reset next year, and the nation could see "another potential tidal wave of foreclosures," said Scott Anderson, senior economist at Wells Fargo amp; Co. in Minneapolis. Some economists worry the massive bailout will lead to bigger problems. By insulating people and businesses from the consequences of risky behavior, it encourages them to take big risks in the future. It also raises the question of where to draw the line on bailouts. Luigi Zingales, a professor at the University of Chicago's Graduate School of Business, said Fannie Mae and Freddie Mac took on too much risk because of an implicit guarantee by the government to back the debt of these government-created companies. Now, with the $700 billion bailout in the works, it appears the United States is ready to give an implicit guarantee to the entire financial system. "You see a disaster and you want to repeat it on a larger scale," Zingales said. "We may be planting the seeds of the next crisis."

Material from wire services was included in this report.