By Mark Landler
THE NEW YORK TIMES
Saturday, September 20, 2008
WASHINGTON — The rescue plan being created by the Bush administration is much like the financial crisis it is meant to end — complex, far-reaching and potentially rife with unpredictable consequences.
Among the dangers cited by economists Friday, as word of the plan began circulating, were an explosion in federal debt, higher financing costs, an escalating reliance on foreign capital, higher inflation and a further erosion of American economic sovereignty.
All of these dangers, these experts say, are hypothetical — except for the cost, which by some estimates could eventually exceed $1 trillion. Taking on that much additional debt could narrow the economic options available to the next presidential administration.
"The implications are that, at some point, you're going to have to see higher taxes, lower expenditures or a combination of both," said Carmen Reinhart, a University of Maryland economist.
Not all of the potential consequences of the plan are negative. Economist Nouriel Roubini, said the rescue, if properly executed, could lift the economy by reducing the burden on households, particularly those afflicted by troubled mortgages.
"If you reduce their debt payments, they will start spending again," said Roubini, a professor at New York University. "It's not going to help us avoid a recession, but it could make it shorter."
To finance the rescue effort, the United States will have to borrow even more from foreign investors. That hasn't been a problem in recent days, given the intense demand for Treasury bills, which are perceived as a safe haven by investors around the world.
But if the bailout doesn't quickly restore confidence in the U.S. financial system, foreign investment could slow, which would drive up the cost of financing that debt, said Kenneth Rogoff, a Harvard economics professor.
So far, the dollar has shown remarkable resilience in foreign markets, suggesting, he said, that foreigners still have faith in America's ability to get out of this crisis.
The concerns of foreign central banks over the fate of Fannie Mae and Freddie Mac played a role in the Treasury's rescue of the mortgage finance giants. That influence is likely to grow, along with the debt they hold.
"The people with leverage are the Japanese, the Chinese and the oil-producing countries, who will want assurances that the debt they hold is worth something," said Eugene Steuerle, a senior fellow at the Urban Institute who worked in the Treasury Department during the Reagan administration.
Steuerle said he hoped that the additional burden would force policymakers to confront the country's long-term budget imbalances.
The last time this happened, he said, was in the early 1990s, after a much more modest government rescue effort in the aftermath of the 1987 market crash.
But first the Treasury and the Federal Reserve must successfully carry out this plan. And the sheer scale and complexity of it left economists and other experts slack-jawed.
"It's like doing a quintuple jump in figure skating," said Edwin Truman, a senior fellow at the Peterson Institute for International Economics and a Treasury official in the Clinton administration. "It's impressive if they can do it. It's impressive even to try."
Among the potential sources of tension is the Treasury's ultimate decision on whether it will buy troubled mortgage-backed securities held by non-American banks. European banks, such as UBS, invested heavily in such securities.
"If (European bank) Paribas has bought a mortgage-backed security, why can't they present it to Treasury?" Truman said. "If the government is going to do it for the American banks, they should do it for everyone."
But that could provoke a strongly negative reaction from lawmakers, who already protested that other countries should chip in for the $85 billion rescue of the insurance giant American International Group, because it has operations in those countries or has insured their banks.
"Are the taxpayers in the United States going to bail out all the banks in the world?" said Allan Meltzer, a historian of the Federal Reserve. "I just don't know how this works out."
Meltzer said he thought the plan would be politically viable only if participation was voluntary and if the banks that received government aid were required to pay it back later. "We're protecting private industry, not the public interest," Meltzer said.
Perhaps the plan's longest-term consequence is a wholesale reordering of the financial landscape. Economists said the government will almost certainly impose a raft of new regulations on banks.
"It's hyperbole to say we're abandoning the free-market system," Rogoff said. "But we certainly seem to be entering a new uncharted territory of regulation."