The Treasury Department has expanded its financial bailout program to $700 billion in an effort to relieve banks and other financial institutions of their troubled mortgage assets.
The bailout may even extend to other types of assets besides mortgage-backed securities. The Treasury indicated it wants to expand the bailout beyond U.S. financial institutions to foreign banks with "significant operations" in the U.S.
Over the weekend, the Federal Reserve granted Goldman Sachs and Morgan Stanley the ability to convert themselves into bank holding companies. The move will subject them to greater oversight by federal banking regulators, but will also enable them to avoid the use of mark-to-market accounting. Instead, they will be able to categorize assets as "held for investment."
The concept of fair value accounting has come under fire from critics who blame it for exacerbating the credit crisis. "To be sure, there is no question that implementing fair value in illiquid markets can be challenging and difficult and there are important questions to be asked," said Financial Accounting Standards Board Chairman Bob Herz in a speech last week in which he defended the concept. "Does it lead, reflect or lag reality? Are there genuine concerns over procyclicality? These are important questions and issues; but I would ask, what is the alternative? Not to try to be truthful about the current value of your assets, to use original cost or some other smoothed value that ignores current market conditions?"
Questions have been raised about how assets will be valued in such an illiquid market. In order for banks to be able to avoid recording steep losses on their books when they sell their assets to the Treasury bailout fund and exacerbate the financial crisis, they would need to value them at a sufficient level that they could realize a gain on the sale. However, under the type of "reverse auction" system that has been proposed, the Treasury would be buying the assets at the lowest price. Still, the Treasury Department recognizes that the need to get the troubled assets off the market is the main goal.
"As illiquid mortgage assets block the system, the clogging of our financial markets has the potential to significantly damage our financial system and our economy, undermining job creation and income growth," said the Treasury Department.
Under the department's proposal, the Treasury will have the authority to issue up to $700 billion of Treasury securities to finance the purchase of troubled assets. The purchases are intended to be residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans. Treasury Secretary Henry Paulson will also have the discretion, in consultation with Federal Reserve Chairman Ben Bernanke, to purchase other assets they deem necessary to effectively stabilize financial markets.
"Removing troubled assets will begin to restore the strength of our financial system so it can again finance economic growth," said the Treasury. "The timing and scale of any purchases will be at the discretion of Treasury and its agents, subject to this total cap. The price of asset purchases will be established through market mechanisms where possible, such as reverse auctions."
To qualify for the program, the assets must have been originated or issued on or before Sept. 17, 2008. "Participating financial institutions must have significant operations in the U.S., unless the secretary makes a determination, in consultation with the chairman of the Federal Reserve, that broader eligibility is necessary to effectively stabilize financial markets," said the Treasury.
Paulson urged Congress to act quickly to give the Treasury and the Federal Reserve the authority to buy up the troubled assets. Congress is scheduled to go into recess next week in the buildup to the November election, so the aim is to pass the legislation this week, even as the bailout package seems to be in flux.
Lobbyists from the banking and financial services industries have been pressing their case to expand the range of assets and institutions that can benefit from the bailout. Democratic lawmakers insisted the bailout package also include provisions to help homeowners and taxpayers. Among the proposals is one that would allow bankruptcy court judges to modify the terms of mortgages on primary residences. Recent legislation allowed bankruptcy court judges to modify the terms of mortgages only on second homes.
"A comprehensive and constructive proposal must include relief for millions of American homeowners facing foreclosure," said Senate Banking Committee Chairman Christopher Dodd, D-Conn. Other lawmakers have insisted that the legislation should be tied to an overall stimulus package that also provides money for infrastructure and unemployment benefits.
Paulson said the legislation should not be bogged down with extraneous measures, however. "We want this to be clean, and we want it to be quick, and it's urgent that we get this done," he said.
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