Money Talks.(The Talk of the Town)

In the latest episode of the financial drama "Credit Crunch," the President, the Presidential candidates, and congressional leaders from both parties gather in the White House to agree on a seven-hundred-billion-dollar bailout for the very financial firms whose greed and recklessness created the crisis. George W. Bush, perched between Senate Majority Leader Harry Reid and House Speaker Nancy Pelosi, is wearing a grim expression. Barack Obama also looks grave, but John McCain, who pretended to "suspend" his campaign before rushing back to Washington to help "solve" the crisis, is grinning broadly. Off camera, House Republican Leader John Boehner is threatening to sink the deal.

As political theatre ("If money isn't loosened up, this sucker could go down," Bush declared at one point in the White House meeting, according to the Times), the wrangling over the Wall Street rescue package is engrossing. As an exercise in crisis management, it is potentially disastrous--and, to the rest of the world, dumbfounding. Willem Buiter, an economist at the London School of Economics, who has served on the Bank of England's policymaking committee, said in a blog entry last Thursday that unless Congress acts now "the freeze of the financial wholesale markets will intensify and the attacks on financial institutions will resume, first in the U.S., then in the U.K., then in the rest of Europe and soon after everywhere in the financially connected world. . . . Instead of a mere recession, there will be a long and deep depression."

Some experts dispute the Bush-Buiter analysis. One school argues that the financial system is a mere "veil" wrapped around the rest of the economy. Strip it away and other business activities--the development and marketing of new products; families buying clothes and going out for meals--will go on unabated. If a bank that was performing a valuable function fails, another will spring up in its place.

Boehner and his Republican colleagues, to judge from their attempts to block the bailout--which coincided with the failure of Washington Mutual, the biggest banking collapse in U.S. history--were apparently intent on organizing a natural experiment to test the veil theory. But they neglected to point out that their get-tough approach has been tried twice before: in the period from 1929-32, when Treasury Secretary Andrew Mellon's advice to bankers burdened with bad loans was "liquidate, liquidate"; and just a few weeks ago, when Mellon's successor Henry Paulson and Federal Reserve chairman Ben Bernanke chose to let Lehman Brothers go bankrupt.

In the first instance, what followed was the Great Depression. In the second, it was outright panic in the markets. The cost of overnight borrowing jumped sharply, and the stocks of other financial firms, including Paulson's former employer, Goldman Sachs, plummeted. Worried that the entire financial system was about to break down, Paulson and Bernanke embarked on an embarrassing reversal, first agreeing to lend eighty-five billion dollars to A.I.G., the giant insurance company, then launching their controversial mortgage-purchase plan.

They had little choice. The big banks are so interconnected, and so important to the economy, that they can hold it ransom. A responsible government has to shore up a system in crisis using public money. The only question is on what terms this should be done. Paulson's first proposal was suspiciously vague and scandalously arrogant. In addition to requesting authority from Congress for the Treasury to spend seven hundred billion dollars--about five per cent of the value of all home loans outstanding--on "mortgage-related assets," the draft legislation he circulated said that the Treasury Secretary's actions "may not be reviewed by any court of law or any administrative agency." After protests from all sides, ...