Paulson's bailout may boost GOP's prospects

WASHINGTON D.C (Fortune) -- Among those free-marketers inside the administration and out, who unapologetically label themselves ideologues, Henry Paulson has a nickname: "Mr. Fixit."

This is not a compliment. Staunch free-marketers harbor a special brand of disdain for government officials like the Treasury Secretary, who combines an instinct for action with a corporate chieftain's confidence that he can untie even the most gnarly financial knot.

As Paulson today unveils a plan he brokered to freeze rates on some 2 million troubled mortgages, economic conservatives are issuing a new round of warnings about the unintended consequences of his well-intentioned tinkering in the housing market.

Economically, their warnings could be right, but so is this political truth: With a heated presidential contest moving into full-swing, an activist Paulson is in the Republican Party's best interest.

As the Iraq war leaves the front pages of newspapers, and fears of a terrorist attack recede, the economy is moving to the top of most voters' agendas in the 2008 presidential election. And opinion polls suggest the public increasingly trusts the Democrats to take care of it.

If rounds of bankruptcies continue, if families losing homes top the nightly news, if the economy stalls, the GOP - the party most associated with free-market policies - suffers in next November's general election. That spells danger for Republicans.

We've seen this act before. In 2002, with a sick economy and facing his first midterm congressional election, President Bush threw his free trade rhetoric to the wind and signed "temporary safeguards" for the steel industry, bolstering the party's position in key swing states Pennsylvania, Ohio and West Virginia. (Translated, these "safeguards" equaled temporary tariffs of up to 30 percent on most steel imports, prompting threats of retaliation from the European trading partners.)

Paulson's various efforts to prevent the subprime mortgage calamity from sinking the rest of the economy have received a cool reception from stalwart free-marketers. His brokering of a bank-led superfund to clean-up balance sheets and boost liquidity was condemned by conservatives such as former Federal Reserve Chair Alan Greenspan (who worried about its repercussions on the markets) and the American Enterprise Institute's John Makin (who labeled it "a gratuitous bailout") .

Today Paulson forwards an equally headline-grabbing proposal-this time to help the bottom of the housing food-chain, homeowners - by freezing interest rates for those with good credit who would be unable to afford higher mortgage payments.

His critics say the plan will undermine the sanctity of contracts signed by investors who will now face a lower return on their mortgage securities. Others accuse him of both bailing out speculators and locking out new home buyers by keeping prices artificially high. On both plans that Paulson has brokered - the first to ease the pain of lenders, the second aimed at borrowers - free marketers worry about the "moral hazard" of a government that rewards greed and stupidity.

By contrast, Democrat Barney Frank, chair of the House Financial Service Committee, said he was "encouraged" by Paulson's efforts and stood "ready to work with the Secretary as this process moves forward."

Of course, Democrats love to fix things - and the party's presidential contestants brim with detailed proposals to insure the uninsured and narrow the gap between rich and poor. So it wasn't surprising that Hillary Clinton - who has her own plan to help distressed homeowners - praised Paulson.

The Democratic presidential frontrunner even accused the Republican former Goldman Sachs (Charts, Fortune 500) chief of stealing her idea to allow state and local governments to temporarily broaden their tax-exempt bond programs to including mortgage refinancing. "I think this is an excellent idea that the administration should have adopted two months ago when I proposed it," she said.

Protective of his own reputation as a free-marketer, Paulson has positioned himself merely as a broker - a Treasury Secretary pressing industry to take action but not directly deploying government might. He also argues that his leadership is necessary because of the "complexity" of the housing market (which raises the question of government's future role since financial instruments will only get more complex).

"An appropriate role for government is to bring the private sector together when innovation has greatly increased the complexity of achieving beneficial solutions for all parties involved," he explained.

No one who knows Paulson thinks he's driven by the electoral interests of the Republican Party. Indeed, quite the opposite: His wife Wendy's financial support for, and college-era friendship with, Hillary Clinton has some insiders wondering about whether he could serve in a Clinton Administration.

Mostly, Paulson observers say, these actions are in Paulson's nature as a Wall Street CEO. Says Edward Lazear, chair of the president's Council on Economic Advisers: "Hank is a markets guy. Hank has been effective at fixing things over his career."

Whether or not he "fixes" the subprime mortgage mess, at least temporarily, will be of keen interest to Republican politicians facing voters next November.