Over the last three weeks or so, a wide spectrum of economists who don't normally agree on policy measures came to a rough consensus: The best, and perhaps only, way to resolve the financial crisis would be a direct injection of capital into financial institutions, in return for ownership stakes. The resulting de facto partial nationalization of the banking system is anathema to free-market conservatives, but when credit markets freeze and the stock market loses roughly a third of its capitalization, laissez-faire ideologues suddenly learn to keep their mouths shut.
Thus the news on Wednesday that the U.S. Treasury Department is "considering taking ownership stakes in many United States banks to try to restore confidence in the financial system," as reported by the New York Times.
Paul Krugman, who had predicted exactly such a denouement on "The Rachel Maddow Show" on Monday, applauds," and points us to a fascinating analysis by Nouriel Roubini, on how this latest twist came to pass.
As first reported by Time's Justin Fox, Paulson hinted in a press conference on Wednesday that the Emergency Economic Stabilization Act of 2008 gave him the authority "to inject capital into financial institutions."
Readers may recall that the original Paulson plan included no provision whatsoever for taking equity stakes in financial institutions. It was a bailout, pure and simple, designed to take "toxic" assets off the balance sheets of participating institutions by paying more than their current market value. But to get his plan past the the Democratically controlled Senate and House, Paulson had to give in on several key points -- one of which was that there should be a way for the U.S. government to get equity in companies that it was rescuing.
There is a bit of a difference, however, between getting some equity in return for buying toxic mortgage-backed securities, and directly injecting capital in order to keep a bank solvent. According to Roubini, some deft maneuvering by House Democrats made it clear that the latter possibility would be authorized by the bailout, even if not explicitly contained in the language of the plan.
In other terms it was necessary to explicitly clarify that the definition of "assets" or "any other financial instrument" in the legislation did allow for such public injection of capital so as to ensure that the regulations following the legislation would allow for such interpretation and actual practice. Since it was too late -- by Wednesday last week -- to explicitly modify the legislation to allow for explicit wording on this matter and since Treasury was resisting such late explicit changes (that would have jolted the banking industry) the tool that was used (in full agreement with the House and Senate leadership) to allow for such interpretation was to have Representative Jim Moran use the October 3rd House floor debate right before the final vote to put on the legislative record such interpretation. See the following important exchange between Jim Moran and Barney Frank that is now on the legislative record of the House:
Mr. MORAN of Virginia. Thank you, Madam Speaker. I won't take that much time. I do want to thank the chairman for his masterful leadership on this bill, and I do want to clarify that the intent of this legislation is to authorize the Treasury Department to strengthen credit markets by infusing capital into weak institutions in two ways: By buying their stock, debt, or other capital instruments; and, two, by purchasing bad assets from the institutions, in coordination with existing regulatory agencies and their responsibilities under this legislation, as well as under already existing authorization for prompt, corrective action and least cost resolution.
Mr. FRANK of Massachusetts. Will the gentleman yield?
Mr. MORAN of Virginia. I'd be happy to yield.
Mr. FRANK of Massachusetts. I can affirm that. As the gentleman knows, the Treasury Department is in agreement with this, and we should be clear, this is one of the things that this House and the Senate added to the bill, the authority to buy equity. It is not simply buying up the assets, it is to buy equity, and to buy equity in a way that the Federal Government will able to benefit if there is an appreciation.
Roubini finishes with a flourish:
It is a sorry reflection of the state of the U.S. democracy that hundreds of Senators and Congressfolks did vote for the biggest bailout ever in U.S. history ($700 billion) without even knowing exactly what they were voting for.
So there you go -- Barney Frank and Chris Dodd took Paulson's bailout plan and transformed it into an authorization for the partial nationalization of the U.S. banking system. I find it extraordinary just to write that sentence.