Government offers historic rescue plan
WASHINGTON — The Bush administration on Friday proposed a historic $500 billion bailout of financial firms that would let the government rather than the cold judgment of the marketplace decide the winners and losers from the crisis that has shaken the U.S. economy for the past year.
The plan, which would be the most sweeping government intervention in the markets since the Great Depression, calls for the Treasury to buy the troubled mortgage securities that have been toppling major financial firms and are at the heart of Wall Street's turmoil.
Millions of Americans could also benefit from other dramatic stopgap measures. Regulators announced efforts to stabilize the mortgage market; curb stock speculation; and insure money-market mutual funds with government money, seeking to protect ordinary investors and preserve a vital source of corporate finance.
The initiatives were precipitated in part by concern that scared investors would race to withdraw their holdings from money-market funds, which hold $3.5 trillion in investments, depleting a major source of short-term funding for corporations.
President Bush, who had remained largely silent as the crisis broadened this week, said it is a "pivotal moment for America's economy." In a Rose Garden speech remarkable for its grim language and ominous tone, Bush said: "This action does entail risk. But we expect that this money will eventually be paid back. ... The risk of not acting would be far higher."
Treasury Secretary Henry Paulson acknowledged that the federal government's previous policy of addressing corporate failures on a case-by-case basis had not stemmed the accelerating crisis. He said the new comprehensive strategy has a better chance of calming the turmoil that froze critical segments of the credit markets and sent stock markets into a tailspin earlier this week.
"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," Paulson said in a speech at the Treasury Department.
The Bush administration, Federal Reserve Chairman Ben Bernanke and congressional allies launched a major offensive Friday to persuade lawmakers to support Paulson's proposal. Because the plan needs the approval of Congress, officials from the Treasury and the Fed are worried that delay by lawmakers would spark fresh anxiety in the markets. They are working with congressional leaders to pass the plan by the end of next week, which would be extraordinarily quick for Capitol Hill.
"I am very optimistic that we can pass a balanced and comprehensive plan within a week," said Sen. Charles Schumer, D-N.Y., who chairs the Joint Economic Committee. "Chairman Bernanke made all too clear the cost of inaction."
Some lawmakers, including Sen. Richard Shelby, Ala., the ranking Republican on the Senate Banking Committee, have expressed concerns about the plan's cost, chance of success and possible unintended consequences. Such opposition could delay passage. "We are being asked to go 'all in' with taxpayer dollars, and once our government and the taxpayer is on the hook, there is no fallback option," said Rep. Jeb Hensarling, R-Texas, a leading conservative. "At the moment I remain skeptical, fearful and unconvinced that this is the proper remedy for our nation."
Paulson and Bernanke held a morning conference call with more than 100 House Republicans, making the case for their plan and describing in "strong and serious" terms the dire situation facing the financial system, according to a participant on the call.
Hours later, the House Republican leadership met with members and lobbyists to warn against cluttering the legislation with amendments or trying to delay its passage. The message, according to a person at the meeting: We want a clean bill.
The Dow Jones industrial average, which jumped between massive losses and gains this week, rose 3.3 percent Friday to close at 11,388.44. Combined with a 410-point gain Thursday, the index ended near break-even for the week — sweeping away Monday's 504-point loss. The Standard & Poor's 500-stock index, a broader measure, rose 4 percent Friday and actually posted a gain for the week.
"It's a massive relief rally on the back of the comprehensive plan," said Joseph Brusuelas, chief economist for Merk Investment. "If you have hundreds of millions of mortgage-backed securities on your books that you cannot value, much less sell, you can now unload them to the U.S. government."
Investors also moved out of the safety of Treasury and back into the broader market. On the expectation that the economy will now recover, the price of light, sweet crude oil jumped $6.67, to $104.55 a barrel, on the New York Mercantile Exchange.
The proposals unveiled Friday capped a dizzying two weeks in which the government has seized the mortgage-finance giants Fannie Mae and Freddie Mac; allowed the 158-year-old Lehman Brothers to collapse; and taken over American International Group, the largest insurer in the world.
In his speech Friday, Paulson identified the mortgage securities that the government would buy as the "underlying weakness in our financial system."
Mortgage securities provide the financing for most home loans sold in the United States and were widely held by big financial firms and banks. When home values started dropping, traditional buyers of these securities ran for the exits, and the value of the securities also plummeted. Those left holding the bag — mainly mortgage firms, big Wall Street banks and hedge funds — started to suffer vast losses, and some collapsed altogether.
Under the administration's plan, the Treasury would offer to buy the troubled mortgages from U.S. financial institutions. The Fed has been talking to its counterparts around the world to set up similar programs for other countries' banks.
The Treasury would hold several rounds of buying, first purchasing securities from the banks that request the lowest prices, in order to limit the cost to taxpayers. The plan could be broadened to include securities based on other kinds of loans, such as student loans and commercial real estate.
The U.S. government could end up holding the securities for years or even decades, depending on whether they recover value.
The troubled mortgage securities "are clogging up our financial system and undermining the strength of our otherwise sound financial institutions," Paulson said. "As a result, Americans' personal savings are threatened, and the ability of consumers and businesses to borrow and finance spending, investment and job creation has been disrupted."
Some Democrats said Friday that they are pushing for the Treasury to help the homeowners whose mortgages the securities finance avoid foreclosure, a debate that is expected to play out next week.
The timing of the administration's plan reflected in part mounting concern about money-market mutual funds, which were widely regarded as safe havens until the bankruptcy of Lehman Brothers caused a major fund to post a loss this week. Officials feared a massive run as investors withdrew about $200 billion during the week, including $50 billion on Thursday, according to Crane Data, which tracks the industry.
The problems accelerated as the massive withdrawals forced funds to sell assets at fire-sale prices. The Federal Reserve, trying to stanch the bleeding, said it would offer funding for banks to buy assets from the funds at normal prices.
The Treasury Department also announced that it would offer an insurance program for the funds that is similar to the long-standing government guarantee of bank deposits. Funds would pay a fee in exchange; if they collapse, the government repays investors.
But the Treasury intervention threatens to drain deposits from already-troubled banks because money-market funds offer higher interest rates and now will feature the same federal protection. People familiar with the matter said banking regulators were not consulted on the plan and were considering how best to limit the impact on banks.
The American Bankers Association released a letter to Bernanke and Paulson that said the government had acted in "great haste" and should reconsider.
"The program announced this morning runs the risk in the long run of profoundly changing the nature of our financial system and, specifically, undermining the nation's banking system," wrote ABA President Edward Yingling.
The Treasury further announced that Fannie Mae and Freddie Mac will increase their purchases of mortgage-backed securities. By buying more of these securities, the two firms will provide more money to fund mortgages and should decrease the interest rate on those mortgages.
The Federal Housing Finance Agency, the regulator overseeing Fannie Mae and Freddie Mac, said it had directed the companies to begin buying more mortgages but declined to say how much more they would buy. Though this could expose the companies to greater risks, FHFA Director Joseph Lockhart said government "examiners will continue to oversee that such activities are done in a safe and sound manner."
Paulson also said the Treasury would expand its plan to buy mortgage-backed securities to supply additional money to Fannie Mae, Freddie Mac and the overall mortgage market. The government plans to buy $10 billion in mortgage securities in the next month, up from $5 billion earlier this year.
— Staff writers Dan Eggen, Zachary A. Goldfarb, Neil Irwin, Paul Kane, Renae Merle, Lori Montgomery and Steven Mufson contributed to this report.