one year. Facing troublesome signs of further deterioration in money and credit markets, Treasury Secretary Hank Paulson finally decided to proceed with the boldest move so far: a general bailout of mortgage-related investments," says Adolfo Laurenti, senior economist of Mesirow Financial, in his September issue of Themes on the Global Markets.
- The Treasury bailout proposal is only two pages long, but would provide the government very broad and virtually unchecked powers to purchase mortgage-related assets from any financial institution headquartered in the United States. The plan would transfer a wide class of assets from ailing banks and investment companies to the balance sheet of the federal government, which would later absorb any losses and realize any profits from the acquired assets.
- One significant improvement of this plan over the policies that the government has followed up to now: it is large and systemic, and it tries to address the problems of the financial sector in a comprehensive manner. This contrasts the piecemeal approach that we have seen so far, which has clearly not worked.
- The Treasury plan does little to address the large imbalance between supply and demand in the housing market, which is the fundamental driver of a disturbing trend: financial companies are under stress because of falling values in their mortgage-related assets, which reflects the broad decline in home prices, with its corollary of rising foreclosures.
- Misleading comparisons are being made to other attempts by the government to rescue the economy, in particular the Resolution Trust Corp. (RTC), which, between 1989 and 1993, liquidated the assets from failed S&L institutions. However, the RTC was created to resolve failed institutions that had already fallen into conservatorship or receivership and whose equity had already been wiped out. In the present situation, the Treasury will come to the rescue of still-operating companies, in order to ensure their survival.
- Legislative uncertainty comes from Congressional leaders, who will likely modify Paulson's plan in some important aspects, and from political headwinds. After all, we are in the middle of a presidential campaign. The proposal betrays the old Republican principles of small government and fiscal responsibility, and by bailing out Wall Street giants, it irks the Democrats' concerns about fairness to the middle class.
"Chances are that Congress will cave in and play along with the Treasury, under the economic and political pressure that 'something must be done.' For all the legitimate doubts that can be expressed on the plan, the fact is that the economic consequences of inaction would be severe. A little more time for deliberation would likely help produce a more balanced and thought-through action, but the Treasury has remained adamant that, in order to address market uncertainty, Congress needs to act promptly. We will see the results," concluded Laurenti.
