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Will U.S. Taxpayers Need A Bailout?

This column, Other People's Money, is written by CNET's Declan McCullagh. It will appear each Wednesday on

President Bush says the move to partially nationalize large U.S. banks, including Bank of America and Wells Fargo, is necessary to "preserve" the free market.

He may be right. But left unmentioned during this week's flurry of announcements from the Federal Reserve, the White House, and other government agencies are the potential perils.

Not all the details are clear. It appears as though the Treasury will end up owning sizable chunks of U.S. banks for the foreseeable future, whether bank executives choose to participate or not.

The almost-nationalization will happen even if, as the Wall Street Journal
delicately put it it, bank executives and shareholders are "unhappy" and oppose the idea.

This invites micromanaging from Washington, D.C. Members of Congress will have a strong incentive to demand preferential treatment for borrowers in their home districts or among politically-favored constituencies. Politicians who are members of the committees overseeing the Treasury Department's budget will enjoy outsize influence. So will Treasury and other regulators that banks must please to stay in business.

Washington bureaucrats charged with writing billion-dollar checks may be tempted to favor their former banking colleagues, especially if they plan to return to their Wall Street jobs after departing the Bush administration. As the title of this inaugural column on indicates, they're spending Other People's Money, and nobody is as careful and prudent doing that as they are when their own finances are at risk.

Over time, in other words, decisions made for illegitimate political reasons may end up crowding out ones made for legitimate business reasons.

Perhaps Treasury Secretary Henry Paulson and Neel Kashkari, a 35-year-old former investment banker at Goldman Sachs hired to oversee the bailout, will demonstrate their independence from politics. But in a political culture where influence-peddling has flourished (see Stevens, Ted; Rangel, Charles; Abramoff, Jack; and Jefferson, William), it's unclear if anyone in that position can do what's best for taxpayers instead of what will please influential special interests.

To be sure, Paulson has indicated that Treasury will be buying shares without voting rights, meaning the Feds won't be choosing board members. Bush said on Tuesday that "the government's role will be limited and temporary."

On the other hand, history is littered with "temporary" laws that became permanent fixtures -- a supposedly temporary tax imposed in 1898 to fund the Spanish-American War didn't end until 2006.

And even coordinated action with other central banks wasn't enough to prop the stock market up; the Dow Jones index closed Tuesday at 9,310, down 0.8 percent for the day, and off 34 percent from last year's highs.

Some of these potential pitfalls might have been avoided if the $700 billion bailout bill that slid through Capitol Hill two weeks ago had been crafted more carefully (or not passed at all). Like the Patriot Act seven years ago, the bailout legislation was written hastily and rushed to a vote before most legislators had a chance to understand the intricacies of a complex 442-page regulatory measure.

One change that could have been made is setting a hard cap on how much this would cost taxpayers. The law says that the Feds can purchase and hold $700 billion of assets "at any one time." That permits the Treasury to buy $700 billion worth of assets in 2008, sell those assets off gradually over the next few months at a (probable) loss, and repeat the same process in 2009. Losses to taxpayers, in a worst-case scenario, could run into the trillions.

Another problem with the law is that it's possible for a bank to buy $100 billion of bad debt--perhaps in the form of subprime mortgages that are becoming quickly worthless--declare bankruptcy, and sell it to the Treasury Department for $200 billion.

Although the Treasury Department is supposed to look out for the best interests of taxpayers, a loophole permits those kinds of unjustified windfalls if the toxic mortgages were "acquired in a merger or acquisition" or purchased as part of a bankruptcy sale. Nowadays, at least, that's a pretty huge exception.

Some of these problems can be solved through careful legislative fixes. Others go hand-in-hand with the idea of nationalizing private companies.

You can't take politics out of Washington: banks may be first in line for a handout, but other politically influential industries are in the queue.

Take the example of how bank stocks jumped on this week's news. Bank of America and Goldman Sachs are each up about 30 percent from last Friday's close, far higher than the overall market. If their shareholders have already benefited so handsomely, does anyone think General Motors, Ford, and innumerable other troubled companies won't ask for the same treatment? (In exchange, taxpayers get stuck with assets of dubious value that nobody else was willing to pay that much to buy.)

The Bush administration's economists have no doubt concluded that the theoretical benefits of partial bank nationalization outweigh the costs.

But in the real world of Washington politics, what may work in theory may not work nearly as well in reality.

Declan McCullagh is the chief political correspondent for CNET. He previously was Wired's Washington bureau chief and a reporter for and Time magazine in Washington, D.C. He has taught journalism, public policy, and First Amendment law. He is an occasional programmer, avid analog and digital photographer, and lives in the San Francisco Bay area. His e-mail address is

By Declan McCullagh

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