US shares in freefall after shock rejection of bailout

The House of Representatives stunned world markets yesterday when it categorically rejected a bill, crafted to bail out the American banking industry and unclog global credit flows, in a display of flat-out defiance of party leaders and the White House.

At the end of a morning of dizzying suspense, members of the House voted the multibillion-dollar bill down by 228 votes to 205. The White House, the US Treasury and the leadership of both parties were left to ponder whether it could be revised to assuage its opponents in time for a second attempt later this week.

Even as electronic voting began, party leaders – as well as investors around the world – held their breath. The instant it became clear that it was set to fail, the Dow Industrials average plummeted a head-spinning 700 points. By the trading day's end, the Dow was down 777 points – or more than 5 per cent, and its biggest point drop in history. The credit markets, meanwhile, were in a freeze.

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The House Speaker, Nancy Pelosi, indicated last night that she intended keeping the House in session to consider how to revive the bill, described by its proponents as the world's best hope of averting a recession worse than any seen since the Great Depression. "The legislation has failed ... the crisis has not gone away," she said. "What happened today cannot stand, we must move forward."

The rejection may prove to be temporary but its ripples could circle the world and its financial markets quickly. "There's a monster amount of fear out there. This is global contagion. It's no longer just the United States," said Joe Saluzzi, co-manager of trading at Themis Trading in Chatham, New Jersey. With the Jewish New Year today, no new legislative action can happen before tomorrow. While most of those voting against the bill were Republicans, nearly 100 Democrats also opposed it. The bill's rejection was a kick in the stomach to President Bush, who had appealed for its passage. He said he was "disappointed" at the outcome. Hardly less damaged were the Treasury Secretary, Hank Paulson, and Ms Pelosi. The bill had also attracted support – though fairly tepid – from both presidential candidates, Barack Obama and John McCain.

"Democrats and Republicans need to step up to the plate and get it done," Mr Obama said last night. "We have more work to do to make sure that Main Street is getting the same kind of help Wall Street is getting." It is his opponent, Mr McCain, however, who stands to lose the most from the Washington train wreck.

Mr Paulson voiced his disappointment and said he was committed to putting the bailout package "back together" without offering any details of what it may or may not include. "We need it as soon as possible. This is much too important simply to let fail."

More Republicans opposed the bill than supported it, in spite of an emotional appeal for support from their leader in the House, John Boehner. It was a "mud sandwich", he conceded, adding, however, that it was better than doing nothing and potentially pitching the economy into a steeper tailspin. "I have been here a long time ... and we have cast a lot of tough votes along the way," Mr Boehner said minutes before the vote. "But I don't know if they get tougher than this. Nobody wants to vote for this, nobody wants to be anywhere around it ... but we have a product that may work."

The bailout, still unpopular with voters across the country in spite of the administration's selling efforts, has consumed political energies in Washington for 10 days and proved a distraction from the race for the White House. It had been hoped passage in the House would allow the Senate to vote tomorrow. Lawmakers had been anxious to return to their districts to campaign for the November elections.

Further evidence of the depth of the crisis in Wall Street came with news that Wachovia, until recently one of the shiniest of American retail banks, had agreed to be swallowed up in a fire-sale to its rival Citigroup. Like so many other institutions, Wachovia had been crushed by bad mortgage-related debt. Its demise followed the failure of Washington Mutual, snapped up last week by JP Morgan Chase.

It emerged, meanwhile, that law enforcement officials have issued subpoenas to both Fannie Mae and Freddie Mac, the two American mortgage loan giants rescued earlier this month by the government, as part of a growing federal investigation into possible accounting fraud at both institutions.

Many members of Congress were heeding constituents who see the bill as a bailout for Wall Street that it does not deserve. They are not buying the administration's pitch that it is the best worst option, assuming it succeeds in averting another economic meltdown. Republican member Jeb Hensarling was among those voicing his scepticism before yesterday's vote. "I fear that it may not work. I fear that it is too much bailout and not enough workout."

Serial amendments aimed at reducing opposition to it had been introduced to the bill since it was first proposed by Mr Paulson and the Federal Reserve chairman Ben Bernanke. While the price tag remains a staggering $700bn (£385bn), the money would have been released in instalments with Congress free to intervene after the first $350bn if it deems all further payouts unnecessary. There was tougher oversight, including by a bipartisan congressional panel. And it also included steps to curb excessive salaries for executives at participating banks and end golden parachute severance deals. But those changes did not convince the critics.

Blame for the bill's failure was laid by some at the feet of Speaker Pelosi, allegedly because she used her speech on the House floor partly to criticise the economic policies of President Bush. However, other Democrats rejected the notion that Ms Pelosi's words could have been enough to change Republican votes.

The bill What happens next

*Is the rescue package dead?

It's on life support, and with every new outbreak of political finger-pointing yesterday, the prognosis got worse.

*Will new concessions have to be made to conservative Republicans?

The conservatives pushed an alternative proposal, namely that Wall Street should buy government insurance for losses on bad mortgages, rather than expect the taxpayer to buy these toxic mortgages from them. The Treasury might have to take that more seriously.

*Can the plan work if it is modified?

If conservatives reduce the amount of money being made available, or impose too many conditions, the chances of getting banks lending again are reduced.

*What if Congress does nothing?

The risk, if the turmoil continues, is that even a small shock could trigger a run on banks and full-blown financial panic.

Stephen Foley