As international leaders gathered Saturday in Washington to grapple with the global financial crisis, the Bush administration embarked on an overhaul of its own strategy for rescuing the foundering financial system.
Two weeks after persuading Congress to let it spend $700 billion to buy distressed mortgage-backed securities, the Bush administration has put that idea on the back burner in favor of a new approach, which would have the government inject capital directly into the nation's banks. The plan comes closer to a partial nationalization of the banking system than at any time since the Depression.
While the Treasury Department says it still plans to buy up distressed assets, the scope of that plan is unclear. And the government meanwhile has directed Fannie Mae and Freddie Mac, the government-controlled mortgage giants, to ramp up their purchases of troubled mortgage bonds, in what could be a speedier and less formal process than the reverse auctions proposed by the Treasury.
The Federal Housing Finance Agency, which last month seized Fannie Mae and Freddie Mac and placed them into a conservatorship, has ordered the companies to buy substantially larger amounts of mortgage securities – mostly subprime or other classes of mortgages in default.
The surprising turnaround by Treasury Secretary Henry Paulson announced Friday as part of a coordinated plan to rescue the financial industry, has raised questions about whether he squandered time by trying to sell Congress a plan that he and other administration officials had failed to think through in advance.
It also raises questions about whether the administration's deep philosophical hostility to government ownership in private companies aggravated the financial crisis by delaying rescue action.
Some experts now say they believe that the Treasury Department's decision last month not to rescue Lehman Brothers with taxpayer money exacerbated the panic that quickly metastasized into an international crisis.
Underscoring the gravity of the situation, President Bush convened an early-morning meeting at the White House on Saturday with finance ministers from the Group of Seven.
“All of us recognize that this is a serious global crisis, and therefore requires a serious global response, for the good of our people,” Bush said afterward in the Rose Garden, flanked by the ministers, who are in Washington for the annual G-7 meeting.
Bush said the countries had agreed to general principles in responding to the crisis, including working to prevent the collapse of important financial institutions and protecting the deposits of savers. But he offered no details on other measures, suggesting that there were still differences among countries about which steps to take to shore up their respective financial systems.
Like the U.S., Britain plans to inject capital directly into banks. But the U.S. and other countries have not adopted Britain's proposal to guarantee lending between banks as a way to unlock the credit market. Germany has been reluctant to put state capital directly into banks, though officials said there were signs of movement in the German position on Saturday.
Bush's remarks came at the beginning of a day packed with meetings with finance ministers and other officials, as motorcades and limousines with tinted windows clogged downtown Washington.
Among the most closely watched gatherings was a meeting of the Group of 20 nations, convened by Paulson. This group includes major emerging economies such as China and Russia, which have enormous foreign reserves and are being viewed as a potential lifeline for smaller countries that run into financial trouble because of the crisis.
With European leaders planning to meet today, there are growing expectations of a joint announcement of measures to shore up European banks. Germany, which had been reluctant to inject state capital directly into banks, is now moving in that direction, officials said.
Some experts said the delay in carrying out the Bush administration's $700 billion bailout plan has only hurt its prospects for success.
“Even if it was adequate before, it's not adequate now,” said Frederic Mishkin, a professor of economics at Columbia University business school who stepped down as a Federal Reserve governor at the end of August. “If you delay and create uncertainty, the amount of money you have to put up goes up.”
As recently as late September, the idea of letting the government acquire part of the banking system had been unthinkable in the Bush administration. To many officials, such intervention seemed like a European-style government intrusion in the marketplace.
“Some said we should just stick capital in the banks, take preferred stock in the banks. That's what you do when you have failure,” Paulson told the Senate Banking Committee on Sept. 23. “This is about success.”
Paulson told lawmakers it made more sense to jump-start the frozen credit markets with “market measures,” by which he meant buying up assets rather than institutions. He staunchly resisted Democratic proposals to require that the government receive an equity stake in the companies it was helping.
But on Friday, Paulson not only confirmed his intention to buy up stakes in banks but gave the idea central billing.
“We can use the taxpayer's money more effectively and efficiently, get more for the taxpayer's dollar, if we develop a standardized program to buy equity in financial institutions,” Paulson told reporters. He refused to say whether the capital infusion program for banks would be bigger than the original concept to buy troubled assets.
Treasury officials said they hoped to make the first capital infusions within the next two weeks. That would be earlier than any government purchases of unwanted mortgage-backed securities. One reason for Paulson's rapid reconsideration was that global financial markets have been going downhill faster than anyone had seen before.
Because Fannie Mae and Freddie Mac, the mortgage giants, buy and sell mortgage securities every day, they could avoid the arduous process of establishing a price for the assets through auctions.
That could free up the Treasury to devote more resources to injecting government inject capital directly into the nation's banks, something that administration officials had publicly opposed until just a few days ago.
People familiar with the planning efforts for a systemic bailout said the chairman of the Federal Reserve, Ben Bernanke, argued that it would be easier and more efficient to inject capital directly into banks. But Treasury officials initially recoiled at the idea, in part because they were ideologically opposed to direct government involvement in business.
But as the financial markets spiraled further during the past 10 days, a growing number of top-tier institutions, including Goldman Sachs and Morgan Stanley, became worried about their own survival.
“The crisis in confidence goes way beyond the actual losses that will be incurred from debt securities,” Mickey Levy, chief economist for Bank of America, said Friday. “It's truly incumbent on policymakers to address that crisis.”