The Rescue Package Will Delay Recovery

by Frank Shostak

In his testimony to the Congress on September 24, Fed Chairman Bernanke urged the legislators to quickly approve the bailout of the financial sector with a package of $700 billion. Bernanke echoed Treasury Secretary Paulson's view that the bailout expense, while hefty, is needed to remove from banks' balance sheets the mortgage-linked assets, which are paralyzing the flow of credit.

I think it's extraordinarily important to understand that as we have seen many previous examples in different countries and in different times that choking up of credit is like taking the lifeblood away from the economy.

Most experts came out in strong support for the package. Without the rescue package, many large institutions that are "too big to fail" could go belly up. Many believe that the consequences of all this could be very severe to the real economy.

It is true that the financial system must be rescued; it must be rescued from the institutions holding bad debt that are currently draining capital while waiting for a bailout and adding little in return. It is they that are preventing wealth-generating activities in the financial sector and the other parts of the economy from expanding real wealth.

The Essence of Economic Adjustment

Conventional thinking presents economic adjustment — also labeled as "economic recession" — as something terrible, even the end of the world. In fact, economic adjustment is not menacing or terrible; from an economic point of view, it is nothing more than a time when scarce resources are reallocated in accordance with consumers' priorities.

Allowing the market to do the allocation always leads to better results. Even the founder of the Soviet Union, Vladimir Lenin, understood this when he introduced the market mechanism for a brief period in March 1921 to restore the supply of goods and prevent economic catastrophe. Yet for some strange reason, most experts these days cling to the view that the market cannot be trusted in difficult times like these.

If central bankers and government bureaucrats can fix things in difficult times, why not in good times too? Why not have a fully controlled economy and all the problems will be fixed forever? The collapse of the Soviet Union's centralized system is the best testimony one can have that controls don't work. A better way to fix economic problems is to allow entrepreneurs the freedom to allocate resources in accordance with society's priorities.

In this sense, the best rescue plan is to allow the market mechanism to operate freely. Allowing the market to do the job will result in some activities disappearing all together while some other activities will in fact be expanded.

Take, for instance, a company that has six profitable activities and four losing activities. The management of the company concludes that the four losing activities must go. To keep them alive is a threat to the survival of the company; these activities rob scarce funding from profitable activities.

Once the losing activities are shut down, the released funding can now be employed to strengthen the winning activities. The management can also decide to use some of the released funding to acquire some other profitable activities.

This is precisely what the government rescue package prevents from happening. The government package is not going to rescue the economy, but it will rescue activities that the economy cannot afford and that consumers do not want. It will sustain waste and promote inefficiency, draining resources from growth and efficiency. Remember: government is not a wealth generator; it can only take resources from A and give them to B.

Can the Rescue Package Prevent Economic Disruptions?

Some supporters of the package are of the view that the package is necessary in order to prevent economic disruptions. They mean by this that various phony activities should be kept alive by wealth generators for a little bit longer until a proper system is established. By "proper," they mean more controls.

For a while, the government's package can appear to be working; this is because there is still enough real savings to support both profitable and unprofitable activities. If, however, savings and capital are shrinking, nothing is going to help, and the real economy will follow up with further declines.

Hence the rescue package cannot prevent so-called economic disruptions. If anything, government intervention would make these disruptions much worse. Again, a better alternative is to let the market do the job. The market's ability to make swift adjustments without much drama was vividly illustrated only a few weeks ago when the very large investment bank, Lehman Brothers, was allowed to go belly up. The world did not come to an end. Instead, this was a healthy development. A money loser was eliminated from the market. This freed up resources to promote growth.

One could have made the case that when Lehman was on the brink it was too big to fail — assets of $639 billion and employing over 26,000 people. Yet in a few days the market, once allowed to do the job, reallocated the good pieces of Lehman to various buyers and the bad parts have vanished. It was poetry.

Likewise Merrill Lynch, which was bought by the Bank of America, will see the good parts of it reinforced while the useless parts are likely to be removed.

On September 18, 2008, Washington Mutual, the largest US saving and loan bank, was forced into liquidation. The bank had $307 billion in assets and $188 billion in deposits. What prompted the closure are heavy losses on its $227 billion book of real-estate loans, of which a large portion was in subprime mortgages.

The bank lost $6.3 billion in the nine months ending June 30. Against this background, and coupled with customers withdrawing $16.7 billion over the past ten days, government regulators decided to close the bank.

Observe that this was the largest US banking failure. Note that the closure of the bank didn't result in the end of the world. JP Morgan Chase bought some of the good assets of Washington Mutual for $1.9 billion.

On this, Jeffrey Tucker made the following observation,

But as wonderful as the daily shifts and movements are, what really inspires are the massive acts of creative destruction such as when old-line firms like Lehman and Merrill melt before our eyes, their good assets transferred to more competent hands.… This is the kind of shock and awe we should all celebrate. It is contrary to the wish of all the principal players and it accords with the will of society as a whole and the dictate of the market that waste not last and last. No matter how large, how entrenched, how exalted the institution, it is always vulnerable to being blown away by market forces — no more or less so than the lemonade stand down the street.

Most commentators have accepted that the root problem of the current financial crisis is the lack of proper control over mortgage lending. But the out-of-proportion explosion in the mortgage lending didn't occur out of the blue. Without the aggressive lowering of interest rates by the Fed, mortgage lending couldn't have exploded. The Fed lowered the federal-funds rate target from 6% in January 2001 to 1% by June 2003. The 1% was kept until June 2004.

The loose monetary stance prepared the ground for various false activities that wouldn't have been around without the loose stance. If authorities had kept strong controls over mortgage lending, while at the same time creating money out of thin air, the excesses would have popped up in some other sector. The banks would have ended up having plenty of bad non-mortgage-related assets.

The Fed's loose policies are the crux of the problem. So rather than blaming the symptoms, what is required is to let the market work and close all the loopholes that allow the creation of money and credit out of thin air.

Can Making Banks' Balance Sheets Look Good "Fix" the Economy?

Recall that Treasurer Paulson and the Fed chairman are of the view that once banks' bad assets are removed, the banks are likely to move ahead and start lending. We suggest that making the balance sheet look pretty is not going to alter the essence of the problem, which is the poor state of capital and savings to support such high lending activities.

The essence of a sound credit market is not lending money as such but lending the real stuff that people require by means of money. Without the real stuff — the preceding savings and subsequent productivity to fund the lending — no lending is possible.

Decades of nonproductive consumption (consumption that is not backed up by production) that emerged on the back of loose monetary and fiscal policies have severely damaged the store of wealth that serves as the foundation for credit markets. If this is the case, it will be futile to try to boost lending by pushing more money into the banking system. More money cannot generate real wealth. If it could, world poverty would have been eliminated a long time ago.

When the market is allowed to take charge, the relationship between savings, lending, and productivity will be brought into proper perspective. At last we will know which activities are genuine and which are phony.

Does the Fall in Stock Prices Cause an Economic Slump?

The proponents of government intervention maintain that one cannot allow the market to take charge since this will cause a drop in stock prices, which will be bad for the economy. Within the confines of this way of thinking, it is not surprising that Bernanke and Paulson panicked on September 18, once a large money-market mutual fund — the Reserve Primary Fund — was on the brink.

They argue that were it not for the Fed's injecting $105 billion and the subsequent announcement of the rescue package, the stock market would have had a massive fall. They also believe that the massive monetary injection prevented a run on money-market mutual funds and prevented a major disaster.

They further believe that if people had taken the money out of their money-market mutual funds, banks wouldn't be able to secure money to fund credit cards and various consumer and business loans. This in turn would have paralyzed the economy.

So let us think about this. Say that people take their money from the money-market mutual funds. What happens then? They will have placed it somewhere else, mostly likely with commercial banks. Hence money wouldn't disappear and banks could continue to fund activities as before.

If large money-market funds were to go under, some of their assets would be sold and the shareholders would suffer losses; this however, cannot provide justification for the Fed to pump money and to introduce a rescue package. Monetary expansion and a rescue package do not undo the bad investment decisions of the money-market-mutual-fund managers. Why should people who didn't risk investments in the fund pick up the tab?

A fall in asset prices, including stocks, and a run on financial institutions are just symptoms and not the cause of anything. The key factor behind the current difficulty in the credit markets is the lagged effect coming from the Fed's tighter stance between June 2004 and August 2007, when the federal-funds-rate target was raised from 1% to 5.25%.

The tighter stance started to undermine various bubble activities that had emerged from the previous loose stance. A tighter stance slowed the diversion of real savings from wealth generators towards bubble activities. Without an adequate supply of real funding, these activities started to crumble. Obviously, then, banks that have been providing support to these activities by providing loans have ended up holding a large amount of bad assets.

As a result, bank stock prices started to come under pressure. With a time lag, bubbles in the various other parts of the economy are also likely to come under pressure, and this again is going to hurt financial stocks. So the fall in economic activity is not the result of a fall in stock prices, but rather comes on account of the tighter Fed stance that throttled the supply of real savings to non-wealth-generating activities.

Would the stock market have come under pressure if the Fed had kept the interest rate at 1% for an indefinite period of time? A prolonged loose stance would have given rise to a much greater amount of nonproductive bubble activities. As a result, the pace of real wealth generation would have continued to slow, and consequently the growth momentum of profits would have come under pressure. In response to this, commercial banks would have become more cautious in their expansion of credit out of thin air.

All this in turn would have undermined the existence of bubble activities. Bubble activities cannot stand on their own feet; once the rate of growth of the money supply slows down, the pace of the diversion of real savings towards false activities follows suit. As a result, the survival of these activities is threatened.

From this we can infer that a fall in non-wealth-generating activities — also labeled an economic slump — is not due to a fall in the stock market as such but to the previous loose monetary policy that has weakened the pool of real savings.

"The government package is not going to rescue the economy, but it will rescue activities that the economy cannot afford and that consumers do not want."

The central-bank policies aimed at preventing a fall in the stock market cannot prevent a fall in the real economy. In fact, the real economy has already been damaged by the previous loose monetary stance. All that the fall in the stock market does is inform us about the true state of economic conditions. The fall in the price of stocks just puts things in a proper perspective. The fall in the stock price is just an acknowledgment of reality.

Conclusion

Only a few weeks ago, we saw that the liquidation of a large bank such as Lehman Brothers and the sale of Merrill Lynch did not cause massive disruptions. In fact, the adjustment was swift and almost invisible. The reason for the smooth adjustment is that the market was allowed to do its job. If government and Fed bureaucrats had tried to intervene with bailouts, the whole process would have taken much longer and would have been very costly in terms of real resources.

U.S. Seals Bailout Deal

WASHINGTON -- The White House and congressional leaders agreed on a deal to authorize the biggest banking rescue in U.S. history.

The $700 billion program would effectively nationalize an array of mortgages and securities backed by them -- instruments whose deteriorating value has clogged the nation's financial system.

After a weekend of tense negotiations, Congress settled on a tentative $700 bailout plan. WSJ's Washington Bureau Chief John Bussey looks at the deal and how markets are likely to react.

Lawmakers finished writing the bill late Sunday, after which Speaker of the House Nancy Pelosi declared it "frozen," meaning no changes would be made. The bill leaves many mechanics of the operation up to the Treasury. Among these are the crucial issues of how the U.S. government would decide which assets it will buy and how it would decide what to pay for them. The legislation leaves the Treasury 45 days to issue guidelines on those procedures. The bill awaits votes in Congress starting on Monday.

From big Wall Street houses to small community banks, executives have expressed an interest in signing up for the bailout. But some have said the extent of their involvement will depend on critical details.

The political fallout from the bailout could be substantial, given the enormous expenditure of taxpayer money. Some polls show wide opposition. But the legislation includes provisions designed to guard against ultimate losses for the government. And it calls on the Treasury, as an owner of mortgage securities, to "encourage the servicers of the underlying mortgages" to minimize foreclosures.

The deal came after tension-filled weekend negotiations, where the specter of a faltering economy collided with the politics of a presidential election to create one of the biggest congressional dramas of recent years. Saturday included a high-decibel exchange between Treasury Secretary Henry Paulson and congressional Democrats, a ban on handheld email devices to forestall news leaks, and a battery of lobbying calls from the president and the presidential candidates.

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House Financial Services Committee Chairman Barney Frank, Senate Majority Leader Harry Reid, Speaker of the House Nancy Pelosi and Senate Banking, Housing and Urban Affairs Committee Chairman Christopher Dodd talked about the compromise legislation between Congress and the Bush Administration for the $700 billion bailout plan.

"The key was to work through this and incorporate everybody's concerns but in a way that gave us the tools we needed," Mr. Paulson said in an interview. "We had to just insist that we can work on things. We can compromise, but at the end of the day it had to be something that was workable in the marketplace."

At the bill's core is Mr. Paulson's concept of buying impaired mortgage-related assets from financial firms -- giving them cash to replace the toxic debts that have put them in danger or dissuaded them from lending. The plan is to help the firms restore their capital bases as well as the trust that enables them to borrow and lend at reasonable terms. Without this, officials worry that the credit markets, the lifeblood of the economy, would grind to a halt.

Credit Unions

Sellers of assets could include a broad range of financial entities -- not just banks but also credit unions and pension funds. The assets offered to the government must have been originated or issued on or before March 14, 2008.

The Treasury wouldn't get the entire $700 billion for purchasing such assets upfront. Just $350 billion would be immediately available. But the other $350 billion would be available unless Congress specifically holds it back.

Mr. Paulson doesn't expect the funds to unclog the financial situation immediately. "I'm hoping that, in a very fragile system, this restores some confidence when it's announced. But it will take several weeks" before the asset purchases begin to work, he said.

The plan would impose some curbs on executive compensation at firms that sell assets to the government. These include a ban, for those that sell a large amount of securities to the U.S., on creating new "golden parachute" payments to departing top executives. Companies also would have to have provisions to "claw back" past bonuses found to have been based on misleading financial statements.

The Bailout Deal

• Full Text of the Draft Bill | Summary
• Rescue Will Help Borrowers Keep Homes
• Bailout Tests Bush's Conservative Legacy
• GOP Leaders Try to Secure Rank-and-File Vote
• Sen. Dodd's Shot at Redemption
• Real Time Econ: Bailout Bill Assists Fed

The Treasury would receive warrants giving it the right to acquire nonvoting common stock or preferred stock in firms benefiting from the bailout. The program would be subject to oversight that includes a bipartisan committee and the Government Accountability Office. The GAO would have an office located within the Treasury Department.

The Treasury plans to hire asset managers to determine the criteria for the purchase of securities and oversee the portfolio once the buying begins. While those details remain murky, the Treasury expects to buy up large chunks of assets at a single time. The asset managers would likely start buying the simplest assets first, such as mortgage-backed securities, and then move on to more complex ones, such as collateralized debt obligations.

One likely method of purchasing and pricing assets is a reverse auction. In this, firms would offer to sell securities at given prices, and the Treasury could buy the least expensive on offer. Institutions would presumably offer to sell at prices high enough to alleviate their woes but not so high they'd be passed over in favor of lower-priced offers.

The historic legislation is an attempt to stem a crisis that threatens to stall the U.S. economy. Treasury and Federal Reserve officials dubbed it their "break the glass" plan.

The agreement came together only after concessions on all sides. Democrats backed down from a proposal to let bankruptcy judges alter the terms of mortgages, and from another that would have steered government profits from the package to affordable-housing programs. The Bush administration, for its part, agreed to much broader executive-compensation limits than it originally envisioned, among other things.

Pivotal Point

At a pivotal point Saturday afternoon, Mr. Paulson met with lawmakers and argued over whether the funds would come in one tranche or in installments. "Damn it, if you think you need $700 billion right away you better tell us," Democratic Sen. Charles Schumer of New York told the Treasury secretary, according to two people familiar with the matter.

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Sen. Judd Gregg, left, and Sen. Christopher Dodd talk with reporters on Capitol Hill Sunday.

"I'm doing this for you as much as for me," Mr. Paulson shot back. "If we don't do this, it's coming down on all our heads."

The House plans to vote on the measure Monday, with the Senate likely to follow later in the week. Both parties have already started the process of pressuring and cajoling members to vote for the bill. Passage is seen as likely, despite the measure's unpopularity.

Support from House Republicans, who staged an 11th-hour revolt on Thursday, is still uncertain. Asked about the outcome of the House vote, Rep. Christopher Shays, a Connecticut Republican, said, "I think it's up in the air. This is what we call a legacy vote."

An exhausted Sen. Chris Dodd, a central player in the negotiations, expressed Congress's split emotions Sunday morning. "I'm pleased that we've come to a result," the Connecticut Democrat said. "I think it's dreadful that we had to come to this result."

Several days ago, it wasn't clear any kind of deal would be reachable, amid divisions between Democrats and Republicans in Congress and between Democratic negotiators and the Bush administration. The tensions of election-year politics ratcheted the pressure further.

On Thursday, talks broke down after a showdown at the White House featuring congressional leaders and the presidential candidates. House Republicans, emboldened by the emergence of Sen. John McCain on the scene, demanded wholesale revisions, including an insurance plan through which banks would pay into a fund to protect against further declines in asset values.

Mr. Paulson didn't believe this would be as effective as buying assets outright. Fearing the defection of House Republicans, he agreed to consider it. Inside the Treasury, there was deep concern that divisions between the White House and House Republicans could blow up the deal.

Mr. Paulson's negotiators arrived on the Hill Friday with a basic message: We can compromise on certain things, but we can't agree to anything that will limit participation in the program. Treasury staff members and congressional staffers separated the legislation into piles, one for bipartisan agreement and another pile for contentious items. At least 10 issues remained unresolved.

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House Speaker Nancy Pelosi (right) speaks during a news conference on Sunday evening with Rep. Barney Frank (left) and Senate Majority Leader Harry Reid.

At 3:15 p.m. Saturday, a group of lawmakers met in a conference room outside the office of Rep. Pelosi. Republican aides complained as they saw eight Democratic lawmakers arrive for the meeting, but only two Republicans.

Mr. Paulson, who looked exhausted, reiterated his warnings about the consequences of a failure to act. "The crisis is ongoing," he said. "You saw what happened earlier this week with Washington Mutual" -- which on Thursday became the largest lending institution to fail in U.S. history. "There are other companies," Mr. Paulson said, "including large companies, which are under stress as well. I can't emphasize enough the importance of this."

The meeting grew contentious. Senate Democrats, many of whom had felt let down by the Bush administration when the plan nearly derailed at the White House, were more assertive. For over two hours the group argued, with several members yelling at Mr. Paulson. The Treasury secretary, growing agitated at times, continually told members they needed to design a program that would work and that it made no sense to create a program if financial firms didn't want to participate in it. "The situation is fragile," he said repeatedly.

Democratic Sen. Max Baucus of Montana, chairman of the Senate Finance Committee, became frustrated that Mr. Paulson appeared to be arguing for softer language on the executive-pay rules, arguing loudly that executives at these companies shouldn't be handsomely paid. "Let's not get emotional," Mr. Paulson responded, according to someone who was in the room.

Mr. Paulson objected to language that would give a new oversight board power to control how the new program would be run. "All we're talking about is having Groucho, Harpo, and Chico watching over Zeppo," said Rep. Frank, before Democrats backed off.

The meeting ended around 5:30 p.m., and lawmakers broke into smaller working groups. Sandwiches and pizza were delivered later. Many lawmakers grazed on a big bowl of pistachios in Rep. Pelosi's office.

The House speaker's office was furious about leaks coming out of Saturday's afternoon meeting. In order for Capitol Hill aides to stay in the meeting, they had to hand over their BlackBerrys, said one participant. A Pelosi staffer walked through the meeting with a trashcan. The devices were later put on a table with Post-it notes identifying each owner.

Senate Majority Leader Harry Reid, House Speaker Nancy Pelosi and Treasury Secretary Henry Paulson announce a tentative deal on a Wall Street bail out. Video courtesy of Fox News. (Sept. 28)

On the tough issue of limiting severance pay for executives, Sen. Schumer wanted a one-size-fits-all approach. Mr. Paulson said this would make the program impossible to implement quickly, by requiring every company to redo its employment contracts. They agreed to a compromise under which any firm that sells more than $300 million of assets to Treasury wouldn't be able to create new golden-parachute provisions for executives for the duration of the program.

The final hangup was a move to see that taxpayers were reimbursed if the plan lost money. Democrats earlier wanted a fee or tax levied on financial firms to cover losses.

By 11:30 p.m., there was a breakthrough. The administration would be required to submit a plan to Congress "to recoup those losses from the entities that benefited from this program," according to a summary circulated among House Republicans.

Lawmakers and the administration also struggled with details of the Republicans' insurance plan, which ultimately survived in limited form as an option for the Treasury. An official familiar with the conversations said Sen. McCain also tried to encourage reluctant House Republicans. "He would say, 'You are absolutely right -- the first round was a bad deal,'" and then go on to explain the urgency of acting on something else, this person said.

From 1 a.m. until 4 a.m. Sunday, three Treasury staffers -- General Counsel Robert Hoyt, head of legislative affairs Kevin Fromer and Neel Kashkari, assistant secretary for international affairs -- worked with congressional staff to continue drafting the legislation.

Early Sunday, Mr. Paulson, Rep. Pelosi, Sen. Reid and other lawmakers emerged to say an agreement was in hand. "I think we're there," Mr. Paulson said.

—Sarah Lueck, Michael R. Crittenden, Susan Pulliam, Christopher Cooper, Laura Meckler and Patrick Yoest contributed to this article.

What We Can Learn From Chile's Financial Crisis

MARY ANASTASIA O'GRADY

You wouldn't know it from all the panicky headlines but the current turmoil on Wall Street is not the world's first financial crisis. Latin America has suffered more than a few, and many were on a larger scale relative to the economies they hit.

One was triggered by Chile's 1982 economic collapse. For a small country it was a lot worse than what is happening in the U.S. today. The Bush economic team could learn from how it was handled.

The solution to Chile's 1982 banking crisis is a model other countries can follow, Mary Anastasia O'Grady tells Kelsey Hubbard.

The Chilean plan helped the banks recapitalize and protected depositors. It also minimized moral hazard and kept the government's role from expanding. The intellectual support for economic liberty was preserved and this protected the market system, which over the past 25 years has not only survived but prospered.

The Hank Paulson-Ben Bernanke testimonies before Congress last week warned of a looming crisis of biblical proportions. President George W. Bush went on television Wednesday night to stir even more public fear.

This produced a predictable result: It spooked holders of dollars around the globe, and by Thursday credit spreads had widened to record levels. Over the weekend pressure on Congress was increased to hand over the $700 billion Mr. Paulson said he needs to execute his plan.

That plan proposes to spend taxpayer money to buy the bad debt of speculators. By wiping impaired assets off the balance sheets, the idea is that new investors will be willing to come in and recapitalize the banks.

It may be too late to reverse the effects of the hysteria that the Bush administration created last week. A solution that would let the market sort out the mess -- once it gets clear signals from Washington that no money is forthcoming -- may no longer be tenable. But even if federal help is needed, there are alternatives to the Paulson plan.

The main problem with buying distressed and hard-to-value assets from a bank is that, if the bank is to attract new capital, it is necessary for the government to overpay. And while the value of those assets may eventually move higher, the taxpayer is exposed to great risk, risk that really belongs to the bank and its shareholders. Such a huge federal expenditure also raises the risk of inflation.

A further problem is that the Treasury is itself engaging in hedge-fund speculation. This expands the role of the state in the economy at a time when downsizing that role is more important than ever.

One alternative to the Paulson plan would be to provide secured loans to troubled institutions as a way to allow them to recapitalize. The collateral against the loans would be bank assets (presumably impaired assets) but the transaction would be similar to a "repurchase agreement." In this transaction, otherwise known as a "repo," the borrower is required to repurchase the securities, with interest, in the future in order to retire the loan.

Chile used such an instrument to recover from its 1983 banking crisis. It is true that the government intervened directly in two banks, wiping out shareholders, removing management and nationalizing the firms. Those banks were later re-privatized in a sale that gave tax incentives to encourage Chileans to participate in the offering.

The many other banks that were in trouble were handled differently. For those, the government provided loans that were secured by bank assets, with an agreement that the banks would later repurchase those assets.

These "repos" had conditions attached, including a provision that the shareholders could not take profits out of the company until the loan was repaid. This meant that shareholders were asked to give something in return for getting rescued by taxpayers; and it gave the bank a strong incentive to get back on its feet and return the money.

Another advantage of this model over the Paulson plan is that although the Chilean government took the bank assets as collateral against the loan, it did not adopt responsibility for managing the assets. That role stayed with the bank.

It was important that the government was a subordinated creditor; otherwise it would have been difficult to bring new capital into the bank. But if the U.S. were to use secured loans, it might not be necessary to make the loans at subsidized rates, as Chile did. Chile was in a depression. In the U.S. case, a penalty rate might be preferred in order to ensure that the banks will use the facility only as a last resort.

It took several years for Chile to recover from its banking crisis and the U.S. will also need time to work off its credit mania. Federal assistance may be required. But that doesn't mean that we need to hand a blank check to the government that will allow it to expand its powers yet again.

A Main Street Rescue

Congress passed this 'bailout' a long time ago.

The $700 billion financial rescue that Congress votes on today must surely rank as the least popular legislation in modern times. Most Members want it to pass, though not with their vote after it has been trashed so relentlessly in the press as a Wall Street "bailout." And yet it deserves to pass because in reality it is an attempt to shield middle America from further harm caused by the mistakes of Wall Street and Washington.

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From left: Nancy Pelosi, Henry Paulson and Harry Reid.

For 13 months, the U.S. economy has held up remarkably well despite the implosion in financial markets. But that has recently changed, as market strains have become a global panic that threatens to trigger a deep recession and perhaps a crash. It is hard to sell voters on insurance against damage that hasn't occurred. (See Fannie Mae, 30-year history of.) But as Michael Darda argues, the current seizure in the credit markets is real and will do far more harm if not repaired soon. The weekend runs on Fortis in Europe and Wachovia in the U.S. should concentrate Congressional minds about what could happen if the bill fails.

Today's vote is essentially a pledge of public capital to defend and rebuild the financial system. Some of that capital has already been committed via the Federal Reserve, albeit with politicians preferring not to notice. With this vote, Congress is at last taking some ownership for the mess its policies helped to create by fueling the credit housing mania earlier this decade.

Congress long ago committed taxpayers when it let Fannie Mae and Freddie Mac run wild risks with a public subsidy. It's a little rich to see some of Fannie's most devoted GOP patrons now invoking "free-market" principles to oppose cleaning up their mess. More than one Republican opponent also seems to be angling for a leadership challenge next year, even at the risk of causing a bigger GOP defeat if the bill fails.

Background on a Crisis

• 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.

We agree with those who say there are better ways to provide this public capital, but Treasury Secretary Hank Paulson's plan should do some good, and if executed properly shouldn't cost taxpayers anything close to its $700 billion showroom price.

The minute he gets his money, Mr. Paulson should seek a prominent financial pro to supervise the auctions for dodgy mortgage securities -- someone who isn't out to make a killing himself (as is Bill Gross of Pimco). If Mr. Paulson fails to do so, he or his successor will be whipsawed on Capitol Hill as the Members fly-speck every transaction. There was never any danger of too little "oversight"; the real danger is too much political interference that blocks the rapid creation of a market for this paper.

Thanks to the House GOP's intervention, the Paulson plan is also better than it would have been. Republicans helped to eliminate the Barney Frank-Chris Dodd slush fund for liberal housing lobbies; a plank to let judges shield deadbeat homeowners from bankruptcy laws; and a ploy to stack bank boards with union members.

The details of the taxpayer "protections" in the bill also seem workable, at least based on what we had heard by deadline yesterday evening. Banks that sell more than $300 million in securities to Treasury will only be able to deduct from their taxes $500,000 in compensation for their five most senior executives.

Something like this was inevitable as political cover, and it's hard to argue that the Italian suits at Goldman Sachs or Morgan Stanley don't deserve everything they won't get if they dump their mistakes on the feds. But one unintended consequence will be to drive the most talented financial managers away from these banks and into hedge funds and private equity, where they won't be subject to such compensation caps. Revenge is overrated as a policy design.

We're also told the government ownership provisions in the bill are narrow enough not to ruin the securities auctions. The government will get warrants to benefit from any market upside in return for buying the securities, and this will probably be reflected in the price the feds pay for the debt. Our Treasury sources say the warrant provision is de minimis enough that it shouldn't interfere with price discovery, which is one of the major goals of this exercise.

Even if the Paulson plan passes today, more public capital will be needed to protect depositors at banks that fail -- and there will be more such failures. Done right, the Paulson plan should at least reduce the number, while also lessening the damage from the mortgage mania that Congress did so much to promote.

Calling J.P. Morgan

He was more effective than Paulson and Bernanke combined.

• L. GORDON CROVITZ

In the fall of 1907, it took J.P. Morgan just eight weeks to resolve a credit crisis similar to ours. Several years of buoyant growth and too much risk-taking in poorly understood investments led to needs for capital that could not be met. Morgan, then 70, locked the nation's top bankers into the ornate library at his home for late-night confession sessions. He asked them to lay bare their balance sheets, keeping himself alert with endless Havana cigars.

Corbis

The bankers reviewed one another's assets and liabilities. Morgan then decided which financial institutions had to go and which would live, getting commitments from the survivors and from the U.S. Treasury for infusions of capital. This Panic of 1907 had rattled the New York Stock Exchange and the markets for gold and municipal bonds, ruined several banks and trust companies, and nearly bankrupted New York City. Share prices fell by half. But once Morgan was done knocking banking heads together, markets swiftly recovered.

In other words, Morgan was more effective in his day than the combination of Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke have been in ours. We're now well over a year into this credit crisis. One big difference is that each of the bankers in Morgan's smoke-filled room actually knew the details of his bank's respective assets and liabilities. Today, financial instruments are so complex that banks are still trying to unravel the different pieces of mortgage-related securities.

"J.P. Morgan and his men had direct access to the books of nearly every troubled institution, enabling them to fairly appraise their value," wrote Robert Bruner and Sean Carr, authors of "The Panic of 1907," in Newsday. Now, "despite mandated regulatory reporting, it is difficult, if not impossible, for financial decision-makers to know with clarity what is going on."

As sophisticated as we are now, with hundreds of categories of debt available on a single trading screen, in some ways more information about assets and liabilities was available in 1907, when the workflow device for traders was a simple pencil and scrap paper. We also seem to have forgotten a basic point well known to Morgan, who would have recalled the panics of 1837, 1857, 1873 and 1897: Until prices are established, credit panics will not end and financial firms will remain frozen. The lesson of previous credit crises is that the sooner new valuations are set for bank assets and liabilities, the sooner recovery begins.

A key holdup to getting past this crisis is the continuing unknown of the remaining value of mortgage-based securities. In Morgan's day, price discovery resulted when he went around the room seeking details of balance sheets. Today we need to achieve price discovery more actively, such as by holding auctions of the bad debt so that the market can find a new normal. Getting our arms around the scope of the bad debt would define the capital needs for banks, and there would be prices set that potential private-sector buyers of the debt could consider.

There have been few efforts to determine the true value of the mortgage-related securities. One was the 22 cents on the dollar that Merrill Lynch got in July by selling some $30 billion in supposed value of mortgage-backed derivatives for just under $7 billion. The average portfolio might be worth closer to 60 cents on the dollar, but whatever the level, once prices settle, financial recovery can begin.

The difficulty in establishing value suggests the need for more disclosure. Added transparency is a familiar goal for regulators, with the 1933 and 1934 Securities Acts based on the idea that disclosure makes for the most efficient markets, with the fewest surprises. Many of today's most mispriced financial instruments have no disclosure requirements.

Indeed, perhaps the biggest remaining unknown is the some $60 trillion of notional debt outstanding in credit-default swaps. This instrument was a smart innovation, even if there was too much of a good thing. These swaps give lenders protection from bad borrowers, thus increasing funds available for investments. But swaps are private contracts, not securities, and because they don't trade on exchanges, they are not subject to disclosure requirements. Securities and Exchange Commission Chairman Chris Cox has urged that some level of disclosure be required.

We can't stop credit crises, which inevitably occur as innovative financial instruments are periodically put to the test. As we're now painfully reminded, trial and error is a tough system, but it's also the only system known to markets. We're not powerless, however. We can make it easier to resolve future panics with a more transparent investing environment. More disclosure, to match the complexity of evolving financial instruments, would at least make the next credit crisis less of a surprise and ultimately more manageable.

Wall Street bail-out goes to vote

President Bush says he expects the bill to be passed unopposed.

The US Congress is preparing to vote on a $700bn (£380bn) deal to bail out Wall Street and end the credit crunch.

President Bush has urged the House of Representatives to pass the bill and send a strong signal to the markets.

He said the deal was a "bold" one which he was confident would restore strength and confidence to the US economy.

However, he cautioned that the bail-out would not answer all the economic woes and said that difficulties would last "for some time".

Speaking at the White House President Bush said: "I'm confident that this rescue plan, along with other measures taken by the Treasury Department and the Federal Reserve, will begin to restore strength and stability to America's financial system and overall economy."

But the agreement has done little to calm global stock markets, which have fallen sharply.

Financial services firms were still in trouble, with Benelux giant Fortis bailed out by three governments and the UK's B&B bank nationalised on Monday.

Every American has an interest in fixing this crisis - inaction would paralyse the economy Harry Reid Senate majority leader Announcement in quotes Santander to buy parts of B&B Q&A: Bail-out plan

"No one is taking any chances and we must wait until the vote to confirm [the bail-out deal] has passed," said Joshua Raymond of City Index.

The House of Representatives is expected will vote on the package later. The fiercest resistance to the bail-out came from Republican politicians in the House, who scuppered an earlier outline deal agreed last Thursday.

Leaders of the US Senate are planning to put the the bail-out to a vote on Wednesday.

If approved by the Senate and House, the revised plan will lead to the biggest intervention in the markets since the Great Depression in the 1930s.

Political timetable

READ THE BAIL-OUT BILL Emergency Economic Stabilization Act[189KB] Most computers will open this document automatically, but you may need Adobe Reader Download the reader here

Time is of the essence, not only to end the log-jam in financial markets, but also because of the election timetable in the United States.

US Congress was supposed to go into recess last Friday, and with presidential and congressional elections in early November, politicians are keen to hit the campaign trail with a resolution to the crisis under their belt.

The two candidates for the presidency, Democrat Barack Obama and Republican John McCain, gave their cautious support for the proposed legislation.

The original bail-out package proposed by the US administration was deeply unpopular with many Americans.

During a weekend of negotiations, numerous clauses were added to the Emergency Economic Stabilization Act of 2008, designed to reassure taxpayers.

Nancy Pelosi, the Democratic Speaker of the House of Representatives, said the agreement was "not a bailout of Wall Street", but designed to ensure pensions, savings and jobs would be safe.

Democratic Senate leader Harry Reid said the deal was a big improvement on the initial proposal.

"They wanted a blank cheque and we couldn't give them one... Now we have to get the votes."

No golden parachutes

The deal addresses several of the key concerns raised by both Democrats and Republicans:

• The government will get the money in tranches - $250bn straight away, and $100bn at the request of the White House; Congress can veto the release of the remaining $350bn
• Banks that accept bail-out money will have to hand over shares in return, which allows tax payers to benefit from the banks' recovery
• Top bankers, meanwhile, will see their pay limited, and "golden parachutes" - huge payments when they leave the firm - will be banned
• The banking industry will have to help finance the bail-out if the money can not be recovered from the struggling banks themselves
• Four agencies will monitor the deal, including an independent Inspector General and a bipartisan oversight board
• Banks will be obliged to join an insurance programme to protect them against the losses of mortgage-backed securities

The proposed legislation was now "frozen", said Ms Pelosi, which means critics can not strike out individual provisions that they do not like.

However, several key critics of the deal called on their fellow legislators to block it.

Financial woes

The Bush administration submitted its initial proposal after several financial institutions got into trouble - unable to free up the money to keep their daily business going.

The liquidity problems have not been limited to the US.

• In the UK mortgage lender Bradford & Bingley was nationalised on Monday morning, with the savings part of the business to be sold to Spanish banking group Santander
• The governments of Belgium, Luxembourg and the Netherlands agreed to invest 11.2bn euro in huge financial services group Fortis, in effect nationalising it.
• Last week, in what was the largest US banking failure, Washington Mutual was taken over by regulators and sold on to JPMorgan Chase
• Lehman Brothers collapsed, Merrill Lynch sought refuge in a takeover by Bank of America, and Morgan Stanley secured a large capital injection from a Japanese rival
• US insurance giant AIG had to be bailed out by the US government, which in effect took an 80% stake in the firm, while mortgage giants Freddie Mac and Fannie Mae were nationalised.

Money-Market Rates Jump as Bank Rescues Stoke Lending Concern

Sept. 29 (Bloomberg) -- The cost of borrowing in euros for three months rose to a record after government-led bank bailouts heightened concern that more will fail, prompting financial institutions to hoard cash.

The euro interbank offered rate, or Euribor, climbed 10 basis points to 5.24 percent, the European Banking Federation said today. That's the biggest jump since June. The London interbank offered rate, or Libor, for three-month dollar loans rose to 3.88 percent, the highest level since Jan. 18 and up from 2.81 percent a month ago. Singapore's benchmark rate for such loans increased to the highest level in eight months.

Rising rates show central-bank attempts to breathe life back into money markets haven't succeeded, even after U.S. lawmakers agreed on a $700 billion plan to remove tainted assets from bank balance sheets. The ECB said today it will make additional funds available to banks through the end of the year in ``special'' auctions. The central banks of Japan and Australia added more than $20 billion to money markets.

``The root of the banking story is in the money markets, which are still in awful shape,'' said Padhraic Garvey, the Amsterdam-based head of investment-grade debt strategy at ING Bank NV. ``Banks are dealing with central banks for liquidity purposes, but are very careful about dealing with one another in this environment, which effectively means that the interbank wholesale- money market is not working.''

The U.K. Treasury seized Bradford & Bingley, Britain's biggest lender to landlords, while governments in Belgium, the Netherlands and Luxembourg extended an 11.2 billion-euro ($16.3 billion) lifeline to Fortis, Belgium's largest financial-services firm. Hypo Real Estate Holding AG, Germany's second-biggest commercial-property lender, received a 35 billion-euro loan guarantee from the state to fend of insolvency.

`More Victims'

``Tensions remain elevated and liquidity is drying up,'' said Patrick Jacq, a fixed-income strategist at BNP Paribas SA in Paris. ``After Fortis, this situation will persist as people worry that there will be more victims. Confidence has not been restored yet and that's a prerequisite before rates come down.''

The Libor-OIS spread, the difference between the three-month dollar rate and the overnight indexed swap rate, jumped to a record 219 basis points today, after breaching 200 for the first time on Sept. 25. It averaged 8 basis points in the 12 months to July 31, 2007, before the credit squeeze began.

Funding is typically tighter at the end of quarters as companies try to settle trades and buttress their balance sheets.

The world's largest central banks are injecting liquidity into money markets as more than $554 billion in writedowns and losses tied to the U.S. mortgage market prompt banks to stockpile cash to meet their own funding needs.

Extra ECB Cash

The ECB said it will loan banks extra cash today for about five weeks. ``The special term refinancing operation will be renewed at least until beyond the end of the year,'' it said in a statement. The ECB also lent banks $30 billion for one day in a separate operation.

Banks deposited a record 28.1 billion euros with the ECB on Sept. 26 as they sought a haven for their cash, the central bank said today.

The difference between what banks and the U.S. Treasury pay to borrow money for three months, the so-called TED spread, was at 303 basis points today. It rose last week to the most since Bloomberg began compiling the data in 1984. It was 110 basis points a month ago.

Singapore's three-month interbank offered rate for U.S. dollars, or Sibor, increased for a third day, adding 1 basis point to an eight-month high of 3.79 percent, according to the Association of Banks in Singapore. In Hong Kong, the three-month Hibor rose 9 basis points to 3.49 percent, the Association of Banks in Hong Kong said.

Paulson Must Make $700 Billion Rescue for Banks Work (Update1)

Sept. 29 (Bloomberg) -- Treasury Secretary Henry Paulson and congressional Democrats hammered out a consensus on spending up to $700 billion to rescue the financial industry. There isn't consensus on whether it would work.

Lawmakers reached agreement yesterday as House Republican leaders backed away from opposition to the proposal after it included plans to create insurance for mortgage-backed securities. The House and Senate are scheduled to vote on the bill early this week, although it wasn't clear last night that it has sufficient votes to pass the House.

Giving the Treasury authority to buy so many distressed securities from lenders is without precedent, and it's unclear how the government will pay prices that strike a balance between protecting taxpayers and preventing more bank failures.

``This has a reasonable chance of pulling back from the brink and having some success, but it's far from certain that will be the case,'' said former Fed Governor Laurence Meyer, now vice chairman of consultant Macroeconomic Advisers LLC in Washington.

Stocks tumbled around the world after the worsening credit crisis threatened to topple more banks. In Europe, governments have been forced to rescue Fortis, Belgium's largest financial- services company, and three other institutions in the past two days alone.

Market Drop

The region's Dow Jones Stoxx 600 Index dropped 3.5 percent and futures on the Standard & Poor's 500 Index declined 1.8 percent. While the dollar strengthened against the euro and the pound, the cost of borrowing the U.S. currency for three months rose to 3.88 percent, the highest level since January. That's up from 2.81 percent a month ago.

``You're not resolving the two fundamental issues: You still have to recapitalize the banking system, and household debt is going to stay high,'' said Nouriel Roubini, chairman of Roubini Global Economics and economics professor at New York University.

The bill gives Paulson $250 billion at the start to buy assets, increasing the amount to $350 billion upon ``written certification'' from the president that the secretary is ``exercising the authority'' to buy assets. The Treasury chief, or whoever succeeds him, may use the remaining $350 billion if Congress fails to reject a request for it within 15 days.

Buying Assets

The proposed law lets Paulson buy assets ``at the lowest price that the Secretary determines to be consistent with the purposes of this Act.'' The bill doesn't require any specific method for the purchases beyond saying mechanisms such as auctions or reverse auctions should be used ``when appropriate.'' Treasury officials declined to discuss how the plan will be implemented.

Democratic and Republican leaders trust that Paulson can avert a collapse after Lehman Brothers Holdings Inc. filed for bankruptcy and the government was forced to take over American International Group Inc. Success hinges on whether he can help banks raise capital after $556 billion in writedowns and losses, and get credit flowing through the economy.

``We have clearly seen a run of failures of financial institutions not like anything we've seen since the Great Depression,'' House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, told reporters yesterday. ``If we didn't do this, there would be far worse pain in the sense of the lending freezing up.''

`Fragile Situation'

The plan, which foreign banks with U.S. operations can also tap, failed to staunch concerns across global markets about the health of the banking system. Governments have been forced to rescue Belgium's Fortis, Iceland's Glitnir Bank hf, U.K. mortgage lender Bradford & Bingley Plc and Germany's Hypo Real Estate Holding AG in the past two days.

``It's a fragile situation,'' Paulson said in an interview on CBS television's ``60 Minutes'' program broadcast yesterday. ``It's gotta do it, and we're going to make this work.''

The draft legislation was posted on the House Financial Services Committee's Web site yesterday. It includes a provision to give taxpayers equity stakes in the companies that benefit from the plan.

The bill has a section aimed at limiting the pay of executives at companies that take advantage of assistance by prohibiting tax deductions for officials that exceed $500,000, which is half the normal deductible limit. It also allows ``clawbacks'' of money already paid to executives at troubled companies and forbids so-called golden parachutes.

Community Banks

The legislation takes steps to let some 800 community banks that held preferred stock in Fannie Mae and Freddie Mac before the mortgage giants were taken over by the federal government on Sept. 7, make better use of losses for tax purposes than they would otherwise be allowed.

House Republicans offered early resistance to the Paulson plan. They complained that it put the country on the road to socialism and instead argued that elimination of the capital gains tax would spur a wave of investment that would render the bailout plan unnecessary.

House Minority Leader John Boehner of Ohio commissioned Virginia Representative Eric Cantor to draft a rival plan without telling Democrats or Paulson. The plan, which depended on self-funded insurance premiums, was abandoned after Democrats lashed out at Republicans at a White House meeting Sept. 25.

Limited Insurance

Ultimately, Republicans got none of the tax breaks they sought, though the bill includes a limited self-funded insurance program for companies that benefit from the bailout. Last night Boehner, the top House Republican, urged his colleagues to support the bailout plan.

Some House Republicans, such as Representative Mike Pence of Indiana, are still holding out. ``We now have a deal that promises to bring near-term stability to our financial turmoil, but at what price?'' Pence said in a letter to colleagues.

Pence called the plan ``the largest corporate bailout in American history'' and that it would ``nationalize almost every bad mortgage in America.''

Paulson, the 62-year-old former Goldman Sachs Group Inc. chairman, said such a strategy is necessary to stabilize financial markets. ``We will have turbulence and turmoil in our financial system for some time, but I believe that this is going to work,'' he said on ``60 Minutes.''

`Some Doubts'

Yet as members of Congress and their staffs worked late nights over the past week negotiating and writing compromise legislation, money markets failed to improve. ``It just raised some doubts in my mind whether this was going to be sufficient,'' said Meyer, who was on the Fed board when the Asian financial crisis struck in 1997.

Should the plan fail, ``there may have to be a more substantial participation by the federal government to buy mortgages,'' Frank said last night. Any alternative proposal would involve ``significant purchases directly of the foreclosed mortgages.''

Paulson and Federal Reserve Chairman Ben S. Bernanke, who will be on a five-member oversight board for the program, have signaled that their priority is shoring up the nation's banks even if it means they don't get taxpayers the cheapest prices for the devalued assets the government buys.

The proposal also sets the stage for an overhaul of financial regulation next year, something Frank is already planning. The draft bill requires the Treasury secretary to report to Congress and make recommendations by April 30 on whether to regulate additional participants in the financial markets.

``It'll give us some temporary respite from the earlier pressures,'' said Joseph Mason, a Louisiana State University finance professor who formerly worked in the bank-research division of the Office of the Comptroller of the Currency. ``If we don't use that respite to design more permanent policy, we will find ourselves back in the same place.''

Stocks in Europe, Asia, U.S. Index Futures Slump; Dexia Falls

Sept. 29 (Bloomberg) -- Stocks tumbled in Europe and Asia and U.S. index futures retreated as bank bailouts accelerated and the $700 billion plan to rescue American financial institutions failed to unlock money markets.

Dexia SA sank 28 percent after the governments of Belgium, the Netherlands and Luxembourg were forced to rescue Fortis and the U.K. seized Bradford & Bingley Plc. Hypo Real Estate Holding AG slumped 70 percent as the German government and a group of private banks provided a 35 billion-euro ($50 billion) guarantee for the commercial-property lender. Westpac Banking Corp. of Australia slid 3.5 percent. Wachovia Corp. declined 56 percent on increasing speculation the sixth-largest U.S. bank by assets may be forced to seek a buyer or mortgage partner.

Europe's Dow Jones Stoxx 600 Index lost 3.2 percent to 257.45 at 12:40 p.m. in London. Futures on the Standard & Poor's 500 Index dropped 1.6 percent following the measure's steepest weekly slump since May. The MSCI Asia Pacific Index slid 2.7 percent today.

``There's more pain to come,'' said Andy Lynch, who manages about $3 billion at Schroder Investment Management Ltd. in London. ``People knew the bailout was going to happen. Now it's back to the same-old, same-old of capital writedowns and weekend bailouts. Earnings estimates for next year still are too high.''

Credit losses at UBS AG, along with profit declines at technology companies such as Ericsson AB, helped send earnings lower at 153 of the 332 members of the Stoxx 600 tracked by Bloomberg that reported quarterly results since the beginning of July. More than 40 percent of the Stoxx 600's companies trailed Wall Street's estimates, Bloomberg data show.

Credit Losses

The MSCI World Index is down 23 percent this year as banks worldwide racked up more than $554 billion in credit losses and writedowns, pushing the global economy toward a recession.

National benchmark indexes fell in all of the 18 western European markets. The U.K.'s FTSE 100 sank 3.5 percent, while France's CAC 40 lost 3.1 percent. Germany's DAX slid 2.9 percent as Commerzbank AG and Siemens AG also declined. Luxembourg's LuxX plunged 8.3 percent, led by Fortis and Dexia, the steepest drop today among benchmark gauges worldwide tracked by Bloomberg.

The cost of borrowing in euros for three months soared to a record after the bailouts deepened concern more financial institutions will collapse, prompting banks to hoard cash. The euro interbank offered rate, or Euribor, rose 10 basis points to 5.24 percent, the biggest jump since June, the European Banking Federation said today.

Volatility Rises

The VStoxx benchmark index for European options, which measures the cost of using options as insurance against declines in the Euro Stoxx 50 Index, rallied to an eight-month high.

U.S. lawmakers reached agreement yesterday as House Republican leaders backed away from opposition to the bank rescue proposal after it included plans to create insurance for mortgage-backed securities. The House and Senate are scheduled to vote on the bill early this week, although it wasn't clear last night that it has sufficient votes to pass the House.

European confidence in the economic outlook fell to the lowest since the slump in the wake of the Sept. 11 terrorist attacks. An index of executive and consumer sentiment dropped to 87.7 in September from 88.5 in August, the European Commission in Brussels said.

The British pound declined the most against the dollar in 15 years and the euro weakened. The currencies also retreated versus the Japanese yen.

`Not Over'

Fortis lost 10 percent to 4.68 euros after the company received a bailout of 11.2 billion euros. Belgium will buy 49 percent of Fortis's Belgian banking unit for 4.7 billion euros, while the Netherlands will pay 4 billion euros for a similar stake in the Dutch banking business, the governments said. Luxembourg will provide a 2.5 billion-euro loan convertible into 49 percent of Fortis's banking division in that country.

``The banking crisis is not over,'' said Jacques Porta, who helps manage $180 million at Ofivalmo Patrimoine in Paris. ``Look at Fortis today, we are not sure other banks in Europe are not going to have the same problems. The problem is even if we have the good news with the Paulson plan, investors think it is not enough to stop all this mess.''

Dexia plunged 28 percent to 7.25 euros. The company may soon announce a plan to raise capital in a bid to reassure markets, Le Figaro newspaper, said without citing anyone. Dexia spokeswoman Ulrike Pommee told Bloomberg News the bank held a board meeting last night to discuss Fortis and the financial crisis. She declined to comment on the report the bank may raise capital.

Hypo Real Estate

Bradford & Bingley, the U.K.'s largest lender to landlords, was seized by the government after the credit crisis shut off funding and competitors refused to buy mortgage loans that customers are struggling to repay.

Banco Santander SA, Spain's biggest lender, will pay 612 million pounds ($1.1 billion) to buy Bradford & Bingley branches and deposits, the U.K. Treasury said today. Santander shares declined 3 percent to 10.59 euros.

Hypo Real Estate slumped 70 percent to 4 euros. The German government and a group of private banks will provide a guarantee to rescue the bank from insolvency. The country's second-largest commercial-property lender earlier said it expects to scrap a 2008 dividend payment after securing a ``multi-billion-euro'' credit line to shield itself from turmoil on financial markets.

Commerzbank, Germany's second-biggest bank by assets, sank 18 percent to 11.77 euros even after saying its funding is secure. Westpac, Australia's third-largest bank, declined 3.5 percent to A$23.15.

Wachovia

Wachovia slid 56 percent to $4.40 in trading before the market opened. Three days after Chief Executive Officer Robert Steel told employees Wachovia was ``strong and performing well,'' the Wall Street Journal said the Charlotte, North Carolina-based bank was in advanced takeover talks with Wells Fargo & Co. Citigroup Inc. also may make a bid, the newspaper reported.

Iceland agreed to buy 75 percent of Glitnir Bank hf for 600 million euros in a government bailout of the nation's third- largest bank, as the global credit crisis extends to the Atlantic island. The stock was suspended from trading.

Basic-resource shares retreated as metal prices dropped in London. BHP Billiton Ltd., the world's biggest mining company, lost 7.2 percent to 1,270 pence. Rio Tinto Group, the second- largest iron-ore exporter, retreated 6.2 percent to 3,475 pence. Copper, lead, nickel and tin prices sank.

Renault SA, France's second-biggest carmaker, fell 3.5 percent to 45.67 euros after Credit Suisse Group AG downgraded the shares to ``underperform'' from ``outperform.''

Siemens AG lost 2.4 percent to 65.18 euros. Europe's largest engineering company may face a ``certain slowdown'' in the growth of its orders in the coming months as the economy falters, Les Echos reported, citing CEO Peter Loescher.

Akzo Nobel NV sank 9.6 percent to 32.08 euros. The world's biggest maker of paints postponed a plan to repurchase 1.6 billion euros of its stock, as debt repayments loom.