It may be time for the Bush administration to start looking for a Plan B.  Two Republican Senators have now come out in opposition to the Paulson bail-out plan, and with Democrats like Chris Dodd allying themselves to the conservative rebellion in Congress, the White House has begun looking very isolated in its attempt to resolve the credit crisis.  Richard Shelby and Jim DeMint have begun a conservative pushback to rescuing Wall Street from a situation that they claim is all Wall Street’s doing.

First, DeMint:

“There are much better ways of dealing with this problem than forcing American taxpayers to pay for every asset some investor doesn’t want anymore. We should start by reforming government policies and programs that created this mess, including the Federal Reserve’s easy money policy, the congressional charters of Fannie Mae and Freddie Mac, and the Community Reinvestment Act. Then Congress should pass a number of permanent and proven pro-growth reforms to encourage capital formation and boost asset values. We need to make permanent reductions in the corporate tax and the capital gains tax rates. We have the second highest corporate tax rate in the world, which encourages companies to take jobs and investment overseas.”

“It’s a sad fact, but Americans can no longer trust the economic information they are getting from this Administration. The Administration said the bailout of Bear Stearns would stop the bleeding and solve the problem, but they were wrong. They said $150 billion in new government spending using rebate checks would solve the problem, but they were wrong again. They said new authority to bailout Fannie Mae and Freddie Mac would solve the problem without being used, but they were wrong again. Now they want us to trust them to spend nearly a trillion dollars on more government bailouts. It’s completely irresponsible and I cannot support it.”

The Wall Street Journal profiles Shelby’s opposition:

With anger mounting from the left and right against the Treasury Department’s proposed financial bailout, one of the opponents’ most powerful allies is Alabama Sen. Richard Shelby, a Democrat-turned-Republican who espouses free-market principles with a populist streak.

Mr. Shelby, the ranking member of the Senate Banking Committee, said in an interview Tuesday that he is likely to vote against the proposal. “I’ve never supported a direct bailout,” Mr. Shelby said. “I voted against Chrysler when I was a freshman congressman. They said, ‘Well, Chrysler will fail.’ And well maybe if it’d failed then we wouldn’t have the problems facing us today.” …

“I think we’re going down the road of France now,” Mr. Shelby told one television interviewer Tuesday, before quickly adding, “in all due respect for my French friends.”

While I’m pleased that both Senators are standing up for conservative principles, and from DeMint this comes as no surprise, the fact is that this mess is not just of Wall Street’s making [see update below].  Right now, Congress is doing its level best to pretend it had nothing to do with this failure, and Chris Dodd — as the chair of the committee that was supposed to exercise oversight on this industry — is spinning the fastest.  The more Congress can shove the blame entirely onto Wall Street, the better off it looks, but that’s simply not the case.

The heart of this failure came from a mandate by members of Congress from both parties that demanded easier loan terms for marginally-qualified buyers.  At first, this meant working-class families, but it also resulted in easier terms all the way through to the highest income levels.  Lower qualifiers meant more buyers, and buyers buying bigger houses.  The net effect of this was to create a much higher demand for housing and for mortgages.

How did these get structured?  The trouble came when people stopped providing solid down payments to ensure equity from the start of the loan.  They got adjustable-rate mortgages for loans they couldn’t afford, betting that the quickly-rising price of housing would continue its trajectory and magically give them enough equity by the time the ARMs adjusted so that they could refinance their loans to something affordable.  And for a few years, that’s exactly what happened — and so more and more people followed that example.

This produced two other effects.  First, the government had Fannie Mae and Freddie Mac sponsor many of these questionable loans and convert them into investment products, which essentially infected the entire investment community with massive, poorly-secured loans.  Second, the demand touched off a residential building boom as people attempted to provide inventory for the massive amount of buyers coming into the market.

Unfortunately, this created a big Ponzi scheme, one dictated by Congress and two administrations.  It only worked as long as housing prices continued to increase.  When the bubble finally popped late last year, it was analogous to the margin calls of 1929, only in slow motion.  Once homeowners realized that their houses would not increase in value, they knew that they were stuck in ARMs that they wouldn’t be able to afford.  The defaults would not just sink the banks but also the investors who bought the securities.

Who created this Ponzi scheme?  Congress did.  Who demanded lower qualifiers for home mortgages and then insisted on having Fannie/Freddie turn them into investments to support the lenders?  Congress did.  The lenders share the responsibility as well, but without Fannie/Freddie making their bad lending decisions profitable, they would never have jumped into the sub-prime market with the kind of enthusiasm they did.  Now Congress wants to leave them holding the bag and all the blame — and that’s pretty convenient for Congress.

DeMint gets closer to the truth here than Shelby.  Congress didn’t demand that Chrysler build K-cars and other lousy models and poor business practices that led to their bad performance, which is why Congress shouldn’t have had anything to do with the Chrysler bailout.  That doesn’t apply here.  DeMint, though, rightly points out that this is actually Bailout v4.0 in this crisis, and versions 1-3 didn’t solve the problem.

Taxpayers don’t want to be on the hook for the credit-market failure, but in the end, we’re responsible for Congress.  Not many objected when home loans got so plentiful and our home equity skyrocketed over the last ten years.  We need a responsible, market-based plan that undoes the damage our Congress created, and that means we’re going to have to shoulder some of the burden in the short term to make it happen.  That’s our penalty for letting Congress run wild, and it should result in a lesson learned for the American taxpayer that, in Robert Heinlein’s words, there ain’t no such thing as a free lunch.  The plan should have accountability for those running it, and it should include a plan to completely dismantle the government’s reach into private lending markets permanently.

Update: I want to clarify something regarding Jim DeMint.  He’s really been one of the best voices on this, and he agrees that government got us into this meltdown:

Sen. Jim DeMint, a South Carolina Republican, differed with Schumer, saying Congress should resist the Bush administration’s pleas for the legislation. He said, “The government broke it. I don’t trust them to fix it.”

DeMint isn’t passing the buck.  He’s got the right diagnosis.  Now we need Congress to fix what it broke, and to keep itself from breaking more in the future.