Specialists: Inaction on bailout will bring pain

Deep recession, job losses called likely if credit market stalls

Economists and academics surveyed by the Globe yesterday said the Bush administration and congressional leaders should not scrap the defeated $700 billion bailout for financial firms, but rather make modest changes to win over enough opponents to pass it.

"I'm not telling them what to do, but the result has to be the freeing up of credit markets," said Jack Welch, former chief executive of General Electric Co. "It's about credit and confidence, and they did nothing [Monday] to help either one."

The plan aimed to restore confidence and improve the flow of credit by buying mortgage-backed securities and related assets from financial firms, allowing them to get the troubled assets off their books.

Financial firms have been reluctant to lend to one another out of fear their counterparts have large holdings of mortgage-related assets, which have already sunk several large companies, and that in turn is drying up credit for businesses and consumers.

Without a free flow of credit, businesses stop expanding and hiring, consumers cut spending, and the economy shrinks.

Barry Bosworth, an economist and senior fellow at the Brookings Institution, a Washington think tank, said the Bush administration and congressional leaders need to more effectively communicate that the plan is aimed not at saving Wall Street firms, but rather at preventing a deep recession that would send unemployment soaring.

"That's why the person on Main Street should care," said Bosworth. "It's about jobs."

Alicia Munnell, director of the Center for Retirement Research at Boston College and a former assistant Treasury secretary, said leaders need to communicate better that the bailout ultimately will cost much less than $700 billion when the government sells mortgage assets, once the market returns to normal.

Munnell said some conservative Republican opponents of the plan might be won over by adding provisions to examine possible changes to accounting rules. Some have raised concerns about so-called mark-to-market accounting, which requires firms to value assets based on their current worth in the market.

This system has required financial firms to continually reduce the value of mortgage-backed securities as the housing market deteriorated, and then raise additional money to cover the losses.

Some, such as investment firm Lehman Brothers Holdings Inc., couldn't find money fast enough and failed.

The bailout bill was rejected by 23 votes, as 133 Republicans and 95 Democrats voted against it. Some Democrats could be won over by including additional provisions to keep struggling homeowners from foreclosure, said informed observers.

Jeffrey Frankel, an economics professor at Harvard University's John F. Kennedy School of Government and a former member of President Clinton's Council of Economic Advisers, said that adding a small tax on stock and bond transactions to finance the bailout might also melt opposition. That would transfer the costs from taxpayers to the industry, and perhaps take political pressure off lawmakers who are running for reelection.

"They're hearing from their constituents, 'Wall Street got us into this mess, and now we have to give them money?' " Frankel said. "This would be taxing the sector that got out of control and is the source of the problem."

Another way to reduce taxpayers' contributions would be to expand provisions that allow the government to take ownership stakes in the financial firms it helps, said Simon Gilchrist, a Boston University economics professor. Instead of buying the troubled assets, which would then make it easier for financial firms to raise additional capital by selling stock, the government could provide the capital directly and take a controlling share. It could recover much of its money later by selling off its share.

Sweden took this approach when it had to bail out its financial system in the 1990s, and reduced the initial costs by more than half as it sold off the holdings it bought, Gilchrist said.

Such an approach has another advantage: Company stockholders who profited from risky behavior would now lose money.

For example, shares of Fannie Mae and Freddie Mac became virtually worthless after the government took them over.

"This could be a way forward," Gilchrist said, "and more palatable to taxpayers."

Congress needs to move quickly, said Kristin Forbes, a Massachusetts Institute of Technology professor and former member of President Bush's Council of Economic Advisers. Among her concerns: Foreign investors could lose confidence in the US financial system and pull their money out. That could further weaken the dollar, increase inflation, and lead to higher interest rates, which hurt economic growth.

"This may not be a perfect bill, but the risks of not passing it are greater than passing it," she said. "If we wait too long, it might cost us much more."

Robert Gavin can be reached at rgavin@globe.com.