US Shifts Focus in Credit Bailout to the Consumer

November 13, 2008 at 3:05 am Leave a comment

henry-paulson-5.jpgThe Treasury Department on Wednesday officially abandoned the original
strategy behind its $700 billion effort to rescue the financial system,
as administration officials acknowledged that banks and financial
institutions were as unwilling as ever to lend to consumers.

But with a little more than two months left before President Bush leaves office, Treasury Secretary Henry M. Paulson Jr. is hoping to put in place a major new lending program that would be run by the Federal Reserve and aimed at unlocking the frozen consumer credit market.

The program, still in the planning stages, would for the first time use bailout funds specifically to help consumers instead of banks, savings and loans and Wall Street firms.

Treasury
officials said they hoped to invest about $50 billion from the bailout
fund into the new loan facility, with the aim of helping companies that
issue credit cards, make student loans and finance car purchases.

As
envisioned, the Treasury would put up about 5 percent of the money that
a company would use for lending and private investors would put up
perhaps 20 times that much by buying bonds issued by the new program.

Despite
the mind-boggling amount of money that Congress has authorized the
Treasury to spend — $350 billion immediately, and another $350 billion
that Congress would approve under a fast-track procedure — Mr. Paulson
is running short of money and time.

The news that the government
will not buy soured mortgage assets, along with a string of poor
corporate earnings, disheartened investors on Wednesday, sending the
markets down for a third straight day this week. The Dow Jones
industrial average fell 411.30 points, or 4.7 percent, to close at
8,282.66.

The Treasury has already committed about $290
billion. It has allocated $125 billion to the nation’s nine biggest
banks and investment banks; another $125 billion for publicly traded
regional banks; and $40 billion to expand the existing bailout of American International Group, the insurance conglomerate that collapsed in September.

Mr.
Paulson alluded to the consumer credit plan vaguely in a news
conference on Wednesday, and some Fed officials cautioned that they had
seen few details. But Treasury officials said such a plan would give
them the biggest bang for the buck and might be enacted within several
weeks.

Mr. Paulson conceded that he had scrapped the plan he
originally sold to Congress in September, which was to have the
Treasury Department buy hundreds of billions of dollars worth of
illiquid mortgage-backed securities in order to free up banks to resume
normal lending.

The program is still called the Troubled Asset
Relief Program, or TARP, but it will not buy troubled assets. “Our
assessment at this time is that this is not the most effective way to
use TARP funds,” Mr. Paulson said.

Instead, Treasury will step
up its program of injecting capital directly into banks and, for the
first time, expand it to include financial companies that are not
federally regulated banks or thrifts.

Mr. Paulson made it clear he would not use Treasury money to help bail out the automobile industry, rebuffing pleas from General Motors, Ford and Chrysler as well as from top House and Senate Democrats.

But
Mr. Paulson left open the prospect of providing backdoor support to the
car companies by offering to recapitalize nonbank financial companies
like GE Capital and CIT Financial, and the financing subsidiaries of
Ford, Chrysler and G.M.

House
Democrats are already drafting legislation that would provide Detroit’s
Big Three with an additional $25 billion, on top of $25 billion in
low-interest loans that are supposed to be used for retooling factories
for energy-efficient cars.

“The consequences of a collapse of the American automobile industry would be particularly troublesome,” said Barney Frank,
Democrat of Massachusetts and chairman of the House Financial Services
Committee. Mr. Frank said the assistance would come with strict
conditions aimed at protecting taxpayers.

Some Republican
lawmakers have already objected, saying the effort would amount to
throwing good money after bad. But the White House on Wednesday left
the door open to a legislative compromise with Congress.

“I know
the automakers are important to the United States,” Mr. Paulson said.
“We care about the automobile industry.” But he cautioned that “my
focus is on the financial sector — getting credit going, getting
lending going.”

White House and Treasury officials have been
devising policy on the fly for months now, as what began as a panic
over losses on subprime mortgages broadened into a crisis that wreaked
havoc on Wall Street, at major commercial banks and in the broader
economy itself.

In September, Mr. Paulson went to Congress and
urgently pressed for authority to spend as much as $700 billion to
unclog the nation’s financial pipelines by buying up unsellable
securities from banks and other financial institutions.

But by the time Congress approved the bailout law in early October, Mr. Paulson and the chairman of the Federal Reserve, Ben S. Bernanke,
were already shifting to a strategy he had actually opposed: buying
equity stakes directly in American banks, a move that was reminiscent
of European-style nationalization.

As recently as a few days ago,
Treasury officials insisted that they still intended to buy up the
troubled assets. But by late October, it had become clear that Plan A
had become little more than a sideshow.

“Illiquid assets looked like the way to go,” Mr. Paulson told reporters
at a news conference on Wednesday. But as economic and financial
conditions declined so rapidly, he said, that he had to change gears.
“I will never apologize for changing the approach and the strategy when
the facts change,” he said.

The change in strategy has had only limited impact on the frozen
credit markets. The biggest improvement has been in the willingness of
banks to lend to each other, a change that largely caused by the
willingness of both the United States and European governments to
guarantee bank deposits and interbank loans.

But the market for commercial debt backed by consumer and business loans has remained at a near standstill since Lehman Brothers, one of Wall Street’s leading investment banks, collapsed in September.

Borrowing costs for credit card issuers are at least five percentage points higher than they were before the credit crisis
began. Financing costs for automobile lenders are even higher. Even
student loans that are guaranteed by the federal government have been
difficult to finance.

“You have a market that is frozen,” said Alex Roever, an analyst at JPMorgan Chase.

To
stretch his resources, Mr. Paulson told reporters he was examining
ideas to have private investors contribute capital alongside Treasury.

Mr.
Paulson also made it clear he did not want to use bailout money to
refinance the mortgages of homeowners who are in danger of losing their
homes to foreclosure. Democratic lawmakers and the chairman of the Federal Deposit Insurance Corporation, Sheila C. Bair, have been calling for the Treasury to spend $40 billion in a broad mortgage refinancing program.

As
envisioned by Treasury officials, the Federal Reserve would set up a
new special-purpose lending entity, which would lend cash to investors
or companies that put up collateral in the form of consumer loans. The
Fed might lend up to 80 percent of the value of those loans, providing
a cushion for taxpayers against losses.

The Treasury would
contribute 5 percent to 10 percent of the money to finance the lending.
But the Fed would raise most of the money by selling what is known as
nonrecourse commercial paper to investors.

Treasury
officials said the plan would allow them to leverage the government’s
money by as much as 20 to 1, meaning that the Treasury would provide 5
percent of the money and investors would provide 95 percent. Using $50
billion in money from the government rescue program, they said, could
thus underwrite $1 trillion worth of lending for consumer loans.

Such
an arrangement would bear a similarity to exactly the highly leveraged,
and eventually disastrous, special-investment vehicles that banks like Citigroup created in countless numbers to hold, among other things, securities backed by subprime mortgages.

Although
the Treasury would contribute only a small share of the money for such
a program, analysts said the plan would only overcome investor fears if
the Treasury or the Federal Reserve provided some kind of backstop
against losses. If that were to be the case, taxpayers would be
indirectly liable for the entire volume of lending.

Fed
officials appeared to be taken aback by Mr. Paulson’s public reference
to the idea, and cautioned that it was still in early development.

“Both the structure and the parameters are under discussion and development,” said Michele A. Smith, a spokeswoman for the Fed.

Source: New York Times

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