The Bailout Plan: Paulson's Pivot

The Treasury Dept. is steering away from the original intent of buying questionable mortgage-related securities—much to the chagrin of Wall Street

By Theo Francis

Treasury Secretary Henry Paulson signaled a significant shift on Nov. 12 in how the Bush Administration aims to apply the remaining $400 billion available under the federal government's bailout plan, saying the department would focus increasingly on consumer debt, nonbank financial companies, and homeowners facing foreclosure.

Paulson made clear he no longer plans large-scale purchases of questionable mortgage-related securities, the original model for the $700 billion financial-rescue plan.

In many ways, the change of course (BusinessWeek.com, 11/12/08) wasn't entirely unexpected. Just weeks after Congress passed the authorizing legislation, the Treasury instead announced a plan to invest more than a third of the money directly in banks. And while the agency maintained that it was working on a program to buy assets, in recent days Treasury officials sounded as if they were backing off the option, says Brian Gardner, a Washington analyst for Keefe, Bruyette, & Woods. "You really got the sense that the asset-purchase program was not going to happen," Gardner says.

Instead, the department plans to focus its energies on a wide range of nonhousing debt, encouraging private-sector investors to help shaky nonbank financial companies and reducing the home foreclosures that continue to depress the housing market, Paulson said.

The decision to abandon large-scale asset purchases could in itself help the financial system cleanse itself of the troubled assets.

Time for Private Buyers

While many hoped the Treasury's purchase program would help clarify what such assets were really worth—revitalizing the moribund private-sector market for them—others argue that private buyers might be willing to jump in but were holding off because of uncertainty over what the government would do. "Now that it's clear that the [Treasury] won't be a significant player in that market, we should see an increase in purchases of distressed mortgage assets," says Edward Gainor, a partner at the law firm McKee Nelson.

The Treasury's steps so far—including $250 billion earmarked for investment in banks—have worked to prevent a broader meltdown of the financial system, Paulson said. But more is needed. He offered few specifics but emphasized that the agency is looking well beyond residential mortgages now, at debt from credit cards, auto loans, student loans, "and similar products."

Like mortgages, much of this debt—about 40%—is securitized, meaning it has been divvied up among scores or hundreds of investors. As the credit markets froze this fall, little new debt has been issued by those channels. "Illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans, and credit cards," Paulson said in prepared remarks. "This is creating a heavy burden on the American people and reducing the number of jobs in our economy."

Paulson also said the Treasury and Federal Reserve are "exploring" ways to use the federal bailout funds to help finance private investors willing to return to the troubled market, at the same time that they strive to protect "taxpayers' investments." Similar efforts could also support lending for commercial and residential real estate.

Gardner, the Keefe Bruyette analyst, said the Treasury could use loan guarantees or credit enhancements—both tools available under the bailout legislation—to bolster these credit markets.