The Great Bank Robbery of 2008

by Robert P. Murphy

Henry Merritt "Hank" Paulson Jr.

A.K.A. "The Treasurer"

The Paulson bailout failed in the House. If it isn't a death blow to the plan, it should be. This is not an economic plan: it is a heist.

It will go down as The Great Bank Robbery of 2008.

The economics behind it are nonsense, but we are naïve if we spend much time even considering the "arguments" for it. This is a money and power grab, pure and simple.

Just as magazine covers today feature scantily clad women that would have been scandalous a generation ago, in the same manner Paulson's proposal — made in broad daylight and on national TV! — is almost naked in its audacity.

Austrian economists tend to be libertarians in their political views, and they are often chided for not keeping these systems hermetically sealed and separated in their minds. Fortunately, this alleged vice is a virtue in our present situation. Because of all the mumbo jumbo thrown around to show why the plan is necessary, some very sharp academic economists are in a tizzy trying to treat this as an extra-credit question, rather than a crime scene. That is a waste of time.

In this article, we will of course cover why the Keynesian justifications — coming from a "free-market" administration — are nonsense. But in the grand scheme, that's not entirely relevant. People didn't seriously consider the testimony of the tobacco company CEOs about the nonexistent dangers of smoking, because everyone knew those executives stood to lose billions from the settlement. So by the same token, no one should pay much attention to the official statements made by Henry Paulson, since he stands to personally be put in charge of doling out hundreds of billions of dollars to some of the most powerful people on the planet.

The Keynesian Fallacy: The Paulson Plan Won't Create Wealth

In very simple terms, the Paulson Plan is a straight-up transfer of $700 billion — and counting! — from the taxpayers to a few big financial institutions. (Some smaller banks are complaining that they don't own the exotic mortgage-backed derivatives, but rather simple mortgages. They do not believe they will see a dime of the Paulson money.) It's easy to get all twisted around, but just remind yourself of this: the Paulson Plan has the federal government borrow $700 billion (through issuing Treasury debt) in order to buy assets from Wall Street banks. (We are neglecting the time delay in the program; the entire $700 billion wouldn't be spent all at once.)

Some analysts think that the price paid for these "toxic" assets is important. No it isn't. The government officials running this operation will dole out the favors on both ends, when the mortgage-backed securities are coming and when they are going. Neglecting this insight, some people want to say that if the government pays $700 billion for a portfolio of assets that is really only worth $400 billion, then the taxpayers really only lost $300 billion, not the full $700 billion.

Yet this thinking is naïve. The taxpayers are not going to be treated as equivalent to shareholders of a firm that just acquired $400 billion in assets. The taxpayers are not going to get a cut of the monthly mortgage payments (less the servicing costs on the $700 billion in new debt) tied to the government's massive portfolio. Instead, the government will simply bump up its annual spending by a few billion dollars. Maybe it will have to spend the money on homeownership programs, or homebuilder job retraining, but the net income from those government-owned assets certainly won't translate into a dollar-for-dollar tax cut.

"Some very sharp academic economists are in a tizzy trying to treat this as an extra-credit question, rather than a crime scene."

And then at some point — during a future Republican administration, no doubt — there will be a push to "privatize" the secondary mortgage market, and the government's portfolio at that time will be auctioned off at very generous prices to politically connected institutions. For example, maybe the $400 billion portfolio is auctioned off for $250 billion. (Perhaps the big banks have to set up subsidiaries owned by minorities and women who get preferential treatment in the bidding process. But whatever the ruse, they will find a way to justify the low prices.) When all is said and done, the government will have played hot potato with the MBS, and the national debt — borne by taxpayers — would be $450 (=$700-$250) billion higher. The favored financial institutions would be "up" roughly the same amount, collectively. (Throughout, we are ignoring the timings of the payoffs and the effect on present discounted value.)

It is the crudest Keynesianism to view the Paulson Plan as an injection of capital or "liquidity." That money has to come from somewhere. If it is taxed or borrowed, then it is just a shell game; the liquidity is drained from elsewhere, to be injected into Wall Street.

Besides taxing or borrowing, the government has a trump card: it can have the Federal Reserve simply create the new money out of thin air, by engaging in some "Open Market Operations." Yet even in this case, real wealth still hasn't increased. Certain nominal figures, like "aggregate asset values" might go up. But that's not very relevant, because the economy isn't really richer. After all, there aren't more tractors or office buildings just because Bernanke allows the monetary base to grow more rapidly. So what happens in this case is that prices rise; people find it harder to buy milk, bread, and gasoline. But the Wall Street fat cats are fine with the general price hikes, because they got their hands on the newly injected funny money early in the game.

But Won't the Credit Markets Collapse?

Some observers would admit the legitimacy of my analysis above. "However," they might say, "the Paulson Plan, or something like it, is necessary to avert a total meltdown of the financial system. We're not trying to boost aggregate investment, so much as clearing out a clogged pipe."

This talk of a breakdown in the financial system is a bogeyman. Steve Landsburg does such a great job of exploding this myth that I will simply quote him:

So what's special about banks [that they deserve a bailout]? According to what I keep reading, it's that without banks, nobody can borrow, and the economy grinds to a halt.

Well, let's think about that. Banks don't lend their own money; they lend other people's (their depositors' and their stockholders'). Just because the banks disappear doesn't mean the lenders will. Borrowers will still want to borrow and lenders will still want to lend. The only question is whether they'll be able to find each other.

… [A]s any user of match.com can tell you, the technology for finding partners has improved since [the 1930s]. When a firm wants to raise capital, why can't it just sell bonds over the web? Or issue new stock? Or approach one of the hedge funds that seem to be swimming in cash? Or borrow abroad?

… I'm not sure these big Wall Street banks are really necessary, and I'm not sure we'd miss them much if they were gone. Maybe there's something I'm missing, but if so, I think it should be incumbent on Messrs. Bernanke, Paulson and above all Bush to explain what it is.

Conclusion

The Paulson Plan is a heist. It is a grand scheme in which the public will end up owing hundreds of billions of dollars to holders of new debt claims issued by the US Treasury. The plan won't "prop up" asset values and it won't provide any real stimulus to the economy.

Despite the dire warnings — coming from the same folks who brought you the Iraq invasion to remove WMD — there is no threat of a financial meltdown. If Goldman Sachs failed, the sun would still rise the next morning.

Far from providing stability and confidence, the Fed, Treasury, and SEC's recent moves have ensured that US capital markets will now function with the same efficiency as public education in this country. The Paulson Plan is one more step in the socialization of America, but it is also a great bank robbery.

Financial crisis

Into the land of the unknown

Global market turmoil continues after the rejection of the mortgage-rescue plan in America

HOW many votes in Congress will the latest financial upheaval change? That is the calculus underway in Washington, DC, after the House of Representatives defeated the proposed $700 billion mortgage-rescue plan by 228 to 205 on Monday September 29th. Democrats backed it by 140 votes to 95, while Republicans opposed it by 133 to 65.

Bankers had been under no illusions that the tweaked Paulson plan would cure all the financial system’s ills. But most had seen it as a step in the right direction, and had expected it to pass. Its rejection sent stockmarkets into freefall. The Dow Jones Industrial Average finished down by 7%, and suffered its biggest-ever points loss. Perhaps fittingly in an economy that is in danger of sliding into depression, the only stock among the 500 in the S&P index that finished higher was Campbell’s Soup. The S&P closed 29% below its peak. Reflecting fears that consumer demand will wilt, shares of Apple Computer, creator of the iPhone, fell by 18%. The rout continued in Asia, but shares rebounded in Europe on Tuesday morning on hopes that the bill would eventually pass.

But credit markets, already dysfunctional, were even closer to breaking point. Banks grew even less willing to lend to each other on Monday and Tuesday, and money-market funds fled anything with a whiff of risk. Some corporations are struggling to roll-over commercial paper, short-term debt issued to finance working capital, payroll payments and the like. In an effort to keep money markets from drying up, the Federal Reserve has doubled the size of a vital lending facility for banks, to $300 billion, and expanded agreements with other central banks that funnel dollars to lenders abroad.

These unprecedented injections are aimed at easing concerns that weak participants in the interbank market will fail to honour their debts. But many banks are now assumed to be not only illiquid but insolvent. Last week Washington Mutual, a thrift saddled with rotten mortgages, became the largest-ever American lender to fail. And on Monday Citigroup agreed to buy most of the assets of Wachovia, an even bigger American bank, in a deal brokered by regulators. On Tuesday Barack Obama, the Democratic candidate to be president, proposed that deposit insurance be extended to $250,000 “as a step that would boost small businesses, make our banking system more secure, and help restore public confidence in our financial system.”

The no vote was a big blow to George Bush, Hank Paulson, the treasury secretary, and Ben Bernanke, the Federal Reserve chairman. They gave dire warnings of the consequences of an unchecked crisis, in hopes of persuading Congress to approve an unusually aggressive and early fiscal intervention. (It took many more years for a systemic response to widespread failures of American savings and loan banks in the 1980s). But because the intervention is relatively early, voters have yet to see much impact from the crisis on their lives. “On Monday morning…the sun came up and a lot of people went to work, and [they] couldn't understand what this panic was in Washington,” Paul Kanjorski, a Democrat from Pennsylvania, told Mr Paulson last week. It was far easier for voters to relate to $700 billion of their taxes being spent on a mess in Wall Street.

Party leaders largely agreed with the diagnosis, as did the presidential candidates of both parties. But polls showed that voters were split; constituent phone calls and e-mails ran heavily against the bill. Administration officials and party leaders are back at work trying to find a way to get at least 12 members to switch their vote; the betting both on Wall Street and in Washington, DC, is they will succeed. (Passage in the Senate is considered less problematic.) But it should not be taken for granted. Without amendments, anyone who changes his vote will face fierce criticism when he seeks re-election. Any amendments to appease Republicans could cost Democratic support, and vice-versa.

“You can’t let one day’s trading dictate public policymaking,” argues Scott Garrett, a New Jersey Republican and member of the Republican Study Committee, a block of conservative members who led opposition to the bill. “The market’s going to be a factor, but we’re looking at the larger picture.” Recalcitrant Republicans would rather see a programme to sell insurance to banks against mortgage defaults, rather than buying assets from them. The Treasury strongly opposes this approach. But there may be other grounds for compromise, such as relaxing mark-to-market accounting or extending the Federal Deposit Insurance Corporation's guarantee of a bank’s liabilities to more than just the first $100,000 of each customer’s deposits. Other proposals include giving banks more time to deduct mortgage-related operating losses from future taxable profits, letting companies repatriate foreign profits tax-free and improving the tax treatment of losses sustained by banks on their holdings of Fannie Mae and Freddie Mac stock.

For their part, more Democrats might back the proposal if the administration also agreed to more fiscal stimulus, in particular public-works spending, or taking any profits on the TARP to low-income housing. A deal may be possible, but time is short: legislators are itching to return to their districts to campaign, and investors’ appetite for risk is ebbing fast. The House is not expected to reconvene before Thursday, to accommodate the Jewish new year.

The House vote also represented a stinging rejection of John McCain, the Republican nominee. Mr McCain suspended his campaign last week for two days, citing the financial crisis, and flew to Washington, DC, to help craft a solution to it. His main task was to persuade reluctant House Republicans to back their own president. In the event they voted against the deal made by their own leadership by two to one. The humiliation meted out to Mr McCain is intense.

Amid the efforts to put the deal back together, some small hope remains that not all is lost. What is unlikely to help is the atmosphere of bitterness and recrimination that is pervading Capitol Hill. With some justification, the Democrats are aggrieved to find that they supported Mr Bush's bill while his own party did not. But the Republicans blame the Democratic speaker, Nancy Pelosi, for making a stupidly partisan speech shortly before the vote in which she poured scorn on the Republicans she is trying to court. A lot of bridges will have to be built in a short span of time.

Too Much Money Is Beyond Legal Reach

New York-based funds are abusing 'secrecy jurisdictions.'

ROBERT M. MORGENTHAU

A major factor in the current financial crisis is the lack of transparency in the activities of the principal players in the financial markets. This opaqueness is compounded by vast sums of money that lie outside the jurisdiction of U.S. regulators and other supervisory authorities.

The $700 billion in Treasury Secretary Henry Paulson's current proposed rescue plan pales in comparison to the volume of dollars that now escape the watchful eye, not only of U.S. regulators, but from the media and the general public as well.

There is $1.9 trillion, almost all of it run out of the New York metropolitan area, that sits in the Cayman Islands, a secrecy jurisdiction. Another $1.5 trillion is lodged in four other secrecy jurisdictions.

Following the Great Depression, we bragged about a newly installed safety net that was suppose to save us from such a hard economic fall in the future. However, the Securities and Exchange Commission, the Federal Reserve System, the Comptroller of the Currency and others have ignored trillions of dollars that have migrated to offshore jurisdictions that are secretive in nature and outside the safety net -- beyond the reach of U.S. regulators.

We should have learned a long time ago that totally unsupervised markets, whether trading in tulips or subprime mortgages, will sooner rather than later get into trouble. We don't have to look back very far in history to understand this.

Long Term Capital Management, a hedge fund "based" in Greenwich, Conn., but composed of eight partnerships chartered in the Caymans, was supposed to be the wunderkind of the financial world. At its peak in the late 1990s, its gross holdings were valued at $1.8 trillion. But, regrettably, its liabilities exceeded its assets and the Federal Reserve Bank of New York had to step in and rescue it when the value of its assets plummeted.

Most recently, two Bear Stearns hedge funds, based in the Cayman Islands, but run out of New York, collapsed without any warning to its investors. Because of the location of these financial institutions -- in a secrecy jurisdiction, outside the U.S. safety net of appropriate supervision -- their desperate financial condition went undetected until it was too late.

Of course, BCCI Overseas, which was part of the then largest bankruptcy in history, was also "chartered" in the Caymans.

We have to learn from our mistakes. Any significant infusion to the financial system must carry assurances that it will not add to the pool of money beyond the safety net and supervisory authority of the United States. Moreover, the trillions of dollars currently offshore and invested in funds that could impact the American economy must be brought under appropriate supervision.

If Congress and Treasury fail to bring under U.S. supervisory authority the financial institutions and transactions in secrecy jurisdictions, there will be no transparency with the inevitable consequences of the lack of transparency -- namely, a repeat of the unbridled greed and recklessness that we now face. Because of the monolithic character of world financial markets, a default crisis anywhere becomes a default crisis everywhere.

The Beltway Crash

Congress lives up to its 10% approval rating.

America has survived a feckless political class in the past, and it will again after this week. But Monday's crash and burn of the Paulson plan on Capitol Hill reveals a Washington elite that has earned every bit of the disdain that Americans have for it. This crowd can't even make sausage.

AP

House Speaker Nancy Pelosi ( D-Calif.) with Rep. Rahm Emanuel (D-Ill.) Monday, Sept. 29, 2008.

The 228-205 defeat reflects badly on all concerned, starting with the Democrats who run the House. The majority party is responsible for assembling a majority vote, and Speaker Nancy Pelosi failed in that fundamental task.

Her highly partisan speech on the floor -- blaming "right-wing ideology of anything goes, no supervision, no discipline, no regulation" for the financial distress -- is no excuse for Republicans to vote no. But it is indicative of the way she has governed for the past two years -- like Tom DeLay without the charm. The cynics are saying Ms. Pelosi deliberately tanked the bill by giving 95 Democrats a pass, knowing failure would hurt John McCain, and given her track record we can see why people would believe it.

House Republicans share the blame, and not only because they opposed the bill by about two-to-one, 133-65. Their immediate response was to say that many of their Members turned against the bill at the last minute because Ms. Pelosi gave her nasty speech. So they are saying that Republicans chose to oppose something they think is in the national interest merely because of a partisan slight. Thank heaven these guys weren't at Valley Forge.

Crash Course

• A Main Street Rescue 09/29/08 -- Congress passed this 'bailout' a long time ago.
• The Washington Panic 09/27/08 -- The Paulson plan is a tool to avoid a deeper downturn.
• The Paulson Sale 09/24/08 -- Taxpayers are going to put up capital one way or another.
• A Mortgage Fable 09/22/08 -- Beltway trilogy: the Fed, Fannie Mae, and Bear Stearns.
• Stopping the Panic 09/20/08 – Now the task is to protect taxpayers and restore markets.
• Be It Resolved 09/19/08 – Paulson and Bernanke ask Congress for a resolution agency.
• The Fed and AIG 09/18/08 – Nationalizations aren't stopping the financial panic.
• McCain and the Markets 09/17/08 – Denouncing 'greed' and Wall Street isn't a growth agenda.
• The Fed's Epic Day 09/17/08 – It's only fair to praise the central bank when it does the right thing.
• Surviving the Panic 09/16/08 – A resolution agency, steady monetary policy, and a big tax cut.
• Wall Street Reckoning 09/15/08 – Treasury Secretary Hank Paulson's refusal to blink won't get any second guessing from us.

The vote is also a rebuke for Treasury Secretary Hank Paulson, who could barely explain how his securities auctions would work even as he showed disdain for House Republicans. President Bush did his best to provide cover for the Members, but he is a spent political force. One GOP Member who supported the bill told us that before Mr. Paulson spoke to House Republicans last week, the whip count in favor was about 70; afterwards, it was closer to 20. You can't ask Congress for $700 billion without more modesty and a better explanation for how it would be used.

Given this historic abdication, we're surprised financial markets didn't melt down more than they did yesterday. Equities nonetheless took the worst bath in percentage terms since the aftermath of 9/11, with the Nasdaq falling more than 9%. But that was a sideshow compared to the credit markets, which staged another flight from all risk. The three-month Treasury yield had sunk to 0.132% the last we checked, which means investors will accept essentially no return as long as they can avoid further financial losses.

Safe in their think-tanks, some of our friends have claimed that talk of a financial crash is merely a political invention. Perhaps we'll now test their theory. A financial panic isn't an academic seminar, and a flight from all risk isn't something any free-marketeer should want. A recession now seems certain, as falling commodity prices are telling us, but the point is to prevent systemic financial collapse. Maybe the Members who voted "no" figure at least they'd still have jobs.

What next? One option is that Democrats will tell Mr. Paulson that they can pass his plan with more liberal votes, but that their price has gone up. This would mean more of the tax, spend and regulate provisions that House GOP leaders stripped out before their rank-and-file headed for the exits. These would only raise the price for taxpayers of the Treasury rescue and, if the equity provisions were too onerous, make the Paulson plan far less workable.

If Mr. Paulson wants to be a statesman, he could offer a Plan B that avoids giving Treasury such a big blank check. Instead, he could propose more public capital for the Federal Deposit Insurance Corp., which would do more of the creative financial plumbing it has done over the last week. (See here.) This will have to happen next year anyway, and the FDIC has long experience protecting taxpayers for public capital injections through preferred stock and warrants.

At the same time, the Secretary could salvage his own proposal by promising that while Treasury would start the purchase of toxic securities from banks, he would quickly (within weeks) turn the process over to a new and separate resolution agency. Congress could make this part of the legislation. This would remove Mr. Paulson as the political lightning rod he has become, and also give the rescue process the political insulation it needs. Such an agency could also work closely with the FDIC to protect taxpayers.

Members may not believe Hank Paulson, but they ought to pay attention to markets. The financial system has a huge capital hole due to losses on mortgage securities and other assets, and private capital won't begin to fill it without the life preserver of public capital. Before it leaves town to campaign, Congress needs to act to defend and restabilize the financial system. After the last two weeks, and especially after yesterday, the Members also need to act to redeem their own reputations, to the extent they are still worth redeeming.

Bailout Vote Leaves Big Wall Street Names Hanging: David Pauly

Commentary by David Pauly

Sept. 30 (Bloomberg) -- The three most flummoxed people in the investment community today may be Warren Buffett, Jamie Dimon and Vikram Pandit.

They have just risked billions of dollars of their respective companies -- Berkshire Hathaway Inc., JPMorgan Chase & Co. and Citigroup Inc. -- in banking ventures on the assumption the U.S. government would ease the U.S. credit crisis with a $700 billion bailout.

The U.S. House of Representatives voted against the measure yesterday, sending stocks plummeting. The Standard & Poor's 500 Index fell 106.59, or 8.8 percent, to 1106.42, giving it a 2008 loss of 25 percent.

No doubt the House and the U.S. Senate ultimately will pass a bailout bill. How else will markets, frozen by a series of disasters from slumping home values to failed credit-default swaps, be rescued?

Buffett, Dimon and Pandit certainly will keep praying.

Berkshire Hathaway, Buffett's investment vehicle, last week bought $5 billion in preferred stock of Goldman Sachs Group Inc., an investment-bank-turned-commercial-bank that was crying for capital. Public investors then bought $5 billion in Goldman Sachs common shares at $123.

Buffett negotiated a good deal. His preferred stock pays dividends of 10 percent. He also got warrants to buy $5 billion in Goldman common shares at $115. That looked like an instant bonanza when Goldman stock jumped to $137.99. But in yesterday's market debacle, the shares slumped to $120.70.

Taking on WaMu

Dimon made his bailout bet -- with help from the U.S. Federal Deposit Insurance Corp. -- by buying the assets of the biggest U.S. savings and loan, the disintegrating Washington Mutual Inc. He got WaMu for a song, but along with acquiring branches in California and Florida, he took on $176 billion in WaMu loans. JPMorgan says it will write off $31 billion in bad WaMu assets immediately.

Just hours before the bailout went down, Pandit's Citigroup, also with the help of the FDIC, agreed to buy Wachovia Corp.'s bad loans and bank branches for $2.2 billion. Citigroup, which has already written off $61 billion in its own mortgage losses, will absorb as much as $42 billion in losses from the $312 billion in Wachovia loans it's assuming.

Citigroup said it would raise $10 billion in new capital. Before the House vote, Pandit could hope he would have the same luck JPMorgan did after buying WaMu. Investors snapped up $10 billion in new Morgan shares at $40.50. The stock then jumped to $49 before dropping to $41 yesterday.

Sinking Deeper?

While Pandit's takeover of Wachovia assets may have looked opportunistic, it's a wonder that Citigroup wants to make any acquisition at all. Its adventure as an all-encompassing financial services company has been a flop. Kenneth Lewis, chief executive officer of Bank of America, who is aping Citigroup with his recent takeovers of stockbroker Merrill Lynch & Co. and mortgage giant Countrywide Financial Corp., please note.

John Mack, the CEO of Morgan Stanley, no doubt was also dismayed by the bailout vote. Like Goldman Sachs, Morgan Stanley has become a bank holding company and needs more capital after big mortgage losses. Yesterday, he struck an agreement with Mitsubishi UFJ Financial Group Inc. to sell a 21 percent stake in the firm for $9 billion.

Still, Mack hasn't put huge stacks of money at risk as have Buffett, Dimon and Pandit. Once again, just when you think things have hit bottom, they get worse.

Paulson May Find Turmoil Helps Renew Push for Bailout (Update1)

Sept. 30 (Bloomberg) -- Treasury Secretary Henry Paulson may have to rely more on the worst stock market plunge in two decades and a deepening credit-market freeze than personal persuasion to sell his bank bailout plan to Congress.

Paulson pledged to work with lawmakers after the House of Representatives yesterday rejected a $700 billion rescue, sparking the biggest collapse in the Standard & Poor's 500 Index since the October 1987 crash. As Congress considers returning in the next two days to reexamine the proposed legislation, lawmakers are weighing the implications of inaction.

``The impact this can have on the markets will have a big impact in getting people back to wanting to work together and get this problem solved,'' Representative Roy Blunt, the House Republican Whip, told reporters after the vote.

The vote wrapped up an almost two-week odyssey for Paulson during which he insisted Congress would be making a ``grave mistake'' to curtail or delay the legislation. Now that the market drop is showing lawmakers that some of Paulson's worst predictions are coming true, the Treasury secretary will get another chance to push through his proposals.

The market drop yesterday wiped $1.2 trillion from the value of U.S. stocks -- almost double the borrowing authority Paulson is requesting from lawmakers. The S&P 500 fell 8.8 percent to 1106.42 points, the lowest level since October 2004. Futures on the index rose 2.3 percent today.

Yesterday's decline ``has really put a punctuation mark on how much risk there is right now and how much concern there is right now and how important it is that we take action,'' New Hampshire Senator Judd Gregg, the lead negotiator for Senate Republicans, told reporters yesterday.

Bush Statement

President George W. Bush said in a White House address today that ``we are in an urgent situation and the consequences will grow worse each day if we do not act.'' His lack of political clout was underscored in yesterday's vote, when two thirds of House Republicans voted against the measure.

Paulson will continue to be the lead figure in arguing the administration's case, although his public salesmanship drew fire from Republicans and Democrats alike. He gets get poor marks from some lawmakers and outside experts for allowing the plan to be perceived by the public as a bailout for Wall Street firms.

``Paulson is not a very persuasive speaker,'' said Peter Wallison, a resident fellow at the Washington-based American Enterprise Institute and former Treasury official. ``He should have spoken about this from the beginning as something much closer to an investment in our future.''

Stressed Markets

As Paulson renews his push for a deal, he will have to persuade lawmakers of the economic consequences for Americans should the bill fail. Yesterday he restarted that effort by highlighting the impact on average households, saying they will see car and student loans dry up.

``Markets around the world are under stress, and that reduces the availability of credit that businesses across America use to meet payroll and to purchase inventories,'' Paulson said outside the White House. ``Families, too, feel the credit crunch as it becomes more difficult to get car loans or student loans.''

U.S. House Majority Leader Steny Hoyer said lawmakers, who were due to return to their home states last weekend, will ``continue to work around the clock'' to break the logjam and the Senate may take up legislation on Oct. 2. Senator Mitch McConnell, the Republican leader, said ``no action is not an answer.''

Asian and European stocks dropped today, extending the worst global sell-off in 21 years.

Market Pressure

``Come Thursday, when the package is presented again to the U.S. House, many of the same people who voted against it earlier today will change their minds because of the pressure coming from the markets,'' said Stephen Roach, chairman of Morgan Stanley Asia Ltd. at a seminar in Hong Kong.

While Congress deliberates, the administration may need to make more use of its ``substantial but insufficient toolkit,'' Paulson said. One option might be making more use of the Federal Deposit Insurance Corp. to backstop banks and the financial system, according to an idea pitched to lawmakers by former FDIC chairman William Isaac.

``The FDIC is the source of the greatest amount of expertise on dealing with distressed financial institutions assets anywhere,'' said Joseph Mason, a professor at Louisiana State University in Baton Rouge who used to work at the Treasury's Office of the Comptroller of the Currency.

Election

Proponents of this plan say the FDIC already has the authority to place its backing behind all of the creditors of the banking system, and has done so in the past. Chairman Sheila Bair could issue a statement saying the FDIC is prepared to do this on an institution-by-institution basis.

Yesterday's sell-off reverberated to Colorado and Iowa, where the two presidential candidates were angling for votes. Barack Obama called for calm, saying a bailout ``will get done.'' Republican John McCain urged lawmakers to ``go back to the drawing board'' and come up with legislation that will pass.

The past 10 days of talks between the White House and Capitol Hill are testing the limits of Paulson's endurance to work weekends and nights, which staffers have characterized as relentless. The marathon may be starting to take its toll.

During a negotiating session that extended into the evening on Sept. 28 at the Capitol, Paulson at one point leaned back in his chair and closed his eyes, sparking worries that he might need a doctor. According to a person familiar with the deliberations, it wasn't a health crisis, just fatigue.

U.S. Heading for Slump, With or Without Bailout (Update1)

Sept. 30 (Bloomberg) -- The U.S. may face its longest recession in a quarter century no matter what action Congress takes on Treasury Secretary Henry Paulson's $700 billion plan to rescue the battered banking industry.

Economists including Joseph Lavorgna of Deutsche Bank Securities and David Greenlaw of Morgan Stanley said it now appears the economy shrank in the third quarter as credit- crimped consumers cut spending for the first time since 1991. A further contraction is likely in the next two quarters, some economists predicted, which would make the recession the longest since 1981-82.

``This has been a body blow to consumer and business confidence,'' said Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pennsylvania. ``The next six months are going to be very difficult.''

How bad it gets depends on whether Congress passes some form of assistance for the banks. The Standard & Poor's 500 index plunged 8.8 percent yesterday, its biggest fall since 1987, after the House of Representatives rejected the rescue package. The stock-market rout wiped out a record $1.3 trillion of wealth.

The defeat of the measure -- and the steep price decline that accompanied it -- set off a scramble among the plan's backers for additional support before another vote, which likely won't come until later in the week.

Long and Steep

If Congress ultimately fails to approve a bailout, what is shaping up to be a long and moderate recession might turn into a long and steep decline as credit freezes up and stock prices continue to nosedive, said Allen Sinai, chief economist at Decision Economics in New York.

``We're going through a period of holy terror,'' he said.

The grim outlook puts pressure on Federal Reserve Chairman Ben S. Bernanke and his colleagues to reduce interest rates, following yesterday's move to pump an extra $630 billion into the global financial system.

``They should and will cut rates,'' said John Lonski, chief economist at Moody's Investors Service in New York. Economists at Citigroup Inc. told clients today that they see a ``decent chance'' of European central banks following any reduction from the Fed with ``emergency'' rate cuts of their own.

So far, the economy has largely been able to weather the financial crisis, growing by 2.1 percent during the past year, thanks to well-timed tax relief and healthy corporate cash flow. Both now look to be losing their potency.

Flat Consumer Spending

Consumer spending was flat in August as the boost from $93 billion worth of rebates faded and households grappled with mounting job losses, declining home prices and a squeeze on credit.

Morgan Stanley reduced its forecast for third-quarter gross domestic product and now sees it contracting by an annualized rate of 0.6 percent instead remaining unchanged, Greenlaw said in a note to clients yesterday. The economy grew by 2.8 percent in the second quarter.

Deutsche Bank's Lavorgna also turned more pessimistic after the consumer-spending numbers were announced yesterday, saying the economy looks set to suffer a 0.5 percent decline in the third quarter. He had previously expected a 0.7 percent gain.

``The spending outlook is even worse going forward, given the dramatic tightening in financial conditions that has occurred in the last couple of weeks,'' he said in a note to clients. The outcome could end up looking like the credit- induced slowdown of 1980, when consumer outlays plunged at a 5 percent annual rate over two quarters, he wrote.

Trimming Purchases

Consumers are so pinched they're even trimming purchases of basic goods. Walgreen Co., the largest U.S. drugstore chain, reported on Monday that its profits rose less than analysts estimated after it posted its smallest sales increase in a decade.

Faced with stalling consumer spending and fading profits, companies are also starting to rein in their outlays and pare their payrolls.

Industrial production fell in August by the most in almost three years as slower car sales prompted automakers to cut back on output. Data coming out Oct. 3 are expected to show that jobs declined another 105,000 this month, after an 84,000 drop in August, according to economists polled by Bloomberg News.

Tighter credit is also beginning to take its toll on companies as earnings slow, making them more dependent on loans to expand their businesses.

Financing Gap

The so-called financing gap -- the amount of money companies pay for capital expenditures minus what they generate internally from profits -- rose to an annualized $327 billion in the second quarter from $163 billion in the same period a year earlier, Fed data show.

``Businesses are starting to be squeezed,'' Lonski said.

McDonald's Corp., the world's largest restaurant company, told some U.S. franchisees to seek other ways to finance store improvements after Bank of America Corp. declined to increase lending, according to a memo obtained by Bloomberg.

Even companies that are able to get credit must pay more for it. While Caterpillar Inc. raised $1.3 billion last week in its biggest bond offering ever, it had to offer the highest yields it has paid on such debt in nine years.

Zandi said the combination of strapped consumers and cautious companies may cause the economy to contract by as much as 1 percent in the fourth quarter of this year and again in the first quarter of next.

A bank-rescue package ``is not going to save us from recession,'' said Nariman Behravesh, chief economist at Global Insight Inc. in Lexington, Massachusetts. ``It will only prevent it from getting a lot worse.''

Consumer Confidence in U.S. Unexpectedly Increased (Update1)

Sept. 30 (Bloomberg) -- Consumer confidence unexpectedly rose in September in a survey taken before the recent worsening of the credit crisis and plunge in stocks.

The Conference Board's confidence index increased to 59.8, a third consecutive increase, from 58.5 the prior month, the New York-based group said today. A separate report showed home prices fell in July at the fastest pace on record from a year earlier.

Since the confidence survey's Sept. 23 cutoff, the odds have risen that consumers will retrench in the wake of failing banks, evaporating wealth and paychecks that aren't keeping up with inflation. Stocks tumbled yesterday after the government failed to approve a financial-rescue plan.

``The environment has become pretty negative,'' said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut, who had forecast confidence would rise. ``The momentum has certainly turned down. If the turmoil continues, the risk of a severe recession goes up.''

Americans are likely to lose confidence heading into the presidential election on Nov. 4. Today's report is the next-to- last Conference Board sentiment reading before the vote.

Another report showed business activity slowed less than forecast this month. The National Association of Purchasing Management-Chicago's index fell to 56.7 in September from 57.9 the prior month. Fifty is the dividing line between growth and contraction.

Stocks Up

Stocks extended earlier gains following the reports and Treasury securities fell. The Standard & Poor's 500 index was up 3.2 percent to 1,142 at 10:15 a.m. in New York. The yield on the benchmark 10-year note rose to 3.69 percent from 3.58 percent late yesterday.

Equities rallied on expectations lawmakers would salvage the bank rescue package. The House of Representatives yesterday voted down a $700 billion plan intended to restore confidence in U.S. banks, sending the S&P 500 Index tumbling almost 9 percent.

The confidence gauge was forecast to drop to 55 from an originally reported 56.9 in August, according to the median forecast in a Bloomberg News survey of 62 economists. Projections ranged from 48 to 66. The index reached a 16-year low of 51 in June and averaged 103.4 last year.

Since the cutoff date, Washington Mutual Inc. joined Lehman Brothers Holdings Inc. in bankruptcy, Citigroup Inc. acquired Wachovia Corp. to prevent the collapse of the sixth-biggest U.S. bank by assets, and stocks suffered their biggest drop since 1987.

Home Values Drop

Earlier today, the S&P/Case-Shiller home-price index of 20 U.S. metropolitan areas dropped 16.3 percent in July from a year earlier, more than forecast, after a 15.9 percent decline in June. The gauge has fallen every month since January 2007, and year-over-year records began in 2001.

``The fact that house prices quickened their slide before the worst point in credit markets hit this month does not bode well,'' said Derek Holt, an economist at Scotia Capital Inc. in Toronto.

The Conference Board's measure of present conditions dropped to 58.8, the lowest since 1993, from 65 the prior month. The gauge of expectations for the next six months increased to 60.5 from 54.1.

``These results did not capture all of the tumultuous events in the financial sector this month,'' Lynn Franco, director of the Conference Board's confidence survey, said in a statement. ``Until the dust settles a bit more, we will not know the full impact.''

Jobs Outlook

Temporary shocks usually have a detrimental effect on confidence for two to four months unless they are accompanied by job losses, she said.

The share of consumers who said jobs are plentiful dropped to 12.2 percent, the fewest in five years, from 13.5 percent last month, today's report showed. The proportion of people who said jobs are hard to get increased to 32.8 percent from 31.7 percent.

Compared with other sentiment measures, the Conference Board's index tends to be more influenced by consumer attitudes about the labor market, economists said. So far this month, 466,000 Americans a week on average filed first-time claims for unemployment benefits, up from 443,000 in August and 363,000 in the first six months of the year.

A report last week showed the Reuters/University of Michigan final sentiment reading for this month declined from a preliminary figure issued in early September as the credit crisis deepened. The reading was still up from August, reflecting the decline in gasoline prices, economists said.

Payroll Forecast

The economy probably lost another 105,000 jobs in September, the ninth consecutive monthly decline, according to the median estimate in a Bloomberg survey ahead of a Labor Department report due Oct. 3. Payrolls dropped by 605,000 workers in the first eight months of the year.

Job cuts may swell as the effects of the financial meltdown ripple through other industries. Fewer jobs and less-available credit indicate consumer spending, which accounts for more than two-thirds of the economy, will weaken further.

Fewer Americans were able to obtain an auto loan this month, according to CNW Marketing Research in Bandon, Oregon, which analyzes auto-industry data.

``Given the relatively weak state of the economy, that's obviously impacting the consumer's ability or willingness to come out and buy a new car,'' General Motors Corp. Chief Executive Officer Rick Wagoner said in a Bloomberg Radio interview on Sept. 25 from Flint, Michigan.

Consumer spending this quarter will be unchanged, the weakest performance since 1991, according to the median estimate in a Bloomberg survey earlier this month.

Senate May Try to Revive Bank-Rescue Bill by Tomorrow (Update1)

Sept. 30 (Bloomberg) -- The U.S. Senate will try to salvage a $700 billion financial-rescue package after the measure was defeated in the House of Representatives. The lawmakers won't have a lot of room to negotiate.

While they need to tweak the legislation enough to win over reluctant Republicans, they'll risk losing votes from Democrats if they veer too far from the delicate compromise that congressional leaders hammered out with the U.S. Treasury.

``They're not going to totally revamp the bill,'' said Pete Davis, president of Davis Capital Investment Ideas in Washington, who spoke to House and Senate leaders yesterday. ``They'll make some minor changes and pass it. This is all about political cover.''

The House rejected the legislation yesterday in a 228 to 205 vote, sending the Dow Jones Industrial Average tumbling 778 points for its biggest point drop ever and erasing more than $1 trillion in market value. The Standard & Poor's 500 Index fell 8.4 percent, the most since Oct. 26, 1987. S&P 500 futures rebounded today, rising 3.1 percent at 11:03 a.m. in London.

Senators say they have no choice but to revive the measure, which is designed to restore confidence in the nation's banking system.

``We don't intend to leave here without the job being done,'' said Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, who said the senators may deal with the bill as early as tomorrow.

`Economy in Distress'

Senator Judd Gregg of New Hampshire, the Banking Committee's ranking Republican, said the plunge in stocks underlined the urgency of the rescue package. ``The economy is in distress,'' said Gregg.

Money-market rates jumped in Europe today, with lenders hoarding cash as the third quarter ends. Rates on three-month loans in dollars were as high as 10 percent as of 10:50 a.m. in London, said Ronald Tharun, a money-market trader at Landesbank Baden-Wuerttemberg in Stuttgart.

To pick up the 12 votes needed to pass the bill in the House, the bill will need some cosmetic changes, lawmakers and political analysts say. Ninety-five Democrats joined the 133 Republicans who voted against the bill. Both sides are looking for changes.

House Republican conservatives are likely to keep pressing for a mandatory insurance program they initially proposed for mortgage-backed securities. They may also try to force the Securities and Exchange Commission to suspend mark-to-market accounting and require bank regulators to assess the real value of the troubled assets, lawmakers say.

FDIC Role

Either measure could drive away Democratic votes.

House Republicans are also lobbying the White House to get the Federal Deposit Insurance Corp. to play a greater role in shoring up the financial system, said a House Republican aide.

Under the plan, the FDIC would issue lenders certificates they could use as capital, which the banks would have to pay back with interest. The proposal would give the FDIC more say in how the institutions are run. Democrats may balk at that.

Democrats say they may seek stronger oversight over the plan, tougher limits on executive compensation and more relief for homeowners facing foreclosure.

Bankruptcy Provision

Some Democrats want a provision that would allow bankruptcy judges to alter the terms of a home mortgage for individuals in bankruptcy, even reducing the principal balance. That would be a deal-killer for many Republicans, a danger that presidential nominee Barack Obama recognized: He opposed including that in the original bill, angering fellow Democrats.

The Senate won't hold any roll-call votes today because several lawmakers will be celebrating Rosh Hashanah, the Jewish New Year. Gregg and Dodd urged investors not to view that pause as inaction.

``We can certainly work,'' said Dodd. Senators, he said, will ``hopefully come back Wednesday and get a different result.'' The measure is expected to get far more support in the Senate than it did in the House.

House Majority Leader Steny Hoyer said he expects his chamber to be ready to take up the plan again after a Senate vote. ``We're not out of business until this is addressed,'' Hoyer said.

Hoyer said he has spoken with Republican Whip Roy Blunt and both are committed to working together on a compromise.

Some lawmakers are proving tough to sell on the plan.

`Better Bill'

``We can craft a much better bill,'' said Representative Brad Sherman, a California Democrat who voted against the bill. He objected to the ``tens of billions of dollars'' that could go to foreign companies and said the oversight board the plan would create would be powerless.

Sherman wants more relief for homeowners and stronger restrictions on executive compensation, among other measures.

``It's not just a matter of we pass this bill or we do nothing,'' Sherman said. ``The other suggestion from 400 eminent economists is that we take some time and we pass a good bill.''

Representative Jeb Hensarling, a Texas Republican, said most Republican conservatives oppose the idea of Treasury purchasing troubled assets, because it puts too much of the expense on taxpayers.

``That is a model that House conservatives feel is fundamentally flawed,'' said Hensarling, the chairman of a group of more than 100 House Republican conservatives called the Republican Study Committee.

Still, the markets may dictate that Congress act now.

``It's just not acceptable for Congress to essentially tell Main Street or Wall Street to drop dead,'' said Chris Lehane, a Democratic consultant who was former Vice President Al Gore's communications director. ``The Dow dropping 777 points is a pretty powerful force to find another 12 votes.''