Following the European model, the Treasury willl announce this morning a new approach in the bailout effort. Significant amounts of the $700 billion of approved bailout funds will be used to purchase equity in banks. This is a somewhat different focus than the original idea to purchase directly the bad debt.
The equity purchase approach gives a boost in liquidity as it give banks more lending capital. Purchasing bad mortgages removes illiquid assets and improves the banks' balance sheet.
The stock purchase directly gives banks more capital. The bank can lend $10 for every $1 in capital. This can in a very significant way expand market liquidity.
The plan is to use up to $250 billion of the bailout funds to purchase equity.
Possibly another thought behind the shift in focus is that the mechanics of purchasing, servicing, modifying, and reselling the troubled mortgage assets has not been worked out. It will be a complicated and cumbersome process. Even though it sounds good, it is not an easy thing to accomplish.
Other features of the new direction include a plan to insure inter-bank loans and to remove the $250,000 on non-interest bearing accounts. These two measures are hoped will unfreeze the credit markets that have so severely restricted the conduct of business.
This plan was worked out in coordination with the G7 leaders and in communication with the heads of several major US banks through meetings called over the weekend and yesterday.
My biggest problem with the bailout was that it had not address the larger market problems. Mortgage defaults are a glaring issue for many reasons, but they are only a significant part of the larger problem. The bailout had seemed too focused on purchasing defaulting mortgages, ignoring the larger troubles in the economy.
Not to mention the fact that so many details were unresolved. Yesterday a statement was issued outlining the efforts to resolve the details of the bailout.
This new approach and focus, hinted at over the last several days, seems to give more emphasis on the larger economy. It still provides for the purchase of defaulted mortgages, but the mortgage purchases are now part of a larger plan.
I think it will work. And I think it can be done while protecting the US Treasury.
A final question though. Is this the start of a movement to nationalize our financial institutions? Will the government be ready to sell back the equities when it is time?
Richard Smith
American Acceptance Mortgage, Inc
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Richard, I agree with you that this is a good plan and hopefully it will work. It is however not unprecedented. The treasury did the same thing in 1930 during the depression. The difference its it was not quite enough to stabilize the market and bring back liquidity and it was not emplemented fast enough. Hopefully, we tackled this soon enough to avoid a bigger mess. The other thing is there are always clauses for the bank to sell and /or buy back the purchases stock. So basically we temporarily socialize things.
Bo
Bo,
A good part of what went wrong with the regulatory oversight had to do with relaxing some of the depression era controls.
I hope the coming regulations will not go much further than some updated version of Glass-Steagall.
I think the model for the government response is the Depression era actions, with the difference being that the government is acting quicker and using more resources.
There have been several updates and annoucements today since I first wrote the post. Just have not had time to keep up with them. I cannot wait to read through everything tonight.
Big movement - now we need just to get some buyers for bonds.
Richard,
Thanks for the post. I hope that the under funding of this proposal, doesn't backfire, causing more damage.
Hi Richard, a good post and explanation. What I read this evening is that backs are siting on the equity and not planning on making loans right now. Interesting that they feel the need to sit on all this.
McCain wants to fix the banks and then reprivatize them ASAP.