In Washington, The Bailout Is Toxic

The American political spectrum looked like a horseshoe yesterday, as lawmakers on the left and right ganged up to defeat the Troubled Asset Relief Program (TARP). After a week in which markets begged Washington to set aside political agendas, the $700b rescue plan was scuttled. Congressional leaders had pushed for coöperation, and in the end 133 government-skeptical Republicans joined with 95 market-skeptical Democrats in voting against the measure.

Less than a month before Representatives would stand for reëlection, few were willing to incur the political risk of an increasingly unpopular bailout. News of the failed vote sent global stock markets tumbling and left President George Bush and Treasury Secretary Henry Paulson scrambling to craft new legislation. The Dow Jones industrial average had nearly 8%, wiping out some $1.2t in shareholder value.

The news forced Asian and European markets down, while frantic sell-offs in Russia forced yet another closure of the equities exchange. News from Wachovia, Bradford & Bingley in Britain, and Fortis in Belgium all raised fears over nationalization and deepening bank problems. The spread between 3-moth Libor and 3-month overnight index swaps, a measure of stress on the banking system, blew out yesterday to its highest point in the crisis.

EU Trade Commissioner Peter Mandelson laid into American lawmakers, saying that their rejection of the Paulson plan showed "irresponsibility and political partisanship." Mr Mandelson may soon find himself ensnarled in such political headaches. With so many national governments, the EU could struggle to forge consensus around a rescue plan for European banks. In certain respects, European banks, which are more highly levered than American banks, could be at greater risk of collapse. And with only 4 of the top 20 banks now in the US, it is clear that governments across the globe will need to involve themselves in restoring financial stability. 

Now hedge funds are facing major redemptions, as investors pull their money out of a frightfully volatile market. While many Americans have been reluctant to bail out reckless investment banks, hedge funds are intimately connected to pension plans, endowments, and foundations that are important to a much broader cross-section of the country. 

As these investment vehicles are put under strain, there may be a shift in the electoral pressure felt by lawmakers. Voters may have been unhappy with the bailout, but they are likely to feel the increasing effects of a financial crisis, and will want some form of relief for the markets. In this next round of negotiations, Mr Paulson must do a better job of connecting the current financial peril on Wall Street to average Americans watching from afar. 

For many voters, TARP was itself a toxic asset. If the (highly likely) stock market slide continues, however, these same constituents will press for some form of government rescue plan. In the meantime, the markets try to hang on during a wild ride.