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 is 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 Department 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.
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 subprime 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.