Change of Plan

Over this past weekend the White House indicated a potentially significant shift in its plans for the implementation of its $700 billion economic rescue plan. Trading the difficult to comprehend concepts of reverse auctions of troubled mortgages for something more simple minded and logical, officials seem to now be favoring a direct capitol infusion coupled with direct mortgage purchases by both Freddie Mac and Fannie Mae. So, the question that begs asking is this: will such a change in approach provide a real solution to the problem?

The concept of direct capital infusion into banks (i.e. the federal government would purchase non-voting shares of stock in financial institutions, giving it a direct ownership stake in those companies) is a fundamentally massive change in tactics and approach by the Bush administration, which, until this point, has been driven by a free-markets ideology that labeled any such approach as unacceptable. Fiscal conservatives fear that direct interference into the private sector would lead the nation on a path towards nationalization of the banking system. And so, fears of the hypothetical dictated policy decisions and steered the White House away from even considering such an approach (even while it was being strongly promoted by many Democrats).

Well, message to Mr. Bush: the financial crisis right now is not hypothetical. We cannot decline to fix the problems in front of our face because of the fear of potential problems that may or may not arise around the corner.

If this infusion of capital will help to instill investor confidence and prevent a reenactment of the Lehman Brother’s debacle (which could have been prevented, except for the fact that a bailout didn’t fit with “free market ideology”), then I say all the better. And indications are that this new plan might do just that. When discussed with leading industry executives, they “quickly told Mr. Paulson they liked the idea” (Edmund Andrews and Mark Landler, New York Times). Additionally, this idea is very similar to what was initially suggested by the Chairman of the Federal Reserve, Ben Bernanke, and mirrors similar efforts being made abroad (Great Britain is proposing a similar, albeit more extensive plan, and Germany is expected to propose a plan along the same lines sometime this week).

This proposal also offers much more room for investor understanding, and therefore investor acceptance. The idea of reverse auctions for troubled mortgage back securities is too foreign to too many regular Americans. In fact, it may even be too complicated for government officials as well. One of the key reasons for this change of tactics, according to many officials, is that experts were struggling to create an agreeable method of executing these auctions.

Now, the government can put the solution into simple terms for simple people: “We are going to buy stocks”. So, by being able to better explain the situation and the solution to investors, they might be, if only slightly, more inclined to allow their fears to be marginally calmed.

While I disagree with John McCain’s assertions only a few weeks past that the fundamentals of the economy are largely good, I do think that he was in part correct when he suggested that the economic problems we are facing are somewhat driven by fear. The stock market itself is ninety percent perceptual. And so how could the government expect a rebound in confidence or perception when investors don’t even understand the “fix” being applied to the situation?

This new approach to the problem is better because, if nothing else, it makes more sense. And so, President Bush is now allotted a new and improved opportunity to frame the situation in a way that investors can grasp. Whether or not he will capitalize on that opportunity is beyond my abilities of prediction, but at this point he needs to at least try. And, in the little future that his administration still has, he needs to never again set aside possible solutions for the sake of ideology.