The Treasury’s $700 billion plan to purchase troubled assets has had no visible effect on financial markets. Since the bill’s passage, the Dow has fallen 1,500 points. What’s going wrong?

It could be that the markets hate the bill and do not like the idea of the government interfering with financial markets. It also could be that the bill did not include a suspension of mark-to-market accounting rules. In fact, news on September 30 of a potential change by the SEC to fair-value accounting rules fueled a 400-point rally in the Dow. This rally faded rapidly when the rumors proved false.

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Both of these arguments are probably accurate. But it also is true that the Treasury will not make its first purchase of assets with its new fund for at least two weeks. In today’s world, this is a long time … too long.

Every company that fails increases the odds that another will fail. And every failure undermines confidence in the economy and causes a deeper distrust in the capital markets. So we need a game changer now.

The Treasury should use the broad latitude it has been granted with its $700 billion rescue fund and help firms with liquidity or capital issues.

There are three problems facing investors right now. The first is that a continued decline in asset values (even when cash flows are positive) is putting pressure on capital. This pressure, exacerbated by mark-to-market accounting rules, scares off potential investors who worry that further write-downs will force a further weakening of share prices. This happens even if the losses are just paper losses caused by fire-sale pricing of assets.

The second fear is that even when firms get bailed out by the Treasury or the Fed, the terms are so onerous (in an attempt to protect the taxpayer) that shareholders are wiped out. As a result, investors are leery of government action and use this as another excuse for holding back.

This concern is magnified by the fact that there do not seem to be any guiding principles for market intervention. Why was AIG saved, but Lehman allowed to fail? Why was Wachovia forced to sell to Citigroup for so much less than it was seemingly worth (at least to Wells Fargo)?

Third, liquidity is now a problem. A company can be well-capitalized, but a run can occur on its deposit base if it is a bank, or on its short-term operating capital if it is not a bank. This has the same impact as a capital crisis since it forces companies to either raise more cash or sell assets at fire-sale prices.

What we have here is a cascading series of problems with no end in sight. And we no longer can wait for the Treasury to build up a brand new business to purchase illiquid assets and put a floor under prices. The Treasury must use its intervention authority and provide liquidity directly to the firms that need it right now.

There are two ways to do this. The Treasury either can become a direct shareholder in a financial firm by buying preferred securities or it can provide a company short-term financing. Unfortunately, up to this point, the government has proven to be a harsh investor. By taking 79.9 percent of a firm — AIG — the Treasury wiped out shareholder value. In an attempt to protect the taxpayer, it has driven away private investors who fear they will be diluted to near nothing.

The Treasury needs to think in the long-term interest, and not just the short-term interest, of the taxpayer. In other words, rather than just trying to protect itself from investment losses, it needs to protect its long-term tax revenues by saving the economy from ongoing financial-firm failures.

There is a risk that if Treasury takes too much skin, the plan backfires. What firms need now is liquidity to keep operating and capital enough to build confidence — not government takeovers. As a result, if the Treasury cannot keep itself from taking too much equity, maybe commercial paper is a better way to go.

A good two-pronged approach would be to first suspend mark-to-market accounting regulations so that the pressure on capital accounts from more paper losses is no longer a threat. This will provide a more stable landscape for potential investors, which is really what the $700 billion fund is designed to accomplish.

Second, the wide latitude of the Treasury plan should be used to buy commercial paper, or otherwise directly invest in companies that need liquidity to operate.

The Federal Reserve is already doing this, but it is putting monetary policy at risk. By using the Treasury fund for this purpose, investors will be convinced that liquidity problems will not spread any further. Not only can these actions be taken immediately, the government can extricate itself more quickly from these types of financial arrangements as problems dissipate than it can if it takes equity stakes in corporations.

By fixing the problem of fire-sale write-downs, and by providing the liquidity necessary for businesses to keep operating, the Treasury can stop failures without increasing its ownership stake in the financial sector. At this point, keeping one more domino from tipping over is the simplest and easiest way to stop the crisis from spreading in a completely out-of-control manner. At the least, these actions will provide a bridge, allowing the Treasury time to ramp up its fund and prepare to buy assets in the open market.

— Brian S. Wesbury is chief economist and Robert Stein is senior economist for First Trust Portfolios.