The United States surged into action on Friday to launch an all-out attack against the worst financial crisis since the Great Depression, readying a plan to tap hundreds of billions of dollars in taxpayer funds to buy up toxic mortgage-related debt.
Capping a week that has reshaped Wall Street, US Treasury Secretary Henry Paulson urged Congress to quickly agree on a programme for huge purchases of bad debts held by banks and other financial institutions.
Lawmakers promised fast action on the plan, which two banking industry sources put in the $500-billion to $800-billion range.
Losses on mortgage-related debts have choked the financial system, forced lenders into bankruptcy and led the economy to what US President George Bush called a ”pivotal” moment.
”America’s economy is facing unprecedented challenges, and we are responding with unprecedented action,” Bush told reporters in the White House Rose Garden.
After having taken a series of other emergency steps that failed to erect a firewall against the spreading credit turmoil, US authorities turned their attention to the underlying problem — the rising tide of bad mortgage debt.
Paulson offered few details on Treasury’s proposal but said he would work through the weekend and next week with Congress to get a programme put in place. The proposal being sent to lawmakers would run only a few pages, a source said. A congressional aide said staff on Capitol Hill would be briefed on the plan on Saturday morning.
Representative Steny Hoyer, the Democratic leader in the House of Representatives, said the chamber would likely take up a Bill to implement the programme early next week. House Speaker Nancy Pelosi said lawmakers would stay in town past their hoped-for adjournment next Friday if needed to pass it.
”We must now take further, decisive action to fundamentally and comprehensively address the root cause of our financial system’s stresses,” Paulson said at a news conference.
”We’re talking hundreds of billions. This needs to be big enough to make a real difference and get at the heart of the problem.”
US stocks, which chalked up their best day in six years on Thursday as talk of the more aggressive approach spread, soared again on Friday. The blue chip Dow Jones industrial average closed up 368 points, or about 3,4%.
The news also caused waves in the US presidential campaign. Republican hopeful Senator John McCain knocked the Treasury for taking a haphazard approach to the crisis, while rival Democrat, Sen. Barack Obama, supported the latest moves.
$1-trillion
Paulson and Federal Reserve chairperson Ben Bernanke have already put close to $1-trillion of taxpayer money on the line to try to keep credit flowing.
At a meeting with congressional leaders on Thursday night, Paulson and Bernanke made the case for aggressive action to get ahead of events that could devastate an already weak economy.
”When I heard his description of what might happen to our economy if we failed to act, I gulped,” Democratic Senator Charles Schumer of New York said, referring to Bernanke’s appraisal.
A congressional aide on a telephone conference call between the Fed, Treasury and lawmakers on Friday said Bernanke issued a stark warning: ”If Congress doesn’t act soon, there will be an economic meltdown.”
Fed spokesperson Michelle Smith declined to comment directly on the accuracy of the chairperson’s reported remark, but confirmed that he painted ”a dark scenario”.
At his news conference, Paulson said the latest plan was the best hope of ultimately protecting the public purse and avoiding a grave recession.
”I am convinced that this bold approach will cost American families far less than the alternative — a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion,” he said.
A Treasury official said hedge funds and non-US financial institutions would not be allowed to offload troubled assets under the plan.
The banking industry sources said ”reverse auctions” would be held to purchase $50-billion tranches of debt, which could include residential and commercial mortgages and mortgage-backed securities. One source said the purchases would then be made in further increments of $10-billion and that five outside asset managers would help run the auctions.
A Treasury spokesperson declined to comment on those details, although the Treasury did confirm asset managers would be hired.
Piling on debt?
The White House said it was too soon to say how the plan would impact the nation’s debt, and said it was possible many of the funds could be recovered as markets stabilise and currently bad assets are sold off.
An industry source said there would be no limit on how long the government could hold the debt, which would have had to have been on selling institutions’ books as of September 15.
A congressional aide said the issue of whether the government should receive warrants in companies offloading assets was under discussion. In addition, Democrats signaled they might try to use the legislation to put some limits on CEO pay and possibly extend further help to distressed homeowners.
The plan is reminiscent of the Resolution Trust Corporation, a government agency set up to help the nation out of the savings and loan crisis in the 1980s. The RTC, however, took whole institutions under its wing, whereas the new fund under discussion would remove bad assets from the balance sheets of financial institutions to help revitalise them.
One financial source briefed on calls made by the Treasury to Washington lobby groups said the Treasury feels it has the authority to take on these assets directly, and therefore won’t need to set up a separate agency.
Emergency actions
The emergency effort marked the latest dramatic government bid to prevent credit markets from freezing up over huge losses on subprime and other mortgage debt.
These have forced US investment bank Lehman Brothers Holdings into bankruptcy, Merrill Lynch into a hasty marriage with Bank of America, the Fed to bail out troubled insurer American International Group, and the government to seize control of mortgage finance giants Fannie Mae and Freddie Mac.
”The federal government must implement a programme to remove these illiquid assets that are weighing down our financial institutions and threatening our economy,” Paulson said.
The Treasury also said on Friday that it would siphon up to $50-billion from a fund established in the 1930s to conduct foreign exchange market intervention to backstop the rattled US money market mutual fund industry.
This long-safe corner of financial markets, home to about $3,5-trillion of deposits, has increasingly appeared at risk of falling victim to the year-old credit crunch. Money market fund assets dropped by a record $169,03-billion in the week ended September 17 as jittery investors pulled money out.
The Treasury said it would back money market funds whose asset values fall below $1 a share. Separately, the Fed said it would lend money to banks to finance purchases of certain assets from money market funds.
Paulson also said the administration would step up a programme announced this month to directly buy mortgage-backed securities in the market, and said Fannie Mae and Freddie Mac would also increase their buying to try to get credit flowing.
”They are absolutely petrified of … a run on financial assets,” said Boris Schlossberg at GFT Forex in New York. – Reuters