The American Congress has just rejected a $700bn rescue package formulated by George Bush and his Treasury Secretary, Henry Paulson.

Lines between Republicans and Democrats have been blurred completely during this time of crisis: Bush (a Republican) had the support of most Democrats in the House of Representatives (the lower house of Congress - similar to the House of Commons in the UK) but the majority of Republicans (along with a few isolated Democrats) voted to block the bill. The result is that markets have dropped even further, and lots of banks all across the world have been failing, requiring further bail-outs from national governments (in the UK, Bradford and Bingley has just been taken into public ownership).

But what was actually proposed in the US rescue package, and why might it have helped prop up the rapidly collapsing financial system?

In the last couple of months, hundreds of billions of dollars have been injected into financial markets by governments and central banks around the world. To take one example of many, the Federal Reserve (headed up by Ben Bernanke) in America lent the world’s biggest insurance company (and sponsors of Manchester United), AIG, a massive $85 billion dollars. The idea with loans like this is that they bail out companies who then somehow sort out all of the bad debt themselves (even though at the root of it are a load of poor people who are blatantly never going to pay their mortgages) before paying back the Government or central bank at some undefined point in the future.

The difference with the $700bn package proposed by Bush and Paulson is that unlike with the previous loans, it would have actually bought the bad loans from the banks. The American government would have owned all of the ‘toxic’ liabilities related to the sub-prime mortgage crisis, the hope being that without them in the system, the banks would sort things out and start lending to each other again. In other words, there would be way more liquidity in the market because of decreasing paranoia about who was trying to get rid of bad debts that had very little chance of being paid back.

The problem with the proposed solution (and perhaps one of the reasons that Republicans have blocked it) is that it doesn’t address the cause of the problem. It doesn’t ask why these debts were created in the first place, and it certainly doesn’t give any guarantee that it won’t happen again. The sole thing it would have done is inject confidence into an already flawed system. Jon Stewart puts it well: