Sept. 19, 2008— -- The Bush administration has decided that the country's financial crisis is too big and too urgent to fight piecemeal and is working on a massive government bailout that could cost taxpayers as much as $1 trillion.
News of the plan provided a major boost to Wall Street today: The Dow Jones industrial average closed more than 380 points higher at just above 11,400. It marked the second consecutive three-digit rally for the Dow, which now stands at roughly the same level it closed at last week, before the bankruptcy of the brokerage firm Lehman Brothers and other financial sector news battered the markets.
The rescue plan would have Uncle Sam purchase virtually worthless mortgage-backed investments that have been plaguing Wall Street and the U.S. economy for months.
Details are still being worked out by the administration and congressional leaders of both parties. Officials are expected to work through the weekend to finalize a plan.
While the taxpayer cost of such a bailout isn't yet clear, this could be the biggest government market intervention since the Great Depression and is reminiscent of the Savings and Loan bailout of the 1980s. That bailout ended up costing taxpayers $123.8 billion, according to the Federal Deposit Insurance Corporation.
President Bush said that "this is a pivotal moment for America's economy."
"America's economy is facing unprecedented challenges and we are responding with unprecedented action," the president said this morning from outside the Oval Office with Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke and Securities and Exchange Commission Chairman Christopher Cox at his side.
"Our system of free enterprise rests on the conviction that the federal government should interfere in the marketplace only where necessary," Bush said. "Given the precarious state of today's financial markets and their vital importance to the daily lives of the American people, government intervention is not only warranted, it is essential."
Bush urged Democrats and Republicans to work together to pass whatever laws are needed for the bailout.
"This is no time for partisanship," he said. "We must join to move urgently needed legislation as quickly as possible without adding controversial provisions that can delay action."
Earlier this morning, Paulson said the government must remove these investments which "are weighing down our financial institutions and threatening our economy."
Paulson did not put a specific price tag on this bailout.
"We're talking hundreds of billions. This needs to be big enough to make a real big difference and get at the heart of the problem.
"I am convinced that this bold approach will cost American families far less than the alternative -- a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion," Paulson added.
Financial Markets and Economy
The government today also took a couple of other steps to halt the economic slide. It temporarily banned the short selling of 799 financial companies, and put up $50 billion to back money market mutual funds to stave off a possible run on those accounts as well.
Senate Banking Committee Chairman Christopher Dodd, D-Conn., said on "Good Morning America" today that in his 28 years in Congress, this is one of worst situations he's encountered, especially when told last night "that we're literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally."
"This is about a serious a situation, as both Richard and I would say we've confronted in our collective years in Congress -- I've been here 28 years," Dodd said of Sen. Richard Shelby, R-Ala., the top Republican on the Senate Banking Committee.
Whatever the cost turns out to be, it will be astronomical.
"I figure it'll be at least a half a trillion," Shelby said when pressed on "GMA" on the size of the bailout. "But when you look at what the Federal Reserve has already done, and the extension of power to Treasury to deal with Fannie Mae and Freddie Mac, I believe we're talking about a trillion dollars."
"We know $500 billion or $1 trillion, that's a lot of money. And sooner or later it's going to visit the taxpayer. Sooner or later it's either going to be a debt charged to all of us to our children," Shelby said.
For months, traders have stayed away from the mortgage investments because it is unclear what type of mortgages they contain and how risky they are. Since nobody wants to buy them, one Wall Street firm after another has had to mark down the value of these investments to nearly zero. By doing so, they then needed to raise large amounts of cash to cover their bad bets.
One of the reasons nobody swept in to save Lehman Brothers is that they didn't want to take on the bad debt. Once the company entered bankruptcy, Barclay's offered to take over the profitable parts of the company.
If the government takes these mortgage-backed securities off the banks' hands, Wall Street firms can focus on their other, still-profitable investments without having to constantly divert profits to cover ever-growing mortgage losses.
Debt Crisis and Relief
Many questions still loom, including how this will work exactly, how much will it cost and who will manage all the new government-owned investments?
Also unresolved: How would the government set the price for the bad debt? Will members of Congress be able to act on this before heading home to their districts to campaign? And, of course, will this finally do the trick to end the crisis?
Shelby stressed the need for more information. "Is this their superplan?" he asked on "GMA."
"We want to see the details. This is not a done deal yet, but we know there's a crisis. There's stress in the financial markets," he said.
News of this comprehensive plan has been followed by two other emergency actions by the government.
First, the Securities and Exchange Commission this morning temporarily banned short selling -- basically betting that a stock's value will decline -- of 799 financial companies until Oct. 2. Regulators in the United Kingdom took a similar step Thursday.
"The Commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets," Cox said in a statement. "The emergency order temporarily banning short selling of financial stocks will restore equilibrium to markets.
"At present, it appears that unbridled short selling is contributing to the recent, sudden price declines in the securities of financial institutions unrelated to true price valuation," the SEC statement said.
Consumer and Taxpayer Confidence
Second, to stop Americans from panicking and pulling their money out of money market accounts, the Treasury announced this morning that it will back the value of all such funds so that investors can't take a loss.
"Money market funds play an important role as a savings and investment vehicle for many Americans; they are also a fundamental source of financing for our capital markets and financial institutions," the Treasury Debarment said in a statement. "Maintaining confidence in the money market fund industry is critical to protecting the integrity and stability of the global financial system."
In order to provide such money market insurance, the Treasury was forced to reach back to a Depression-era fund, the Exchange Stabilization Fund which was established by the Gold Reserve Act of 1934.
In the past few weeks, it became clear that the government wasn't doing enough to stop the economy from collapsing. Even the typically free-market Wall Street Journal editorialized that the government needed to do more.
In March, the government bailed out brokerage firm Bear Stearns but that did little to calm the markets.
Then in the past two weeks, the government again had to step in, this time rescuing mortgage giants Fannie Mae and Freddie Mac and then insurance giant American International Group. Those takeovers, along with the bankruptcy of Lehman Brothers and the fire-sale purchase of Merrill Lynch, still didn't put an end to the panic on Wall Street.
Then came word that money market mutual funds -- the most stable and conservative of stock market investments -- might actually be at risk of losing value. Policy and lawmakers decided it was time to act.
With reports from ABC News' Alice Gomstyn.