Economists say rescue plan still needs work

John W. Schoen Senior producer • Profile • E-mail

It’s better than nothing.

That’s the less-than-enthusiastic grade being given the government's financial rescue package by private economists — who continue to express doubts about whether the plan will work.

Last week, some 200 university economists and finance professors wrote an open letter to Congress expressing shared concerns about the government’s $700 billion plan to shore up the banking system and reverse the ongoing unwinding of the global credit markets.

Those concerns centered on three basic issues. One was the fairness of a government bailout of financial institutions that made bad bets. The second was the plan’s ambiguity, as little detail was provided initially about just how it would work. The third was whether taking urgent action just to calm the markets in the short term might actually weaken the financial markets over the long term.

Economists generally agree that the plan has been improved by changes made by the House and Senate to the original three-page plan proposed last week by Treasury Secretary Hank Paulson. But they still have concerns and misgivings.

Some center on the basic question: Will the government’s plan work? Even the plan’s backers on Capitol Hill say there’s no way to know.

“I suspect it’s not going to solve our problem,” said Charles Jones, a finance professor at Columbia University.

The centerpiece of the rescue package is a plan to buy up billions of dollars in mortgage-backed securities that banks can’t sell because nobody knows how much they’re worth.

The hope is that by jump-starting this market with government money, the price of these troubled assets will become clearer, and private investors will come in and start buying the assets as well. Though the Treasury has been tight-lipped about "implementation" issues, the process is widely expected to involve an auction. Holders of troubled assets would offer the sell them to the Treasury, which would buy the cheapest assets first.

“The question in my mind is what happens after the auctions?" said Chester Spatt, a Carnegie Mellon economics professor and former chief economist for the Securities and Exchange Commission. "Will the market forces be able to sustain those higher price levels? I don’t think the policymakers have done a particularly good job articulating why the prices are going to stay at the level the government pays.”

Economists have many more questions. Who will be eligible to sell troubled assets? Who will choose which bids to accept? Will the money be spent all at once or in smaller installments? Treasury officials have deflected these questions from reporters.

“The main concern is that there is not enough specificity about several things,” said Thomas Cooley, dean of the Stern School of Business at New York University. “One is: How are the prices of these assets going to determined?”

The question is more than academic. If the government pays too little for these troubled assets, it could force banks to assign an even lower market value for their holdings of bad debts, forcing them to take further write-downs and book more losses. On the other hand, if the government pays too much, it will amount to a bank subsidy paid with tax dollars.

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