What Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke didn't say before the Senate Banking Committee on Tuesday was as important as what they did say about their proposed $700 billion bailout of the financial system. Here's a closer look at important fine points of their testimony.
Q: Would this vast sum of money be limited to mortgage-backed securities and mortgage loans?
No. Although they're selling the plan publicly that way, arguing that it's vital to get the housing market back on track, Paulson acknowledged that he wants to have discretion to take in virtually any kind of asset for which there is no market.
That's important because it suggests that Treasury is worried broadly about securitization — the process by which loans of all sorts are pooled together and packaged for sale to investors as asset-backed securities. It suggests that there could be a buyer's strike for bonds backed by car loans, student loans and credit card debt similar to the one occurring now for mortgage-backed securities. That could be devastating for consumers who depend on credit for big purchases.
Q: The $700 billion plan would involve Treasury issuing more debt to pay for the “bad assets” it will be taking in. How do we know there will be buyers?
We don't. When asked that question directly, Paulson skirted it by saying he and Bernanke are talking with counterparts in Europe and elsewhere, urging them to take steps like those taken here.
Treasury plans to finance the $700 billion by issuing new debt. It's not clear what terms must apply for there to be buyers for that debt. Japan and China traditionally have been the biggest buyers of Treasury debt. But they may have a changed view of the safety and soundness of investing in U.S. government-issued debt now. If they demand a higher yield for this debt, that could drive up U.S. consumer-lending rates.
Q: Will the Bush administration's plan directly help struggling homeowners avoid foreclosure?
Paulson acknowledged that it wouldn't. Many homeowners simply don't have the income to stay in their homes, he said. Bernanke noted that financial markets are interwoven, and since credit markets are clogged up, removing bad assets from the balance sheets of banks and other lenders opens a path for more lending in the broader economy. That could help some people avoid foreclosure. In addition, Democrats in Congress are determined to include language in the bailout plan that helps rescue people facing foreclosure, but the final terms still are being negotiated.
Q: Did the government officials hint at the next shoe to drop?
SEC Chairman Christopher Cox pointed to credit-default swaps.
These insurance-like instruments are private contracts in which an investor insures against default on a bond or loan by making payments like a premium. In exchange, he gets a big payout if there's a default.
“The $58 trillion notional market in credit default swaps — double the amount outstanding in 2006 — is regulated by no one,” Cox said. “Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market.”
Americans got a whiff of the danger of credit-default swaps when the Fed rescued American International Group on Sept. 16, providing an $85 billion loan in exchange for taking a 79.9 percent stake in the global insurance giant.
Authorities justified it by citing AIG's presence in foreign markets.
What they meant in part was that it'd be a nightmare trying to determine who really owed what to whom in the unregulated swap market if AIG defaulted and avoided settling its commitments.
Paulson called Tuesday for a federal regulator over the insurance industry, which is now governed by 50 different state laws.