Of course, it is also possible that only a smaller amount will be necessary to alleviate the current crisis. Most of the assets purchased in the bailout will be mortgage-backed securities and other mortgage-related assets. The Treasury Department will then own the assets, giving it the right to keep them until maturity or sell them at some other time. If the bailout revives the financial markets sufficiently, it is even possible that the government will eventually make a profit off the purchases, or will at least offset some of the costs.
The objective of the bailout is to restore some order to the current frenzy in the financial markets. Having Lehman Brothers go bankrupt and Merrill Lynch, AIG, Bear Stearns, and JP Morgan Chase all being threatened with a similar fate has badly shaken the confidence in these markets. If people stop investing, these and other companies are bound to fail. Although Congress allowed Lehman Brothers to fail and Merrill Lynch to sell out to Bank of America to keep from going bankrupt, it has committed $29 billion to Bear Stearns and JP Morgan Chase to support a merger that will help prevent the two companies from falling into bankruptcy and another $85 billion to keep the American International Group (AIG) from falling into bankruptcy. All of these companies had invested heavily in mortgage-backed securities. But allowing AIG, in particular, to fail could have disastrous effects on financial markets since AIG insured nearly every other financial company against losses from bad investments. Congress hopes that by selectively propping up a few large companies while purchasing bad assets from others, confidence will be restored in the financial markets.
The bailout has risks. Some have speculated that the ultimate price tag for buying up all of the bad mortgages would reach $1 trillion. The purchases directly benefit the very companies that have been most irresponsible in investing heavily in risky assets, while providing less support to healthier, more conservative companies. In its current form, the bailout plans provides the Treasury Department complete discretion in how it spends the money, and there have been suggestions that it will pay nearly double the current value of the securities it buys from failing firms. If so, there is little possibility that any of the bailout money will be recovered in future profits.
At the same time, if the federal government fails to act while the financial markets collapse, the ultimate cost of the crisis could be enormous. After all, it was partly the federal government’s refusal in 1929 to bail out banks from their bad investments that led to bank runs, the collapse of financial markets, and the Great Depression. It seems likely that the eventual outcome will be a modified bailout plan that leaves less discretion to the Treasury Department and more control in the hands of Congress. The bill seems likely to be bogged down with issues like limits on CEO pay and help for households who have trouble meeting their mortgage payments. These issues are distractions having little to do with the fundamental problem, which is a potential collapse of the financial markets. The question is whether a huge federal subsidy of failing financial firms will stave off a collapse. No one has a clear answer yet. What is clear is that the current bailout plan is the one definite proposal that is before Congress and that Congress will eventually act. Failing financial firms will receive some money from Congress. The question is how much, what restrictions will be attached, and most importantly, whether it will be enough to keep the economy from tipping into a true depression.
