Paulson's Plan.(The Talk of the Town)(Hank Paulson)

In late October, 1907, the American financial system appeared to be on the verge of collapse. The trouble had begun with a seemingly minor event--a failed attempt at stock-market speculation by a bank owner named F. A. Heinze--but it spread quickly after news of Heinze's losses prompted a run on his banks by worried depositors. In a matter of days, financial institutions with connections to Heinze were facing similar withdrawal frenzies, and the stock market was falling precipitously. Amid the turmoil, the financier J. P. Morgan stepped in. Consulting with the Treasury Department, which committed millions in deposits to weak banks, Morgan browbeat bankers into bailing out struggling institutions, funnelled money to cash-starved brokers, and even convinced clergymen in New York City to dedicate their Sunday sermons to the need for "calmness and confidence." Within a few weeks, the fear and chaos had subsided, and the "panic of 1907" left only a small dent in the U.S. economy.

A hundred years later, in the midst of what you might call the panic of 2007, many investors are hoping that a Morgan-style rescue plan will have similarly beneficial effects. The plan, which was unveiled last Thursday, after weeks of orchestration by Treasury Secretary Henry Paulson, seeks to stabilize the chaotic subprime-loan market by freezing the interest rates of some borrowers. Although Paulson works for the government, his scheme involves no action by the state. Instead, he has relied, much as Morgan did, on collective suasion, assembling representatives of the many parties involved--mortgage lenders and servicers, investors who bought mortgage bonds, and borrowers--and pushing them toward a solution that, in theory, will leave the economy better off.

The plan targets a looming crisis. Many subprime mortgages came with so-called teaser rates--interest rates that start out low but quickly reset to become significantly higher. Many of those loans--more than three hundred and fifty billion dollars' worth, in fact--are going to reset next year. That means that hundreds of thousands of people who are currently able to pay their mortgages are about to see their payments rise by hundreds of dollars a month. If the credit and housing markets were more buoyant, these people might be able to refinance their loans or sell their homes. But the sharp decline in housing prices and the tightening of credit standards has closed off those options for most subprime borrowers, which pretty much guarantees a big increase in the number of foreclosures. The Paulson plan is meant to buy borrowers--and, arguably, the economy--some time, by postponing the interest-rate resets for five years.

Not for everyone, though. The plan sets up a system of triage, separating borrowers into three categories: those who will be able to keep paying after the rates reset, or else refinance their ...