McCombs TODAY

THE STRANGE POLITICS OF THE FINANCIAL BAILOUT
by David B. Spence, professor of business law

The political process that led ultimately to the passage of the Troubled Asset Relief Program Act of 2008—better known as the “Wall Street bailout”—was a strange one. By the time the mortgage crisis was fully understood, enormous amounts of bad debt had found their way onto the books of many of the world’s major financial institutions. By Labor Day, it had become clear that credit markets were drying up, endangering the ”real economy,” which depends on short-term credit to keep the wheels of commerce greased.

On Sept. 19, the Treasury Department asked Congress to allocate $700 billion to purchase the banks’ bad debts, a response it hoped would give faltering banks the confidence to lend again. The Administration’s bill contained no real standards governing how Treasury would spend the $700 billion, and it prohibited those spending decisions from being reviewed by the courts. The proposal was nothing short of a political minefield for members of Congress, particularly those members who were up for reelection (all members of the House and one third of the Senate).

The notion of a “bailout” for banks was unpopular, pitting taxpayers against Wall Street. The bill didn’t seem to offer much protection to struggling homeowners, and Congressional Democrats were not predisposed to delegate such broad authority to an unpopular administration for such an unpopular purpose. The Administration had already racked up enormous amounts of debt prosecuting the Iraq war, and now it was proposing to double the size of the budget deficit in one fell swoop. Meanwhile, in the presidential campaign, Republicans were calling the Obama tax plan “socialist,” a charge that would ring hollow if they supported bailout legislation that might lead to increased government ownership of privately owned banks.

Nevertheless, support for the bill did not break down along party lines. While neither party wanted to be identified with the bill, both recognized that a vote against the bailout legislation would be easier to explain to their constituents than a vote in favor. Both parties recognized that doing nothing entailed political costs as well. The emergency was acute: banks were failing, home foreclosures were threatened and more doom was forecast.

When members of Congress want to do something that is wildly unpopular, one potential solution is to enlist the least electorally vulnerable members of Congress— those in so-called “safe” seats—to vote for the unpopular thing on behalf of those more electorally vulnerable members who cannot. It appears that this is what congressional leaders tried to do when the bailout bill first came up for a vote in the House of Representatives.

First, the stock market crash highlighted the costs of inaction to politicians and voters alike.

The parties tried to cobble together a bipartisan majority in favor of the bill by (i) eliminating the provision prohibiting judicial review of the Treasury Department’s decisions, (ii) adding a section providing that the government could take part ownership in banks that received government funds and (iii) adding provisions limiting executive pay at banks participating in the program. Leaders of both parties were hopeful that this new package could command majority support in Congress, but the fragile coalition disintegrated when the House voted in late September. As the bill went down to defeat, the Dow Jones Industrial Average fell more than 700 points.

After the House vote, the political dynamic changed. First, the stock market crash highlighted the costs of inaction to politicians and voters alike. Second, both presidential candidates were more vocal and unequivocal in their support for the bill. Finally, all the bill’s proponents began to do a better job making the case for its passage, referring to it as a “stabilization plan” rather than a “bailout,” and explaining its rationale more clearly. Meanwhile, Congressional leaders went to work buying additional support by loading the bill with “earmarks”—specific spending provisions benefiting specific members of Congress who agreed to support the bill in return. On Oct. 1, the Senate passed a version of the bill that included hundreds of millions of dollars in spending or tax breaks for auto racetrack owners, the rum industry, wool fabric producers and more. The House passed the bill shortly thereafter.

The crisis offered us a rare opportunity to observe Congress under extreme pressure. It eventually took action, but in a crucible of intense political pressure, along the way transforming the Treasury Department’s original three-page bill into the 451-page behemoth that Congress finally enacted into law.

David B. Spence, a political scientist and regulatory lawyer, is an associate professor of law, politics and regulation. His research and teaching focus on regulation of business (particularly energy and environmental regulation) and business-government relations issues.

This is an excerpt from the article “Chaos Theory,” which originally appeared in the Fall/Winter 2008 issue of Texas, the McCombs School of Business magazine.

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