The comprehensive overhaul of the government’s financial bailout plan announced Tuesday is designed to succeed where other plans have failed by unifying a sometimes piecemeal set of policies. But as outlined by Treasury Secretary Tim Geithner, the plan was disappointing in its dearth of detail.
Since the financial crisis began unfolding in September, efforts to resolve it have involved multiple agencies including the Treasury, Federal Reserve and Federal Deposit Insurance Corp. A shotgun approach to fixing the problem has tried everything from pouring money into the banking sector to helping homeowners renegotiate mortgages to save their homes.
“Everything was scattershot, hit and miss,” said former Fed governor Frederic Mishkin. “Now the feds have to go in big time and get this mess cleaned up. I think that there's an understanding in the administration that this is what needs to be done. But, boy, the details surely matter here.”
The latest plan, wide in scope, applies some fixes to existing measures and introduces a few new ideas. But as presented it is short on detailed solutions to some of most critical problems that have stymied past efforts.
Wall Street seemed to share that assessment. Although the announcement of the plan was anticipated for weeks, disappointment over a lack of key details contributed to a sharp sell-off in stocks, with the Dow Jones industrial average down 381.99 points for the day.
Geithner hinted in his speech that additional measures — and dollars — may be needed to get the global economy back on track.
“I want to be candid: This strategy will cost money, involve risk and take time,” he said. “As costly as this effort may be, we know that the cost of a complete collapse of our financial system would be incalculable for families, for businesses and for our nation.”
By underscoring the severity of the problem, Geithner may help lay the groundwork for calls for future sacrifices from voters — and additional spending from Congress. But keeping the plan open-ended also will extend the uncertainty that has undermined investor confidence as the government has moved from one policy to another.
“I think you've got to assume it’s the next step in the process, but I don’t believe it's the last stand,” said Anthony Fry, an investment banker at Evercore Partners. “”I think we are in a developing situation."
The Geithner plan covers four broad areas:
New capital for banks
As banks have lost upward of $1 trillion in mortgage-related assets, they have less money to lend — which has meant calling in old loans and cutting down on new ones. Until they can build up a more solid capital base, lending will remain tight and the economy can’t get growing again.
Last year’s Troubled Asset Relief Program was supposed to solve this problem by swapping those bad assets for cash or solid assets like Treasury securities. But since no one could figure out what the banks' bad assets are worth, the Treasury instead opted for a quick fix by giving them more than $250 billion in fresh capital in return for stock.
That drew fire from Capitol Hill and Main Street. After taking taxpayer money, banks showered bonuses on executives, paid dividends to shareholders and bought up other banks. The head of the TARP oversight committee, Elizabeth Warren, told a congressional panel last week that after handing out $254 billion, the government only got back $176 billion worth of stock. Critics also said decisions about which banks got funded were inconsistent.
The new plan will continue to provide capital and provide some increased oversight — including creation of a uniform “stress test” applied to any bank that gets money to see if it has the financial strength to survive the ongoing meltdown.
The process may also help the government come up with a better accounting of how much bad debt is out there, information banks have hoarded as tightly as cash.
But the plan stops short of applying hard restrictions on what banks can do with TARP money, including wider caps on executive pay. Instead, the Treasury will require more public disclosure on a Web site that will track where the money goes. The hope is that public disclosure will prompt bankers to adhere to the government’s goal of boosting lending to get the economy moving again.
Buying bad assets
The revised plan makes a renewed effort to get bad assets off bank books but sets aside a proposal to make direct purchases through the formation of a giant government “bad bank” to warehouse these assets until they recover some value. Instead the Treasury — possibly in conjunction with the Federal Reserve — will set up an "aggregator bank” and try to get private investors to step up and buy these assets.
The plan is relying heavily on private investors in part because the $350 billion left in the TARP program is not nearly enough to buy remaining the $1 trillion — or more — in bad assets. Geithner said the aggregator bank will need at least $500 billion to get started. But it’s unclear how the private investors will be convinced to put up that much money.
“We are exploring a range of different structures for this program and will seek input from market participants and the public as we design it,” Geithner said.
That leaves unanswered another of the thorniest problems that have plagued financial bailout efforts to date: how to put a price on assets that no one wants to buy. Because these assets have long-term payout schedules, most will be worth something once the housing market and economy recover. But if the price is set too high, investors — or taxpayers — will lose money. If set too low, banks holding similar assets will have to take even bigger write-offs, likely forcing many into insolvency.
“The reality here is we're going through an exercise which has never been tried before,” said Fry, “which is banks are looking at a huge range of assets, many of which are paper assets and which have to be valued at a particular moment in time. (The banks) have to make huge assumptions about where the economy is going to be. And we’re expecting to do that across the financial community. This is not a simple exercise."
New private lending
Though banks have cut back on direct lending, the private investors who supply trillions of dollars to the capital markets are also hoarding cash. Some 40 percent of lending to consumers is made by bundling car loans, credit card loans and student loans into pools that are “securitized” — converted to bonds — and then sold to investors. The latest bailout plan would expand a program already under way at the Fed to guarantee these investments to get investors back into the market.
The Fed has had some success with this approach. A move last fall to backstop the so-called commercial paper market that large companies rely on to raise short-term capital has recently made it easier for those companies to borrow.
In unveiling the governments’ new plan, Geithner was shortest on detail about proposed solutions to most fundamental cause of the financial meltdown — the relentless rise in foreclosures and fall in home prices. Following up on a proposal introduced in the House last month, Geithner said the new plan will include $50 billion to stop foreclosures. The details of how it will be spent, he said, would be announced “in the next few weeks.”
Efforts to unwind the foreclosure mess to date have come largely from private industry, including the industry-sponsored Hope Now Alliance. Mortgage giants Fannie Mae and Freddie Mac, now under government control, also have begun to try to standardize the process of modifying mortgages to more affordable terms. But some 2 million more homes were foreclosed last year and, without more aggressive measures, as many as 3 million more could be lost this year — adding to the already glutted inventory of unsold homes.
“I don't think we've seen a big enough push for it by the private sector,” said Steve Preston, former housing secretary in the Bush administration. “We still have somewhat of an impasse between the people who are sending you your mortgage bills, your servicers, and people who own your mortgages. That's an impasse we have to break.”
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