The Financial Fix Just Got Political

The White House, feeling some pressure, will try to shape the debate with its plan to call for streamlined regulation and greater Fed powers

by Jane Sasseen

U.S. Treasury Secretary Henry Paulson Win McNamee/Getty Images

With political pressure growing to do more to help struggling homeowners and address the crisis in the financial markets, the Bush Administration is moving forward with its attempt to define what promise to be extensive debates over how the government can lessen the pain and reduce the chances of a reoccurrence.

On Mar. 31, Treasury Secretary Henry Paulson laid out a wide-ranging plan to revamp the regulatory structure that governs banks, investment banks, and other financial-services firms. "First and foremost, we are working on getting through this period and minimizing the effect of the housing and capital markets on the economy," Paulson told BusinessWeek. "But at the same time, we also have the responsibility to look forward and say what are the best policies, and the best regulatory structure for the economy, and learn the lessons from events."

Simultaneously, there appears to be support for the first time within the Administration to help many homeowners who are "under water" on their mortgages—that is, they owe more money on their mortgages than their homes are currently worth. As first reported by The Washington Post, the Administration is working on a plan that would provide government-guaranteed insurance for new mortgages set at a lower value when lenders agree to reduce the principal to reflect the lower home value. Banks and other lenders would be encouraged to rework such loans and write off the difference, in exchange for government-backing behind the new, smaller mortgages.

Time to Step In

The moves come after months of criticism that the Administration has been moving too slow to address the housing and credit woes. Analysts say that the Administration may no longer have much choice, now that the government-backed firesale of Bear Stearns (BSC) has changed the political dynamic in Washington. Having offered up $29 billion of taxpayer money in that deal to prop up an investment bank, it is increasingly difficult to argue against broader help for homeowners proposed by Democrats in Congress and on the Presidential campaign trail. To regain leadership and exert influence over the debate, the Administration needed to get its own proposals on the table.

"The Administration's rhetoric has clearly shifted, and its proposals are becoming much more aggressive in terms of government action," says Daniel Clifton, a Washington policy analyst with the investment firm Strategas Research.

In prepared remarks he delivered while discussing details of the regulatory overhaul, Paulson said: "We have been undergoing a period of financial market stress since last August. Markets are repricing and reassessing risk and as we should expect, there are always difficulties during periods such as this.…As we work through this period, our highest priority is limiting its impact on the real economy."

While President Bush, Paulson and other top economic officials have repeatedly talked about the need to avoid doing more harm than good in the policy response to the crisis—and clearly implied that many Democratic measures would do just that—Clifton says they now have little choice but to shift gears. A key question, he says, has become "what's our alternative?" Clifton adds: "It may well be that the right position in reality is to avoid doing harm, but this is politics. They have to do something."

Streamlining and Stronger Oversight

The Adminstration's moves are widely seen as an attempt to set the minimal floor underneath the discussion of further policy moves—a useful first step, though just that.

In the case of the regulatory overhaul that Paulson announced, the first step is a wide-ranging proposal that would streamline and overhaul the system that has governed the financial-services industry since the aftermath of the Great Depression.