Paulson & Bernanke Go Hat in Hand to Congress
Cost of Plan to Wipe Out Bad Bank Debt Will Be Huge
A critical component of the proposal is to remove illiquid mortgage-related assets from the balance sheets of financial companies, assets that are now considered bad debt.
Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke had to meet with Congressional Republicans and Democrats because such a move would entail a large commitment by the U.S. government to buy or guarantee such debts.
The six top U.S. investment banks alone have at least $500 billion in illiquid mortgage-related assets, according to Bloomberg ("Paulson, Bernanke Seek `Comprehensive' Crisis Plan," Sept. 18).
These assets are considered the root of the current credit crisis because there is no way to accurately value them. They are investment vehicles that are linked to loans such as subprime mortgages, which are at a high risk of default as long as home prices fall.
With housing values continuing to plummet, investors and other financial market participants have no idea how much of this bad debt banks are carrying, and fear it will continue to grow, forcing financial institutions to announce ever larger writedowns every quarter.
Such writedowns led to the near collapse -- and sale to JP Morgan Chase & Co. -- of Bear Stearns, the bankruptcy of Lehman Brothers Holdings Inc., and the federal bailout of Fannie Mae and Freddie Mac.
By taking the illiquid mortgage-related assets off financial institutions' balance sheets, this seed of doubt -- which has caused widespread fear throughout the banking world and panic in global stock markets -- will be removed and, it is hoped, investors and other market participants will be reassured.
Such a move may be necessary, and many experts say it is, as without it financial markets will seize up -- as they almost did this morning -- adversely impacting economic growth worldwide.
The danger of such a move, however, is that it creates "moral hazard": those who took the risk of creating subprime mortgage-related investment vehicles like collateralized debt obligations (CDOs) and structured investment vehicles (SIVs) won't pay the consequences for their recklessness.
In fact, it looks like those stuck with the tab will be taxpayers, again.
According to the Wall Street Journal, a Treasury spokeswoman said that Paulson, Bernanke and lawmakers "expect to work through the weekend with Congressional leaders to finalize a way forward." ("U.S. Plans to Clean Up Finance System As Part of Widening Effort to Stem Crisis," Wall Street Journal, Sept. 18.)
If Congress members agree to this plan, expect the cost to be enormous.
Sources:
"Paulson, Bernanke Seek `Comprehensive' Crisis Plan," Boomberg, Sept. 18
http://www.bloomberg.com/apps/news?pid=20601087&sid=aBSQuhba4nTc&refer=home
"U.S. Plans to Clean Up Finance System As Part of Widening Effort to Stem Crisis," Wall Street Journal, Sept. 18
http://online.wsj.com/article/SB122177442732653979.html
Published by Jeremy Rutherfurd
An experienced reporter and editor who has worked for the Economist Intelligence Unit, Foreign Trade magazine, a China business-news site and several trade publications, I have been freelancing for the past... View profile
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4 Comments
Post a CommentI guess it's necessary for the economy, but I hate the idea of government bailing them out. Someone on tv said that in a way it's like an investment for the government since housing values may improve down the road.
Excellent reporting. It sounds necessary for the economy, but I hate the idea of the government bailing them out. Someone on tv said that in a way it's like an investment for the government since down the road housing values may improve.
Good recap of recent events, Les, and a reminder to readers to keep up with the whirlwind of events going on in the economy right now! I'm breathless from each day's news.
Great reporting Les. Americans need to wake up and take an interest as to what is really happening with our financial markets and the economy.