Bernanke Signals Fed May Cut Rates as Crisis Deepens (Update1) By Scott Lanman
Oct. 7 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke signaled policy makers are ready to lower interest rates as the credit freeze worsens the outlook for U.S. economic growth and as inflation concerns wane.
``In light of these developments, the Federal Reserve will need to consider whether the current stance of policy remains appropriate,'' Bernanke said in a speech in Washington.
Today's remarks indicate Bernanke judges that the central bank's record expansion of its balance sheet to unblock credit markets is insufficient to prevent a deeper economic downturn. Investors in the past week increased bets the Fed will cut its main rate by as much as three-quarters of a point this month.
``The combination of the incoming data and recent financial developments suggests that the outlook for economic growth has worsened and that the downside risks to growth have increased,'' Bernanke said to the National Association for Business Economics. ``At the same time, the outlook for inflation has improved somewhat, though it remains uncertain.''
Policy makers aren't scheduled to meet to consider changes to their benchmark lending rate of 2 percent until Oct. 28-29, and some analysts predict they will cut borrowing costs before then. The Federal Open Market Committee has left its target rate unchanged at the last three meetings after cutting it by 3.25 percentage points from September to April.
Rate Outlook
Traders saw about 25 percent odds of a three-quarter-point cut in rates at or before this month's meeting, futures prices showed as of 3:15 p.m. in New York. The probability of at least a half-point cut remained at 100 percent.
The Fed is pumping more than $1 trillion of short-term cash loans into the banking system to head off a global liquidity squeeze against banks and borrowers. Earlier toda, Bernanke moved to backstop the short-term corporate debt market.
``By potentially restricting future flows of credit to households and businesses, the developments in financial markets pose a significant threat to economic growth,'' Bernanke said in his first public talk since testifying before Congress two weeks ago.
The Fed said today it would start buying three-month commercial paper after the credit freeze threatened to cut off the key source of funding for corporations. The action follows a slide in the commercial-paper market to a three-year low of $1.6 trillion last week as investors fled even companies with few links to the subprime mortgage crisis.
Rescue Plan
The Treasury Department is making a deposit with the Fed's special purpose vehicle that is substantial, Fed staff officials said today. The funds won't come from the $700 billion rescue plan authorized by Congress last week, under which the Treasury will purchase distressed debt such as mortgage-backed securities. The Treasury program should, ``with time,'' help make credit flow and revive economic growth, Bernanke said today.
Bernanke linked the Fed's financial-market programs to supporting a U.S. economic expansion. ``To support growth and reduce the downside risks, continued efforts to stabilize the financial markets are essential,'' Bernanke said. ``The Federal Reserve will continue to use the tools at its disposal to improve market functioning and liquidity.''
The Fed chief scaled back his prediction on Sept. 24 that the U.S. economy would expand in the second half at a slow pace, saying instead today that ``economic activity is likely to be subdued during the remainder of this year and into next year.''
Inflation Outlook
Bernanke's dropped his assessment that risks of higher inflation were a ``significant concern,'' while repeating that the outlook for prices is still ``highly uncertain'' because of volatile costs for oil and other commodities.
Today's comments followed reports last week showing that employers cut the most jobs in five years in September. Also, manufacturing shrank at the fastest pace since 2001, reinforcing concern the U.S. is already in a recession.
NABE, the economists' group that hosted Bernanke's speech, released a survey yesterday showing that members expect the financial crisis to deepen a U.S. recession and extend it into next year. Two out of three analysts said the U.S. is now, or soon will be, in a recession, compared with 56 percent in the last survey in May.
``Even households with good credit histories are now facing difficulties obtaining mortgage loans or home equity lines of credit,'' Bernanke said. ``Banks are also reducing credit card limits, and denial rates on automobile loan applications reportedly are rising.''
Fed Powers
Bernanke has pushed the limits of the Fed's powers to create an array of unprecedented lending programs as the credit crisis spread from banks to securities firms, mutual funds, the biggest U.S. insurer and now corporate America.
Over the past week the Fed announced plans to pump an additional $1 trillion into the global financial system through auctions of cash loans to banks. That's on top of the central bank's $147 billion in loans to Wall Street bond dealers and $152 billion in lending to backstop money market mutual funds as of Oct. 1.
Separately, Bernanke moved in March to rescue investment bank Bear Stearns Cos. with a $29 billion loan and last month to save insurer American International Group Inc. with an $85 billion loan.
``We have learned from historical experience with severe financial crises that if government intervention comes only at a point at which many or most financial institutions are insolvent or nearly so, the costs of restoring the system are greatly increased,'' said Bernanke, 54, a scholar of the Great Depression and former Princeton University economist.
``This is not the situation we face today,'' he said, citing ``sufficient capital and liquidity'' at most financial companies. The actions by Congress, Treasury, the Fed and other authorities, along with the ``natural recuperative powers of the financial markets, will lay the groundwork for financial and economic recovery.''
To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net
Last Updated: October 7, 2008 13:57 EDTFed to Purchase U.S. Commercial Paper to Ease Crunch (Update3)
By Craig Torres
Oct. 7 (Bloomberg) -- The Federal Reserve will create a special fund to purchase U.S. commercial paper after the credit crunch threatened to cut off a key source of funding for corporations.
The Treasury will make a deposit with the Fed's New York district bank to help set up the new unit. The central bank will also lend to the program at policy makers' target rate for overnight loans between banks. The Fed Board invoked emergency powers to set up the unit, the central bank said in a statement released in Washington.
Today's action follows a slide in the commercial-paper market to a three-year low of $1.6 trillion last week as investors fled even companies with few links to the subprime mortgage crisis. Companies from newspaper firm Gannett Co. to electricity producer Southern Co. have been forced to tap credit lines or forego raising debt because of the market's disruption.
The Fed's efforts are aimed at ``stemming the bank-run-like panic,'' said Mark Gertler, a New York University economist and research co-author with Fed Chairman Ben S. Bernanke. ``The immediate threat to the real economy is that large corporations are having difficulty obtaining funds via the commercial paper market.''
Fed officials in a conference call with reporters didn't say how much commercial paper, which hundreds of companies use to finance payrolls and meet other cash needs, it plans to purchase. The officials also declined to specify when the purchases would begin.
Entire Market
The central bank's special purpose vehicle will be big enough to backstop the entire market, one official said on condition of anonymity.
Issuers will be able to sell commercial paper to the Fed up to the average amount they had outstanding in August, an official said.
Policy makers began considering buying commercial paper several weeks ago as the market began to seize up, with borrowers increasingly only able to raise funds on a short timeframe, even just overnight, officials said.
The Fed's unit will buy three-month commercial paper, which should help issuers extend the maturity of their borrowing, an official said.
``While we have continued to fund without disruption, the Fed announcement today is an important development that will help restore confidence in the market and facilitate more lending,'' General Electric Co. spokesman Russell Wilkerson said. ``This is a positive move and we applaud the Fed's decisive action.'' The company is the biggest U.S. commercial paper issuer through its GE Capital finance unit.
Yields To Fall
Fed officials anticipate that yields will come down significantly as a result of their initiative.
Yields on top-rated overnight U.S. commercial paper dropped 0.74 percentage point today to 2.94 percent, according to data compiled by Bloomberg. Borrowing for seven days increased 1.25 percentage points to 4 percent.
The Treasury's deposit with the Fed's special purpose vehicle will be substantial, officials said. The funds won't come from the $700 billion rescue plan authorized by Congress last week.
Stocks initially climbed and Treasuries sank after the Fed's announcement, while shares later turned lower. The Standard & Poor's 500 Stock Index was down 0.13 percent at 1,055.50 at 11:49 a.m. in New York. Yields on benchmark 10-year notes climbed to 3.51 percent from 3.45 percent late yesterday.
Economic Outlook
Today's announcement came hours before Fed Chairman Bernanke speaks on the economic outlook at 1:15 p.m. in Washington. He and Treasury Secretary Henry Paulson held discussions yesterday as stock markets slid and money market rates climbed as the crisis deepened.
The Fed's new unit will buy three-month dollar-denominated commercial paper at a spread over the three-month overnight- indexed swap rate, which is a measure of traders' expectations for the Fed's benchmark rate.
Fed officials on the conference call indicated that they would like the facility to be a backstop, which would suggest the special vehicle's rate would be set at a slight penalty to normal market rates. They declined to answer a specific question as to whether the rate would be set above current rates, or below, which would constitute a subsidy for borrowers.
`Funding Backstop'
``The Federal Reserve will consult with market participants regarding appropriate spreads that are consistent with the facility serving as a funding backstop under more normal market conditions,'' the Fed said.
Commercial paper purchased by the vehicle must be rated at least A1/P1/F1, the Fed said. Issuers will pay the unit an upfront fee based on the commercial paper initially sold to the vehicle. The vehicle will cease buying commercial paper on April 30, 2009, unless the Board of Governors agrees to extend it.
The Fed will cap the amount of commercial paper each company may sell to the central bank.
The Fed yesterday said it will double its cash auctions to banks to as much as $900 billion, and telegraphed today's announcement by saying it was looking for other ways to alleviate liquidity strains.
The Fed's move is ``very unusual, very aggressive and a very bold step,'' said Chris Varvares, president of St. Louis- based Macroeconomic Advisers LLC, a forecasting firm. Assuring that corporations can fund their short-term cash needs ``is absolutely essential.''
To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net.
Last Updated: October 7, 2008 11:54 EDTUnfolding Worldwide Turmoil Could Reverse Years of Prosperity
By David Cho and Binyamin Appelbaum
Washington Post Staff Writers
Tuesday, October 7, 2008; A01
What went wrong?
Last week, the nation's political leaders said the financial system would collapse unless they passed a $700 billion rescue package for Wall Street. On Monday, the first day of trading after the plan passed, the financial system continued to melt down anyway.
Here's why: The plan developed by Treasury Secretary Henry M. Paulson Jr. to buy troubled U.S. mortgage assets might not start for another month. And, despite its huge price tag, it already seems paltry compared with the scale of the rapidly evolving global crisis.
"People are realizing that the Paulson plan is not going to be nearly enough. It's not because the plan is ill-conceived. It looks like it's the right thing to do, but the problem is just growing astronomically," said Martin Evans, a professor of finance and economics at Georgetown University.
The bailout plan is focused on buttressing U.S. financial institutions. But it was global markets that plunged yesterday, as investors sold off commodities in Brazil, currency in Mexico, bank stocks in Russia and the short-term debt of the state of California.
Robert B. Zoellick, president of the World Bank, said the global financial system may have reached a "tipping point" -- the moment when a crisis cascades into a full-blown meltdown and becomes extremely difficult for governments to contain.
The mushrooming problems "will trigger business failures and possibly banking emergencies. Some countries will slip toward balance-of-payment crises," he said yesterday, speaking at the Peterson Institute for International Economics.
The crisis threatens to reverse years of prosperity that financed the economic growth in developed and emerging countries through a global financial system that made credit widely available. Banks and governments were able to borrow money on an unprecedented scale by selling debt in new kinds of packages, allowing even the least creditworthy consumers to borrow and spend.
China exported goods and then loaned the money back to the United States by buying those new debt packages. The story was similar for Russia, which exported massive amounts of energy to Europe, and for Brazil, which exported commodities including orange juice and sugar. All used the massive inflows of borrowed money from the developed world to fuel economic expansions and stock market bubbles.
Yesterday, trading on the major stock exchanges in Russia and Brazil was halted after prices crashed. China's major indexes fell about 5 percent. The bubbles appear to be bursting in rapid succession.
Faced with these developments, the markets have not been in a mood to cheer the passage of the Paulson rescue package. At one point yesterday, the Dow Jones industrial average had fallen nearly 800 points, more than 7 percent. It ended the day off 3.6 percent, below 10,000 for the first time since 2004.
"Quite frankly, what the market is looking for is some kind of coordinated action from central banks around the world." said Kathy Lien, director of currency research at GFT Forex. The Paulson plan, she added, is like a "Band-Aid for a problem that stretches way beyond the banking system now."
Treasury officials say that ramping up the rescue package will take time, and that they are working as fast as possible.
(Third Party Administrators, TPAs...privatizing the responsibility? Oversight?--java)
Yesterday, the department released the contracting rules for the asset managers (TPAs) they expect to hire to oversee its rescue program, requiring interested parties to apply by tomorrow. The Treasury also named Neel Kashkari as the interim assistant secretary of the Treasury for financial stability to oversee the rescue program until January, when the next administration takes office.
Despite the mammoth bailout, Zoellick and other leaders are now urging central banks from the leading economies to devise a coordinated response.
They don't have a lot of time.
It's been nearly three weeks since Federal Reserve Chairman Ben S. Bernanke warned lawmakers that the nation was at risk of a full-blown meltdown.
Since then, the same problems have afflicted Europe. Governments have bailed out five large financial firms, including two this weekend, triggering fears of additional bank collapses in Europe.
Hypo Real Estate, a German real estate lender, is collapsing under the weight of its own bad loans, forcing the German government and leading banks to announce Sunday that they would lend the company up to $68 billion.
The rescue follows the nationalization of one of England's largest real estate lenders, Bradford & Bingley. Iceland also rescued one of its largest banks, Glitnir. And several European countries were forced to invest billions of dollars in Fortis, one of the largest banks on the Continent, in an ultimately unsuccessful effort to stave off its collapse. Fortis, too, has now been nationalized.
With confidence in banks basically shattered, governments increasingly have been forced to issue explicit guarantees that bank deposits will remain safe.
Ireland last week guaranteed all deposits and liabilities, totaling about $540 billion, at six domestic banks. The pledge included branches of the six banks outside of Ireland, and excluded branches of other banks in Ireland, raising concerns that deposits would now flow from rivals into the coffers of the six government-protected banks as investors flee to safety.
Germany promised Sunday to guarantee all private savings accounts, which hold at least $800 billion. Denmark yesterday announced that it would guarantee all deposits, as well.
The economies of Ireland and Denmark have officially fallen into recession. Investors meanwhile are worried that Pakistan and Argentina might default on their debts. In India, the average interest on loans between banks jumped above 11 percent, reflecting a breakdown of trust.
The bailout has not even thawed critical segments of the U.S. credit markets.
U.S. corporations sold $1.25 billion in bonds last week, marking the sharpest drop in sales volume since 1999, according to Bloomberg. Short-term commercial borrowing fell to $1.6 trillion, down 9 percent in the past two weeks, almost entirely because of a massive decline in borrowing by financial companies that cannot find lenders at any price.
September saw the worst monthly losses in the history of the hedge-fund industry. Investor withdrawals could lead to the collapse of major funds, triggering further sell-offs and exacerbating the financial crisis.
Investors are also increasingly concerned that more U.S. banks will fail before the Treasury can launch the rescue program. Shares of National City, a regional bank based in Cleveland, fell 27 percent yesterday.
Bank of America said its third-quarter profit fell 68 percent, largely because of losses on mortgage loans and credit cards. The company reduced the dividend on its widely held shares by half and said it would try to raise another $10 billion from investors. Its shares were down about 7 percent, to $32.22.
"These are the most difficult times for financial institutions that I have experienced in my 39 years in banking," chief executive Kenneth D. Lewis said in a conference call.
by Faiz Shakir, Amanda Terkel, Satyam Khanna, Matt Corley, Benjamin Armbruster, Ali Frick, and Ryan Powers
The Page That Won't Turn
According to September polling from Gallup, the percentage of Americans who have "negative" feelings about the economy is now at 81 percent. But Sen. John McCain's (R-AZ) campaign admitted this weekend that it is trying to distract the country from focusing on the nation's economic woes. "We are looking for a very aggressive last 30 days," said Greg Strimple, one of McCain's top advisers. "We are looking forward to turning a page on this financial crisis and getting back to discussing Mr. Obama's aggressively liberal record and how he will be too risky for Americans." "If we keep talking about the economic crisis, we're going to lose," admitted another aide. The issue has for months been the number one area of concern to voters. While McCain hopes to avoid talking about the economy -- perhaps because of his poor understanding of economics -- the crisis is quickly altering the lifestyles of working and middle-class Americans and is not going away soon. Consumers are pulling back on their spending, for example, "all but guaranteeing that the economic situation will get worse before it gets better," the New York Times reported yesterday.
AMERICANS HIT HARD: The poor flow of credit in the U.S. economy is affecting virtually all aspects of American life. The Washington Post reports today that "unemployment claims are at a seven-year high, and factory orders are sharply down. ... Small businesses can't get financing." The landscapes of American cities are changing. Because of the rise in foreclosures, the number of homeless people in Massachusetts, for example, is at a record high. The country is seeing a rise in "tent cities" because of rising homelessness. Hourly and weekly wages in July 2008 were at their lowest levels since October 2005. As a "result of the worsening economy," Medicaid enrollment has risen 2.1 percent this year, with a projected 3.6 percent increase for next year -- the highest rate in five years. In the meantime, the McCain campaign announced yesterday that it would cut $1.3 trillion from Medicaid and Medicare.
STATE-LEVEL FINANCIAL CRISIS: The slow economy is also paralyzing the spending of state governments, forcing massive budget cuts. According to a July survey by the National Conference of State Legislatures, states are being forced to slash spending and cut jobs "in order to close a projected $40 billion shortfall in the current fiscal year," more than triple the size of the previous year's. New York Gov. David Paterson (D) predicted that the 2009-10 state deficit will be a record $8 billion, calling on lawmakers to make $2 billion in cuts. With concerns about their states' ability to access credit markets for short-term borrowing, both California and Massachusetts have asked the U.S. treasury for similar bailouts as given to Wall Street banks. The Department of Labor reported last week that the country shed 159,000 jobs in September, and the unemployment rate has increased to its highest level in five years. "The increase in the rate of job loss may well be rooted in credit market tightening," Michael Ettlinger and Amanda Logan of the Center for American Progress observed. The worker is hit doubly hard, as state jobless funds are drying out, too. According to the National Employment Law Project at least 11 states are facing financial challenges paying their jobless benefits.
STIMULUS NEEDED: Last week, Congress passed a financial rescue package that failed to sufficiently address the underlying problem of creating a mechanism that ensures the restructuring of home mortgages to help homeowners. Today, the country needs a second stimulus package, as CAP has outlined, which would help stimulate the economy and stem the tide of job loss. The second stimulus package should jump-start a low-carbon economy, invest in infrastructure, expand unemployment insurance, increase energy assistance, and boost food stamp support. Contrary to McCain's plan to cut Medicaid, the stimulus package should also expand Medicaid aid to the states. "A proactive Medicaid policy would help preserve health coverage, jobs, and state financial stability -- all of which will help an economic recovery," Ettlinger and Logan noted.
The Top Five Reasons The Bailout Interventions Are Making Things Worse
2008-10-01 — ml-implode.comby Aaron Krowne for The Implode-o-Meter.
- The bailout bill currently under debate isn't the first attempt to "just do something" to "fix the crisis". Many interventions have been concocted over the past year, with each seeming to trump the previous in heft, but pitched as the "bailout to end all bailouts" and finally fix the economy.
Yet, these interventions have all failed -- all the underlying metrics of the market (spreads, share prices, bank lending) have continued to deteriorate. In this piece we examine why. The implication is: this latest "bailout to end all bailouts" will be, well, anything but, and should be vigorously opposed.
1. They've increased leverage.
Fannie and Freddie had their core capital requirements reduced by 30% in early 2008. This was a complete about-face for OFHEO chief Lockhart, which suggests it was a pure panic move to prop up the housing market -- not a logical, considered decision.It certainly aided the cause of pushing most housing market activity through the GSEs. But sure enough, within a few months, even the government had to admit the two were insolvent.
Another example is how FASB rules intended to transition to a mark-to-market of bank assets -- meant to go into effect in 2008 -- were postponed, and will likely be modified or postponed for longer. Since it is obvious that under the current model, the assets are significantly over-valued, the postponement has generally bred distrust of financial companies, and has caused them to hoard cash, and has turned away potential outside investors.
Yet another example is how in the latest batch of hasty Fed rule changes, long-standing restrictions on using deposits for speculative activities were eliminated. Now, banks can raid their core depository capital as long as they plop some collateral in place -- which of course means dodgy collateral that cannot be otherwise monetized.
To be clear, some financial institutions have raised capital and lowered leverage. But most have not, and all the government interventions have had the effect of giving them no reason to do so.
2. Implementing "solutions" geared towards short-term liquidity rather than long-term solvency.
All of the Fed's alphabet-soup facilities (the TAF, the TSLF, the PDCF, and even the trusty 'ol discount window) presuppose that the problem is just that of near-term "liquidity" -- in other words, a brief cash crunch.While the introduction (and periodic expansion) of these facilities has kept the banking system afloat -- and engendered some impressive bear market rallies -- they don't really get to the root of the problem.
By analogy, this situation would be like when you or I fail to accurately track our monthly expenditures, and end up overdrafting as a result.
But as anyone paying even a little attention knows, the problem is more like a Wall Street version of what millions of homeowners are facing: they are underwater on their debt and just cannot afford to support it at the initial loan values anymore.
The loans (and derivatives) must be marked down. The financial companies must raise capital, or go into bankruptcy or conservatorship. A price must be paid for fresh capital that brings it out of the private market woodwork -- in other words, not relying on largesse from the tapped-out government (which is really just the taxpayers).
3. Elimination of market rules.
The government has created a precedent of arbitrary interventions over the past year. This has accelerated as time has progressed, and expanded to touch more and more of the market.It should not require much explanation to understand that markets do not do well in an environment of shifting or uncertain rules. In fact there is a word for that: chaos.
Disturbingly, only two groups do well in chaos: criminals, and the government.
(Or maybe that's one group.)
Remind you of anything you're seeing lately? Like the same people responsible for the mess riding to the rescue with an unprecedented power grab under the mantle of government, all the while invoking economic mushroom clouds?
We should deal with bankruptcy and financial fraud in the traditional ways, and not go beyond lifelines direct to home and business owners in the extension of government assistance -- and do so in ways largely external to the market to the greatest extent possible.
4. Actively destructive interventions like the short-selling ban.
This one is just really bad. Banning short sales instantly does two very damaging things to the markets: it shuts down convertible debt issuance (one of the last decently-functioning holdouts), and it makes genuine hedging very difficult to do. Both are super-destructive for the markets.Indeed, it is hard to figure out how the short-selling ban even makes sense, unless you look at what probably truly inspired it (which is political grandstanding).
You see, short sales, while causing initial selling pressure, also cause eventual buying pressure. A dodgy stock which has been sold short eventually will get a boost as all of those short sellers will have to buy back the stock to close out their positions. And if the short sellers turn out to be "wrong", you get a massive rally called a "short squeeze", as they all rush to buy.
Banning short selling in general creates what are informally called "air pockets" in stock values. That is, with no shorts needing to close out their positions, normal selling has nothing below it to counter-balance the price decline. In the case of UK lending bank HBOS, very few people dared to sell it short (ony 3% of shares outstanding), so when some holders started selling it, it quickly turned into a free-fall.
The "argument" seems to be that short selling causes a self-fulfilling condition whereby initial short sales inspire a pile-on, which can quickly collapse a stock (in which case the short-sellers would never need to buy back). True, in theory. But with an "uptick" rule, shares can only be sold short if they are rising, making this dynamic impossible.
We used to have an uptick rule. But the SEC eliminated it in 2007, and (bizarrely) did not restore it amidst this crisis. If they wanted to make short-selling completely harmless, all they'd have to do is restore the rule. Or maybe they just don't believe their own rhetoric about short-selling being responsible for the collapse of all these financial stocks...
[Note: Some will doubtless bring up "naked" short selling (a "loophole" whereby sellers could get out of buying back the security sold short). But this practice was (rightly) eliminated in July, so it couldn't have been causing any recent problems.]
5. Continually giving hope of an even bigger government bailout.
This is the big one.Why in the world would anyone fess up, admit their mistakes, go into bankruptcy or pay punitive costs for private-market capital, when they could simply have the government alleviate most of their woes at the taxpayer's expense?
It is hard to argue that that is not what we've been seeing all year. Banks like WaMu and Wachovia continued to make ridiculous assertions about their loan quality, until one day it could be denied no more, and they went "poof". They couldn't keep the con going long enough to make it to bailout valhalla, but others are still trying!
In fact, even their FDIC-brokered suitors, JP Morgan and Citigroup, obviously are banking on some sort of general bailout reminiscent of the Paulson plan. Warren Buffett came out and said as much regarding his own $5 billion investment in Goldman Sachs, and now for $3 billion more in GE.
Other evident behavior, such as lack of follow-through from interested parties when these banks tried to find suitors, is also very suggestive. The seller held out for unrealistic terms, and the buyers held out for government intervention.
So deals that could have been done earlier, cheaper, and much farther from crisis have not been done. It's because the "big" bailout is always "just around the corner".
Congress needs to step up to the plate and make a rock solid statement that there will be no general bailouts of derivatives and structured financial assets or the companies holding them.
It should be stated unequivocally that the only help which will be considered will be towards homeowners and businesses directly.
In fact, if we had passed a reasonable housing bill last year with real teeth forcing loan modifications, we would have taken our lumps then and been much better off now. Banks would have had to write down loans, break apart securitizations and raise capital, and fewer homeowners would be in distress now.
Enough support has already been provided with the Fed temporary facilities -- Congress should just end the guessing game and outlaw any permanent public expenditure on structured financial assets.
Asset Sales May Lead to Write-Downs, Insolvencies, Orszag Tells Congress
By Frank Ahrens
Washington Post Staff Writer
Thursday, September 25, 2008; D04
The director of the Congressional Budget Office said yesterday that the proposed Wall Street bailout could actually worsen the current financial crisis.
During testimony before the House Budget Committee, Peter R. Orszag -- Congress's top bookkeeper -- said the bailout could expose the way companies are stowing toxic assets on their books, leading to greater problems.
"Ironically, the intervention could even trigger additional failures of large institutions, because some institutions may be carrying troubled assets on their books at inflated values," Orszag said in his testimony. "Establishing clearer prices might reveal those institutions to be insolvent."
In an interview later yesterday, Orszag explained using the following example: Suppose a company has Asset X, whose value is recorded on the books as $100. Because of the current economic decline, Asset X's real value has dropped to $50. If the company takes part in the government bailout and sells Asset X for $50, the company has to report a $50 loss on its books. On a scale of millions of dollars, such write-downs could ruin a company.
Such companies "look solvent today only because it's kind of hidden," Orszag said. "They actually are insolvent" already, he said.
In hearings on Capitol Hill so far this week, criticism of the bailout plan put forward by Treasury Secretary Henry M. Paulson Jr. and Federal Reserve Chairman Ben S. Bernanke has largely been restricted to the shape of the $700 billion proposal, how the money will be spent and what sort of oversight Treasury should have.
But Orszag yesterday questioned the wisdom of the plan itself, testifying that "it therefore remains uncertain whether the program will be sufficient to restore trust."
In yesterday's interview, Orszag said, "The key question is: What are we buying and what are we paying for it?"
Orszag offered alternatives, such as equity injections into particularly troubled companies, but allowed that those could lead to further problems, as well. In the end, he said, Congress must pass some sort of relief, if only because Wall Street is expecting it.
"If we did nothing, there is a significant risk of another collapse of confidence in the financial markets," he said.
Then, there is the paperwork cost of the bailout.
The budget office "expects that the administrative costs of operating the program could amount to a few billion dollars per year, as long as the government held all or most of the purchased assets," he testified, without defining what he meant by "a few."
Even as the financial markets rallied Thursday and Friday, Orszag said, the credit situation was so dire that "short-term lending was virtually shut down."
He said that the Treasury was acting as a go-between in short-term lending between banks. Instead of Bank A lending directly to Bank B, as is customary, Bank A no longer had confidence that Bank B could repay the loan.
So Bank A would give the money to the Treasury, which issued a security that was put into the Federal Reserve, which then issued the cash to Bank B.
If the government is forced to intermediate such ordinary transactions, commerce slows, credit confidence remains low, and operational strain is placed on the Treasury and the Fed.
"You don't want them in the middle of every short-term financial transaction," Orszag said.
During questioning before the Joint Economic Committee earlier yesterday, Bernanke acknowledged concerns about the bailout's effect on the budget.
"I think those concerns are very serious," he said. "But it's really a question of alternatives."
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