Bush administration officials today defended a plan to unfreeze credit markets by buying hundreds of billions in "toxic" mortgage-related assets, saying the alternative is more failures of banks and financial institutions and a breakdown in lending that would hobble the economy.
The plan has come under fire from lawmakers of both parties, who want more targeted relief for troubled homeowners and assurances that the financial institutions that participate in the massive program won’t profit at taxpayer expense.
In the first public debate over the plan, Sen. Chris Dodd, D-Conn., called the administration’s proposal to take $700 billion or more in troubled assets off the balance sheets of banks and financial institutions "stunning and unprecedented in its scope and lack of detail."
Dodd, chairman of the Senate Banking Committee, complained that the administration’s plan "would do nothing to help even a single family save a home" while allowing financial institutions to dump "billions of dollars of toxic assets on the backs of taxpayers."
Dodd has introduced draft legislation that would amend the administration’s plan by giving the government an equity stake in companies that participate in the program. Dodd’s proposal would also provide relief to homeowners by putting the FDIC in charge of modifying loans and allowing bankruptcy judges to rewrite the terms of mortgages on principal residences.
Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke warned lawmakers against making changes that would interfere with achieving the plan’s overarching goal — ensuring that home buyers, consumers and businesses can continue to borrow money.
The ultimate taxpayer protection "will be the market stability provided as we remove the troubled assets from our financial system," Paulson said.
The administration’s "bold approach" will cost far less than the alternative, Paulson said — "a continuing series of financial institution failures and frozen credit markets unable to fund everyday needs and economic expansion."
Broad participation sought
The Bush administration is asking for the authority to issue up to $700 billion of Treasury securities to finance the purchase of troubled assets such as mortgage-backed securities, which are bundles of loans packaged as securities and sold to investors. Falling home prices and rising delinquencies and foreclosures have made it impossible for many banks and financial institutions who hold such investments to sell them except at fire-sale prices, which limits their ability to make new loans.
The Treasury plan involves buying assets, often through "reverse auctions." Banks and financial institutions would price assets and offer them to the government, and the Treasury Department would select those it determined to be priced most competitively.
In order to work, the reverse auctions must draw not only banks and financial institutions that must sell the riskiest "illiquid" assets in order to stay in business, but healthy companies that want to raise capital by selling higher-quality assets so they can continue to make more loans, Paulson and Bernanke said.
The auctions would serve as a sort of substitute for markets where such assets used to trade before investors lost confidence in their ability to price them. Placing conditions on the companies that want to sell assets could limit participation in the auctions and limit their effectiveness in helping markets determine a fair value for "frozen" assets, Paulson said.
"For something to work here, rather than going to a group of troubled institutions that need to sell, and (the government) saying, ‘Here are all the things we need from you,’ we need and we want a broad range of institutions to (be) willing to participate because we’re trying to find value, and we’re trying to get markets working," Paulson said.
Requiring companies to give the government an equity stake — as was done in bailouts of Fannie Mae, Freddie Mac and insurance giant AIG — would not only discourage healthy companies from participating in the auctions but would do little to help them expand their lending, Bernanke said.
"If you leave the risk on the balance sheet, you really haven’t accomplished anything," Bernanke said.
Sen. Jack Reed, D-R.I., appeared unpersuaded, saying the public needs assurances that the plan "is not one-way salvation for Wall Street at the expense of taxpayers."
As proposed by the administration, "the price of admission is zero," Reed said. "I think it’s (not unreasonable to expect that) if they benefit from the transaction, they will share the benefit with taxpayers."
Dodd vowed that any legislation passed by the committee would also create standards for executive pay at firms that unload assets on the government, including limits on incentive pay and severance packages.
Paulson said he shared concerns about large pay packages for executives at firms that are facing large losses, but said such measures will weaken the plan by discouraging a broad range companies from participating in the auctions.
"I understand how serious the problem (of executive compensation) is and how great the concern and the outrage," Paulson said. "I can just say to you the most important thing by far is to have (a plan) that works well and works effectively."
Sen. Robert Bennett, R-Utah, wondered how the Treasury Department would value assets it will buy.
"The problem with giving you blank-check authority is that in theory it’s easy to describe how it will work, but if you pay too little (for assets) you’re not giving (companies) the support they need, and if you’re paying too much there is no upside support for taxpayers when you liquidate," Bennett said.
That was a concern shared by Sen. Robert Menendez, D-N.J.
"I get the sense that we’re flying by the seat of our pants," Menendez said. "You want to come in strong and have the cavalry be there, but (you are) not quite sure what the cavalry does when it arrives."
Paulson said the Treasury Department would hire outside experts to help determine the value of the assets, and those experts would have access to detailed information from the companies offering them about the basis for their pricing.
"The holders have a view of what they think it’s worth," Bernanke said. "The problem is it’s difficult for those outside (the companies holding the investment) to determine (their worth). It’s just like when you sell a painting at Sotheby’s — nobody knows what it’s worth until after the auction is over."
Paulson said the Treasury would start with small purchases of the simplest asset classes — probably mortgage-backed securities — and move on to more "illiquid assets." Although the Bush administration is asking for authority to buy other assets — which might include credit-card debt and student loans, for instance — Paulson said the program would focus on "mortgage-related" assets.
Because the Treasury would also be selling assets and use the proceeds to buy more, the program’s purchases could exceed the $700 billion in debt the administration has asked Congress to authorize. But taxpayers’ liability would be limited to repaying that debt and, theoretically, the program could make money — although few expect it will.
Paulson and Bernanke said they have not attempted to downplay the risk to taxpayers, but that the ultimate cost of a failure to act will be higher.
"The taxpayer is already on the hook, through no fault of their own, because the system does not work the way it is supposed to work," Paulson said. "You’ve not heard me say there is no risk to the taxpayer. There is less risk to the taxpayer than not doing anything."
Although there was some discussion of cracks in the regulatory system that led to the credit crunch — including the lack of government oversight of credit default swaps, which have played a role in the downfall of several firms — Paulson said a regulatory overhaul is beyond the scope of the proposed "troubled asset relief program" or TARP.
The Bush administration proposed sweeping changes to the regulatory system in March, which would include expanding the Federal Reserve’s limited role of supervising bank holding companies to make it a "market stability regulator" (see story).
Sen. Charles Schumer, D-N.Y., asked whether the Bush administration could live with a smaller initial debt authorization — $150 billion, perhaps, instead of $700 billion. If more money was needed, the Treasury Department could come back in January and ask Congress to authorize it, Schumer said.
"You are not going to use $700 billion in these three months," Schumer said. "It’s a huge sum of money — even $150 billion. The market’s confidence will be determined by how it works initially, not how much money you have left over in your bazooka."
But Paulson maintained that a partial authorization would be "a grave mistake." While the Treasury Department does not expect to use all $700 billion of the authorization by January — it’s been estimated it might buy $50 billion in assets a month — Paulson said "we need the full authority to do the job and stabilize markets."
Disposing of assets
Lawmakers also wanted more insight into what the Treasury Department will do with the troubled assets it buys, which may include whole mortgage loans as well as mortgage-backed securities.
If the government makes a concerted effort to engage in workouts and loan modifications with borrowers, that could forestall or prevent many foreclosures (see story).
Dodd contends that the Federal Deposit Insurance Corp. (FDIC) — which became the conservator of IndyMac Federal Bank in July — has a proven track record of modifying mortgages to prevent foreclosures. For that reason, his bill would require the Treasury Department to hand over mortgage loans and mortgage-backed securities to the FDIC for management.
Although Bernanke said the Federal Reserve has taken no position on bankruptcy "cramdowns" — allowing judges to reduce the principal on a bankrupt homeowner’s mortgage — Paulson said such a move would be "a mistake. What we’re trying to do is get lending going again. I think this … contradicts what we’re trying to do."
Industry groups like the Mortgage Bankers Association have fought attempts to change the bankruptcy code to give judges the power to modify loans, saying it would discourage secondary market investors from buying mortgage-backed securities.
Language that would have allowed the practice was stripped from a foreclosure prevention bill passed by the senate in April (see story).
"What’s disturbing is after having cramdowns voted down on the floor of Senate, to see it come back in an initiative as important as this," MBA Chief Operating Officer John Courson told Inman News. "Let’s debate (the issue on its) merits, not have tucked in as an ornament on this bill."
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