The government must take drastic action to avoid "the mother of all credit contractions," argued former Treasury Secretary Nicholas Brady, former Controller of the Currency Eugene Ludwig, and Reagan-era Federal Reserve Chairman Paul Volcker.
The economists wrote their views days before Treasury Secretary Henry Paulson announced a sweeping plan to bail out the remaining investment banks on Wall Street and to shore up financial markets.
"Until there is a new mechanism in place to remove this decaying tissue from the system, the infection will spread, confidence will deteriorate further, and we will have to live through the mother of all credit contractions," they wrote in a joint editorial in The New York Times.
"This contraction will undercut the financial system, and with it, the broader economy that so far has held up reasonably well."
According to the three experts, huge amounts of toxic real estate paper — backed by defaulting loans and unable to support large amounts of highly leveraged structured financial products — are clogging the financial system.
Only an entity like the Resolution Trust Corp. (RTC) accomplish this, they wrote. The RTC liquidated over $400 billion of assets from over 700 defunct savings & loans in the late 1980s and early 1990s.
Sen. Richard Shelby, the senior Republican on the Senate Banking Committee, said in a television interview that the Paulson plan would cost $500 billion to fund and perhaps as much as $1 trillion.
The new entity, the trio admits, will need "serious money" in the short term and will risk taxpayers' money. But, run by professional management, it could ultimately make money for taxpayers.
Doing nothing is more risky, the economists warned. The financial contagion could spread to the entire economy, producing "incalculable" damage, they stated.
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