In beseeching a skeptical Congress to write a $700 billion check to buy troubled illiquid assets, Treasury Secretary Henry Paulson and Federal Reserve Board Chairman Ben Bernanke appear to have ignored Occam's razor, which holds that the simplest solution is often the best. That is certainly true in this case.
Members of Congress and regulators are operating under the premise that there are only five seconds left on the play clock before our financial system implodes. They either believe or are being told that the only hope to avoid financial Armageddon is to run a complicated new play that was just concocted on the sidelines.
Given the importance of this play, it seems appropriate to call a time-out to see if there is a better option.
The Treasury Department can effectively call that time-out by doing for bank and thrift depositors what it has already done for money market mutual fund investors. It should immediately announce a one-year government guarantee of all such deposits, effectively removing the Federal Deposit Insurance Corp. ceiling of $100,000 per depositor.
Such a move would eliminate fears of a general bank run and allow weakened commercial banks and thrifts to attract deposits at lower rates — deposits that lately have been flowing into gold, Treasury securities, mattresses, and other hidey holes. That, in turn, would buy the time these institutions need to avoid dumping illiquid assets at fire sale prices and to return to profitability.
In fact, the immediate passage of legislation authorizing the purchase of $700 billion of troubled assets by the Treasury is neither necessary nor sufficient nor even advisable to protect taxpayers from a financial meltdown. The purchase of troubled assets will not encourage banks to lend the proceeds of those sales. The losses they would likely incur from such sales would further erode their capital and therefore their lending capacity.
Further, trying to get this legislation passed while the markets are in panic mode runs the risk of invoking the law of unintended consequences. With lobbyists representing every conceivable constituency in financial services seeking special provisions for their clients, bells and whistles would likely get tacked on to this bill that will raise the final cost for taxpayers.
If history is any indication, this proposed legislation, if enacted without careful consideration, could even set the stage for the next financial debacle.
The notion of backstopping all commercial bank and thrift deposits would have been considered unthinkable — even preposterous — just two weeks ago. But not now. Things changed dramatically for the worse last week after the Reserve Primary Fund "broke the buck." Moral hazard went out the window when the Treasury was forced to intervene to stop the run.
Ironically, this action has opened the door to a simpler, more practical approach than the one Congress is currently considering.
Guaranteeing all deposits will not come without a price. Depository institutions will ultimately have to pay additional premiums to the FDIC to cover deposits above the current limit. But guaranteeing all deposits will give banks and borrowers time to fix their problems. And it will give Congress and regulators time to revamp the outdated financial regulatory structure.