WASHINGTON — Treasury Secretary Henry Paulson's surprise announcement Wednesday that he'll shift from purchasing troubled assets under the $700 billion Wall Street rescue plan is likely to result in spending taxpayers' dollars to shore up unregulated financial institutions that aren't banks but are vital to consumer lending.
During the negotiations on a bank rescue bill in late September and early October, Paulson argued that he needed broad authority to purchase distressed mortgages and other bad assets in order to clean up bank balance sheets and allow them to resume lending. Despite extensive misgivings, Congress created the Troubled Asset Relief Program. Now Paulson's ripping up that plan.
"Our assessment at this time is that this is not the most effective way to use TARP funds, but we will continue to examine whether the targeted forms of asset purchase can play a useful role," Paulson said Wednesday in an update on rescue efforts that have changed course.
In a news conference, Paulson was unapologetic, noting that the facts have changed and the global financial crisis has worsened.
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"I will never apologize for changing an approach or strategy when the facts change," he said. "I think the apology should come the other way: if someone doesn't change when the facts change. I think we move quickly, we move powerfully to address the situation as it exists."
Still, the man who shepherded the legislation through Congress, Rep. Barney Frank, D-Mass., was unhappy that the Treasury has moved away from plans to buy mortgage bonds and individual loans in order to prevent foreclosures by modifying the loans.
"We especially put in that bill authority to the secretary of the treasury to buy whole loans (and) mortgage-backed securities to make us the lender — to make us the owner — so we could do these kind of reductions," said Frank, the chairman of the House Financial Services Committee.
Paulson denied that the decision had anything to do with difficulty in determining what the Treasury Department would pay for distressed mortgages and other bad assets. He said it became apparent that direct investments in banks and other companies were a more effective and immediate way to shore up the financial system.
"The top priority has to be stability, making sure we have the resources in reserve to deal with any systemic events and make sure we have got capital to put into institutions," Paulson explained.
Instead of buying bad assets, the Treasury will address a complex area of lending that's been crucial to U.S. economic vitality. Paulson said he'd focus on boosting consumers' access to credit outside the banking system.
The Treasury and the Federal Reserve, he said, are working on a program that targets securitization. That's the process in which credit card debt, student loans and car loans are bundled together and securitized, or sold as bonds to investors, who receive monthly payments as Americans pay on their credit card bills and loans.
Securitization gave millions of Americans more access to credit over the past decade. As of last year, outstanding securitized debt for credit cards, car loans and student loans was valued at almost $2.5 trillion.
Now, however, investors are barely buying any securitized products, largely because securitized sub-prime mortgages have tarnished the image of anything that's packaged and pooled.
The Treasury and the Fed will develop a program that subsidizes the purchase of asset-based securities. It appears that the Treasury, through the Troubled Asset Relief Program, will become a co-investor with pension funds and other institutional investors that traditionally bought asset-backed securities.
"We're in the process of working with the Fed to design it. And the idea I presented very generally was a program of liquidity which would make financing available to the buyers of this," Paulson said. He said that it was difficult since it involved lending to financial market players that weren't directly regulated by the Fed or his department.
TARP money would be used as an incentive for investors to begin buying these financial instruments again, and the asset-relief program would incur the first loss in case of default.
Financial markets were caught by surprise, but they supported the new focus on securitization.
"The recent turmoil has stalled large parts of this market, and restarting it will help ensure consumers get the loans they need for homes, cars and education," Tim Ryan, the head of the Securities Industry and Financial Markets Association, said in a statement.
However, the trade group, which represents some of the biggest players in finance, was unhappy that Paulson shelved the plan to buy troubled assets from banks.
"I am disappointed Treasury is choosing to de-emphasize the asset purchase portion of the TARP program," Ryan said, noting that it would have helped to price assets that no one in the private sector wants to buy. "Until we have a functioning marketplace — where buyers and sellers agree on prices and institutions can subsequently judge the value of the assets they hold — uncertainty could keep many financial players on the sidelines, restricting lending capital for the larger economy."
Tom Deutsch, the deputy executive director of the American Securitization Forum, the trade group for companies that pool and package debt, said attempts to thaw this market were badly needed.
"It is completely frozen. And if banks aren't able to access capital from the securitization markets, they are not able to lend any capital back to borrowers for farms, for cars, for homes, etc.," he said. "And so until we get that securitization process restarted, we're not going to be able to get credit flowing back to consumers in America."
The treasury secretary said he wasn't ruling out a proposal from the Federal Deposit Insurance Corp. that would spend rescue money to help write down distressed mortgages and keep people in their homes. Such a plan requires spending, not investing, as has been the approach with bolstering banks' balance sheets. Officials hope that the invested funds will be repaid when the banks return to profitability.
"Secretary Paulson should be as quick to realize that the foreclosure issue is critical to solving our problems as he was in realizing that equity purchases were necessary," Senate Banking Committee Chairman Christopher Dodd, D-Conn., said in a statement Wednesday, calling for adopting the FDIC plan to help homeowners.
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