Models for What the US is Trying to Accomplish are Already Out There - Use Them

The are models out there for what the US is trying to accomplish with the bail-out program. We should use them. Text in bold is my emphasis. From the WSJ:

Talk about your role reversals. In the past few weeks, officials at the Federal Reserve have discussed the unfolding crisis with at least one central banker from a developing nation who witnessed his own country's financial system implode: Mexico's Guillermo Ortiz.

The Stanford graduate was Mexico's finance minister during the country's 1994-95 peso collapse, which led to a massive government bank bailout and Mexico's biggest economic slump since the Great Depression.

The so-called Tequila Crisis, named after Mexico's national drink, is today seen as the first financial crisis of the globalized economy. The U.S. put together a massive credit line that helped Mexico emerge from the crisis and grow prosperous in its wake.

Last week, before the start of the International Monetary Fund's annual meeting, the Mexican central banker, who steered his nation to recovery in those dark days, met with Fed Chairman Ben Bernanke. Mr. Ortiz had previously met with some Fed officials in mid-September.

Mr. Ortiz declined to discuss details of the discussions, but the fact that officials in Washington are talking to foreign officials such as Mr. Ortiz suggests they are open to learning from other countries' experiences -- even as the current crisis roils those very nations. Mexico, for its part, has had to spend about a tenth of its foreign exchange reserves defending the peso, and the cost of credit is soaring for Mexican companies, as it is for so many others.

Nonetheless, many of the lessons of the Tequila Crisis and others like it apply to the U.S. Among the most important: Don't be ruled by ideology -- stay flexible and act decisively. Help those with mortgages they can't pay. Take stakes in troubled banks. Don't expect to turn a profit on government investment.

"Do whatever it takes to restore confidence," Mr. Ortiz said in an interview. "Once you lose it, it's very difficult to get it back."

In today's globalized financial markets, once trust is blown, the markets will often overreact and the crisis will spin out of control. As a result, policy makers may need to take steps they never imagined taking. The longer they wait, the worse the pain. We are already learning this lesson the hard way.

In nearly all financial crises, the government usually reacts too slowly at first. In the case of the U.S., the Federal Reserve and Treasury tried to put out each fire as it flared, first bailing out Bear Stearns, then insurance giant AIG, then lender Washington Mutual.

At some point, an event happens that causes the market to lose confidence. In Mexico, it was a failed attempt by the central bank to gradually devalue the peso, a move that destroyed the bank's credibility. In the U.S., it may have been letting Lehman Brothers Holdings Inc. fail, a move that created uncertainty among investors as to which financial institutions would be saved and which wouldn't.

Since then, authorities in both the U.S. and Europe have been scrambling to catch up to the crisis. "Despite all of the measures that have been taken, the authorities are now behind the curve ," Mr. Ortiz said in remarks Sunday to the Institute of International Finance in Washington. "It's better to err on the side of doing too much rather than doing too little."

In the end, Mexico acted directly to tackle the underlying problem of bad debt by launching a program to restructure mortgages, with banks, borrowers and the government all sharing loses.

The key to a mortgage restructuring: "Keep it simple," says Vicente Corta, who led Mexico's bank bailout program for several years. "We tried fancy schemes that didn't work. We ended up saying, 'OK, you pay half your mortgage, and we'll pick up the other half.' "

Mexico's bank bailout itself didn't ward off a major economic recession, although the country was also dealing with a currency crash. But within a few years, Mexican banks were healthy and the economy was growing again.

What lasted longer was political bitterness linked to the bailout, which was seen as having helped rich bankers at taxpayers' expense.

The Mexican and U.S. bank rescue plans have both involved the government taking bad loans from bank books in order to get credit flowing again. Much like Washington, the Mexican government expected to break even and possibly make some money on the bad loans that it purchased.

The reality: The government lost money -- lots of it. The bailout's final price tag of about $75 billion was three times what the Mexican government expected. In other words, the $700 billion U.S. rescue plan could be just the beginning of the final cost.

In Mexico's bailout, banks were required to recapitalize as a condition of selling bad loans to the government. In some cases, bank owners put up new money. Banks that couldn't were forced to merge or sell to a foreign bank, or were taken over by the government.

In recent days, the U.S. government has appeared to be moving toward a major recapitalization program, opening the door to the possibility that the U.S. government might take direct stakes in the banks.

A government stake in banks might help ease the inevitable political fallout. Mexico learned -- again, the hard way -- the importance of designing a bailout that gives the government, and by extension the taxpayers, some upside in an eventual recovery. Consider the case of Banamex, Mexico's biggest bank.

Banamex's owners recapitalized the bank and sold billions of dollars in bad loans to the government -- which didn't take a stake in the bank. Once healthy, the bank was later sold to Citigroup for $12 billion, in a transaction in which Banamex's owners didn't pay a dime in taxes.

In Mexico, many voters felt betrayed by the bailout, which poisoned the political atmosphere for years. It was one reason why a left-wing populist candidate, Andrés Manuel Lopez Obrador, nearly won the presidency in 2006. Every year at budget time, there are still debates about spending so much money on rescuing banks, versus public schools.

Whoever wins the U.S. presidential election is bound to deal with other political fallout as well. The auto industry is already using the financial bailout to win a big loan program in Congress; expect other troubled industries to line up for rescues, too. And every time an industry gets bailed out, ordinary workers and powerful unions will expect help as well.