Negotiators on Capitol Hill finally reached an agreement on a sweeping bailout of the financial sector by the Treasury early this morning, attempting to head off bank runs and panics around the world when the Asian markets open tonight.  The plan includes options for asset insurance that House Republicans demanded, as well as broad accountability for actions taken by Treasury in purchasing assets.  The deal also allows a wider group of banks to rid themselves of the toxic assets, created in large part by Congress over the last ten years:

A summary of the tentative agreement released by Ms. Pelosi’s office said the plan “gives taxpayers an ownership stake and profit-making opportunities with participating companies; puts taxpayers first in line to recover assets if a participating company fails; (and) guarantees taxpayers are repaid in full — if other protections have not actually produced a profit.” (See Ms. Pelosi’s summary.)

Additionally, the summary said the legislation will expand the range of firms that can sell troubled assets to the government to include pension plans, local governments and community banks serving “low- and middle-income families.” …

The summary issued by Ms. Pelosi’s office said the legislation will include provisions giving Treasury the ability to work with cash-strapped homeowners whose mortgages are purchased by the federal government to refinance into a more affordable mortgage. Other foreclosure-prevention measures included in the agreement are an extension of the tax holiday for homeowners who face foreclosure, as well as a tax break for community banks who held shares of Fannie Mae and Freddie Mac. The rescue plan will allow affected banks to take an immediate tax deduction on losses from investments in the two firms, which were taken over by the federal government earlier this month.

Lawmakers also included provisions allowing them to keep a close eye on the Treasury program, including a bipartisan oversight board appointed by members of both parties in Congress, an inspector general to monitor Treasury decisions, and regular audits from the Government Accountability Office. Additionally, Treasury will be required to make transactions made through the troubled asset program available publicly online. Unlike the original Treasury proposal, which would have given the department legal immunity in the program, the tentative agreement reached late Saturday allows for judicial review of Treasury decisions.

This looks like the rare occasion when Congress manages to improve an idea.  The original Paulson plan would have imposed immunity from legal action on any moves made by the Treasury, exactly the wrong direction for a crisis already caused by unchecked government manipulation.  In the new plan, Treasury officials have accountability for their management of the $700 billion plan.

The new agreement may have made the plan larger, but the politics of this probably required it.  In the original Paulson plan, the bailout focused solely on the institutions choking on the government-mandated Mortgage Backed Securities (MBS) and credit swaps based on them.  Congress broadened this to give more direct relief to homeowners facing foreclosure and eviction.  While more painful in the short run, it will probably make the economy more stable in the long run, and give the securities the Treasury buys more value, as foreclosures are a severe loss for the lenders.  If we can keep people in the homes and help them to pay back the mortgages, we may not lose much money at all over the next 25 years.

Some will complain that this will bail out foreign institutions as well as American banks.  That is the result of the government’s creation and sale of MBSs as investment products to people around the world.  Fannie Mae and Freddie Mac sold MBSs to anyone who would buy them, and both Americans and foreigners bought them with the implicit backing of the US government.  Congress made that grave error in the 1990s and created an entire class of junk bonds worse than anything seen in the 1980s, although with some handholding, we may get to see value out of them yet.

This will still be a painful lesson for us about government manipulation of markets.  We will have to tighten belts and cut spending to pay for the initial outlay from this bailout, and we still have another financial crisis coming on entitlements to resolve.  However, this agreement — as painful as it is — will probably make the difference between a recession and a global collapse.  Those of us with market assets will almost certainly not have to worry about Monday, and the possibility of watching them get wiped them out in a panic.

After this, we need to demand humility from Congress on economic policy.  Government-imposed “fairness” led to this catastrophe, and we’ll pay the price for the Community Reinvestment Act and the manipulations of Fannie Mae and Freddie Mac for a generation.  Had we allowed the market to work normally, this never would have happened.

Update: The funding of the Housing Trust Fund, the slush fund that feeds ACORN and La Raza, is out.  You can thank House Republicans for enough obstructionism to get that result.  Other changes made to the final version of the bailout, according to a source on the Hill, were the removal of several provisions:

  • Provision to provide unions and other activist groups with proxy access for corporate boards
  • Provision to mandate shareholder votes on compensation issues (union priority)
  • Diversion of funds into a housing fund to support left-wing activist groups like ACORN
  • A provision to allow trial judges to arbitrarily adjust mortgages, creating bonanza for trial lawyers
  • A provision to require the government to sell to state and local governments at a discount homes the government acquires as a result of foreclosure

It also suspends mark-to-market rules and requires a study on their effects on the collapse.

Update II: Just to clarify, the bullet points are items removed from the plan.  Sorry; it was very unclear.