By Greg Ro
November 12, 2008
Treasury Secretary Henry Paulson laid out details for the next stage of the government’s financial-market rescue package Wednesday, announcing that he has shelved the original plan to buy troubled mortgage assets while turning his attention to nonbank financial institutions and consumer finance.
In a broad and deep review of the controversial $700 billion effort, Paulson defended the steps taken to date, but in the same breath said that financial markets remain fragile and that the focus must remain on “recovery and repair.” See MarketWatch First Take commentary.
“I believe we have taken the necessary steps to prevent a broad systemic event. Both at home and around the world, we have already seen signs of improvement,” Paulson said in a speech at the Treasury Department. See the full text.
But in a striking admission, Paulson said that buying up mortgage assets “is not the most effective way” to use government funding.
Purchasing these so-called “toxic” assets was once the cornerstone of the rescue plan for financial markets and was almost the entire focus of Congress when the package was being debated before its enactment. But almost as soon as Treasury received the money, it decided that giving capital to banks in return for preferred stock was a better use of the funds.
Paulson said that he was “still comfortable” with the $700 billion price tag for the rescue plan and that he didn’t need to go to Congress for additional funds: “I still am comfortable that with the $700 billion we have what we need.”
The Treasury Secretary said he met with members of President-elect Barack Obama’s economic team to discuss the rescue package earlier this week.
Some of the money saved from not buying mortgage assets will now be used to shore up the market for credit-card receivables, auto loans and student loans, according to Paulson.
“This market, which is vital for lending and growth, has for all practical purposes ground to a halt. With the Federal Reserve, we are exploring the development of a potential liquidity facility for highly-rated AAA asset-backed securities,” he said.
The plan to shore-up asset back securities is not ready yet, he added. “This will take weeks to design and then it will take longer to get up and going.”
Paulson declined to say how much it would cost, saying only that “it would need to be significant in size to make a difference.”
Alex Merk, president of Palo Alto Calif.-based Merk Investments, a mutual-fund firm, said that market participants were frustrated with Paulson’s communication skills and changing tactics.
“He’s been flip-flopping on every plan and it doesn’t look like he has a plan,” Merk said in an interview.
According to Merk, the rescue plan is failing to get banks to lend money, and that holders of mortgage assets who had been hoping to sell to the government at a good price have now seen these hopes dashed.
Earlier Wednesday, federal bank regulators issued a joint statement jawboning banks to start lending money to consumers. But Merk said that there are many factors that are making banks hoard capital.
“They don’t trust their own balance sheets, and why lend to consumers when the consumer sector is going down the drain?” he commented.
Markets are also looking beyond Paulson to the Obama administration, which is likely to be much more focused on helping consumers and homeowners — putting some of Paulson’s plans at risk, Merk added.
Brian Bethune, U.S. economist at HIS Global Insight, said that Paulson’s Treasury remains “behind the curve in the sense of understanding the systemic risk.”
The Treasury would also consider giving some capital to nonbank financial institutions, following completion of bank funding. Banks that are publicly traded have until Friday to request government assistance.
At a sensitive stage
“Although the financial system has stabilized, both banks and nonbanks may well need more capital, given their troubled asset holdings, projections for continued high rates of foreclosures and stagnant U.S. and world economic conditions,” Paulson said.
Paulson only described nonbank financial institutions in general terms, saying they “provide credit that is essential to U.S. businesses and consumers.”
However, many are not directly regulated and are active in a wide range of businesses, and taxpayer protections in a program of this sort would be more difficult to achieve,” he commented.
Bethune of HIS Global Insight said that insurance companies and the financial arms of the auto companies were the likely candidates for government assistance.
Economists said the plan would not stem the sharp drop in consumer spending.
“I doubt this is going to have a big offset to the really dramatic fall in consumer spending that we’re going to see in the coming year,” said Martin Feldstein, an economics professor at Harvard University.
Meanwhile, sweeping proposals to modify mortgages remain on the table, Paulson said. The cost of these programs will be substantial and don’t belong under this rescue package, he added.
On a related matter, the Treasury secretary pointed out that funding for the U.S. auto industry should not come out of the financial-market rescue plan. Congress has other vehicles to use to fund for the troubled sector, he said, adding that the key to any program for the industry was “long-term viability.”
Over the weekend, leaders of 20 countries will gather in Washington to discuss how to improve cooperation to foster stability in the global financial system.
Paulson took a cautious line on the meeting. “To adequately reform our system, we must make sure we fully understand the nature of the problem, which will not be possible until we are confident it is behind us.”
The White House won’t support a plan under which the International Monetary Fund would be responsible for devising a strategy to solve the problems, “unless member nations all see that they have a shared interest in a solution.”
Paulson said that the U.S. had a major role in the global crisis but wasn’t the only culprit. Global trade imbalances — the high U.S. deficit between imports and exports as well as matching surpluses in Asia — also played a role, along with Europe’s rigid structural regimes.
“Those excesses cannot be attributed to any single nation,” he remarked.
Figuring out oversight issues won’t be enough. “If we only address regulatory issues — as critical as they are — without addressing the global imbalances that fueled recent excesses, we will have missed an opportunity to dramatically improve the foundation for global markets and economic vitality going forward,” according to Paulson.