New direction for rescue plan

Cash injections favored over mortgage purchases

 

I found this article and read it. it has very interesting information that can be helpful.

 

 

The Bush administration today announced a change of course in its implementation of the $700 billion Troubled Asset Relief Program, with most of the initial $350 billion authorization now earmarked to buy preferred stock in banks rather than mortgage-backed securities and whole mortgage loans.

Part of a global response to the credit crisis that officials said was necessitated by the continued reluctance of banks to loan each other money — is intended to restore lending by recapitalizing banks.

Investing directly in banks instead of buying up their troubled assets will allow for a faster deployment of money the U.S. Treasury Department was authorized to borrow under the rescue package approved by Congress and signed into law by President Bush Oct. 3.

That could help ease fears banks have had in recent weeks about lending money to each other, which has pushed up short-term interest rates that are tied to adjustable-rate mortgages. Most subprime and alt-A adjustable-rate mortgage (ARM) loans are tied to the six-month dollar London Interbank Offered Rate, which has risen dramatically in recent weeks.

In addition to investing in banks, the Bush administration has instructed the Federal Deposit Insurance Corp. to insure loans between banks and provide full coverage of non-interest-bearing accounts such as business payroll accounts above the current $250,000 limit. The program will be funded through special fees and does not rely on taxpayers, the FDIC said.

LIBOR for three-month dollar loans fell 12 basis points to 4.64 percent today, down from a high for the year of 4.82 percent on Oct. 10 — a sign that the plan by the U.S. and other major economic powers to provide money directly to banks is already having an effect.

But if Congress blocks Treasury from accessing the remaining $350 billion of the $700 billion envisioned for TARP, the plan detailed today by the Bush administration today leaves only about $100 billion to buy up troubled assets like mortgages and mortgage-backed securities.

That could mean the government will have less influence to prevent foreclosures by arranging workouts and loan modifications for troubled borrowers whose debt it owns or has an interest in — a goal outlined by the Treasury Department Monday (see story).

If the government scales back purchases of troubled assets, it may also take longer to unfreeze secondary markets where mortgage-backed securities not backed by Fannie Mae and Freddie Mac are traded — meaning jumbo loans will continue to be harder to find and more expensive than conventional, conforming loans.

Objectives unchanged

The thinking behind the program revealed by Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke today is “a little different than the reasons they (gave Congress in September about) why they needed the $700 billion,” said Lawrence Yun, chief economist for the National Association of Realtors.

But Yun said the overall goal of the program remains the same — to provide capital to the financial system to restore the flow of credit. Instead of buying troubled assets like mortgage-backed securities from banks and financial institutions, the new strategy is to buy preferred stock in the banks, providing them with a cash infusion in exchange for an ownership share for taxpayers.

“The goal was, the financial market was clogged, and the way to unclog it is provide capital to the system,” Yun said. Originally, Paulson and Bernanke emphasized plans to purchase troubled loans and other assets so banks and financial institutions could take them off balance sheet. “Now the strategy seems to be give them the money directly in exchange for ownership,” Yun said — a power granted to Treasury by the legislation authorizing the TARP program.

The government is expected to take ownership stakes totalling $125 billion in nine of the nation’s largest banks, with Citigroup, JPMorgan Chase, Bank of America and Wells Fargo each receiving $25 billion. The government will buy another $125 billion in preferred stock of hundreds or thousands of small and mid-size banks by the end of the year.

In announcing the plan, President Bush called the shift in strategy an “essential short-term measure to ensure the viability of America’s banking system.” He said the program “is carefully designed to encourage banks to buy these shares back from the government when the markets stabilize and they can raise capital from private investors.”

Partial authorization

The Emergency Economic Stabilization Act of 2008 gave the Treasury Department initial authorization to borrow up to $350 billion to fund the Troubled Asset Relief Program, with $250 billion available immediately and the remaining $100 billion available if the president certified it was needed. Congress reserved the right veto the final $350 billion of what was envisioned as a $700 billion program.

The president today certified that Treasury needs the authority to borrow the full initial $350 billion authorization. With $250 billion earmarked for purchasing preferred stock in banks, it appears that for the moment only $100 billion is left for the TARP program to purchase mortgages and mortgage-backed securities.

“One impact of the prior plan (as originally pitched by the administration to Congress) was the potential of working out loans so foreclosure pressure is lessened,” Yun said. “Just providing capital to the system does not do that.”

Dick Lepre, a loan agent for San Francisco-based Residential Pacific Mortgage who writes about economic issues and mortgage markets, said that the numbers put forward by the administration today may merely be posturing to convince Congress not to block Treasury from borrowing the final $350 billion.

“They will probably need the whole $700 billion, and I think Congress should go back and say, ‘You seem to know what you’re doing, here’s the whole thing,’ ” Lepre said.

Structuring the TARP bill so that Congress has veto power over the remaining $350 billion debt authorization is like “having to decide to increase the budget for the fire department while the fire is still burning,” Lepre said.

The Treasury Department said it remains committed to moving forward with plans to purchase troubled assets, and announced today that it had hired Bank of New York Mellon to provide accounting, auction management and other services needed to portfolio of troubled assets it will purchase.

Other companies vying for TARP contracts include LandAmerica Financial Group Inc., which said today it wants to provide whole loan asset management services for portfolios of troubled mortgage-related assets.

LandAmerica says its eZLoanOptimizer service could help the Treasury Department project the future performance of a portfolio, identifying loans with the greatest potential for loss while recommending specific steps to reduce losses and retain borrowers.

Will it work?

But the administration’s plan may have been to make direct investments in banks all along, Lepre said. Buying troubled assets at less than their face value would still have left banks without the capital ratios needed to expand lending, he said.

The plan outlined today addresses two problems, Lepre said: It provides liquidity while preserving capital, and also includes protections for taxpayers by giving them an interest in the banks that receive a capital injection.

Taking an ownership stake in the banks will make it easier for them to raise capital from private sources, Lepre said, because instead of depleting banks’ capital by buying their assets at a discount, the government is building it up.

“It makes the whole thing (investing in banks) more attractive,” Lepre said. “If you are a hedge fund or a Warren Buffet wanting to take an investment in a bank, now you’ve got the Fed’s capital working with you, not against you.”

The big question is whether banks will use the additional capital they are getting to make loans, Lepre said.

“(The government) can’t say that if you don’t lend the money, we’re going to take it back,” Lepre said. But banks can’t make money without making loans, Lepre said, so they have an economic incentive to use their new capital the way the government intends them to.

Yun said that because the government has placed mortgage financiers Fannie Mae and Freddie Mac in conservatorship and provided a financial backstop, the market for residential mortgage loans eligible for purchase and guarantee by Fannie and Freddie has remained stable. That means home buyers eligible for conventional, conforming loans can find them at affordable rates.

But the credit crisis has restricted the availability of commercial mortgages — something the new plan to recapitalize banks should help, Yun said.

“The fundamentals (in) commercial real estate are doing much better than residential, but credit flow into commercial is frozen because of the global credit crisis,” Yun said.

Not only do banks need to lend money to businesses, but money market funds need to get back into the commercial paper market to get the economy healthy, Lepre said. Businesses issue commercial paper to fund their short-term operations, and money market funds have traditionally been big purchasers of such debt because it was considered a safe investment.

But the failure of Lehman Brothers generated losses that threatened to “break the buck” at some mutual funds — an almost unheard of situation in which mutual fund investors faced the prospect of getting back less than $1 out for each $1 they put into such funds, which are uninsured.

To stop a run on mutual funds, the Treasury Department on Sept. 19 created a fee-based program to guarantee existing deposits for one year. But with mutual fund managers still wary of buying commercial paper, the Federal Reserve today announced it would begin buying commercial paper beginning Oct. 27.

“I think they are on the right track — they are getting liquidity into the market in such a way as to preserve net bank capital,” Lepre said of the government’s plan to take an ownership stake in banks.

As for the long-term impact on mortgage rates, Lepre thinks that while yields on Treasurys could rise, the “spread” — the difference in rates between bonds that fund mortgages and Treasurys — may come down. With the government standing behind Fannie Mae and Freddie Mac’s debt, there’s no reason for investors to expect to be rewarded for a risk that’s not there.

“When the dust settles, here, there are some serious reasons that Treasury yields should be higher,” Lepre said. “I don’t know how mortgages will relate to that, because mortgages are overpriced with regard to Treasurys. But we could see Treasury yields rise, and the (spread) between (Treasurys and bonds backing mortgages) return to more classic levels.”

That, along with the reduced risk of inflation posed by the slowdown in the global economy, is why Lepre sees rates for 30-year fixed-rate mortgages staying in the range of 6 3/8 percent for the near future.

Restoring confidence

David Crow, who is in charge of regulatory and housing policy for the National Association of Home Builders, said that financial markets “seem to be taking this as a reasonable way to restore confidence in the banking system.” But home builders still want to see the government begin buying up troubled assets, he said.

In the past, Paulson has argued that once the government started buying up mortgage-backed securities and other troubled assets that investors don’t know how to value, the private sector would follow suit. With the precedent set by competitive reverse auction purchases, investors would have a better idea what such troubled assets would be worth to “buy and hold” — an alternative to their fire-sale value, Paulson has said.

Even if Treasury used the entire $700 billion debt authorization to purchase troubled assets, that would not be nearly enough to buy all such investments that are out there, Crowe said. But it might spark a “free market resolution” to the credit crunch.

“If the reasonable presumption is that one reason these assets are sitting on the banks’ books is because no one knows what they are worth, and the government can establish that … that could induce the markets to say, ‘That’s reasonable,’ and begin trading again,” Crow said of the theory.

Restoring investor confidence in mortgage-backed securities not backed by Fannie Mae and Freddie Mac could make jumbo loans more available and affordable again.

For now, jumbo loans are funded almost exclusively by “portfolio lenders,” such as banks, who make loans against their deposits and hold the mortgages for investment, rather than securitizing them for sale on Wall Street.

As long as that’s the case, home buyers seeking jumbo loans shouldn’t expect to see much relief from the rescue package, Crowe said. “You would hope this unlocking (of credit markets envisioned by Paulson) would move to that sector, but I feel lending institutions are also concerned about (falling) house prices,” Crowe said. Lenders “are afraid of moving outside the avenue (of loans) securitizable by Fannie, Freddie or FHA. I think we need a recovery in the housing market to see a recovery in the jumbo-loan market.”

Susan Woodward, who has served as a chief economist for both the U.S. Department of Housing and Urban Development and the Securities and Exchange Commission, says that better valuations of troubled assets will also help restore investor confidence in banks that can demonstrate they have “truly adequate capital.”

In a Washington Post opinion piece today, Woodward said there’s simply no point in the Treasury buying stock in insolvent banks “only to have it gobbled up by losses.”

The Treasury could better control the cost of the rescue plan if it began with the best available estimates of mortgages’ “hold-to-maturity” values, she said — recommending that experts at Fannie Mae be employed to do just that

 

The Bush administration today announced a change of course in its implementation of the $700 billion Troubled Asset Relief Program, with most of the initial $350 billion authorization now earmarked to buy preferred stock in banks rather than mortgage-backed securities and whole mortgage loans.

The new direction — part of a global response to the credit crisis that officials said was necessitated by the continued reluctance of banks to loan each other money — is intended to restore lending by recapitalizing banks.

Investing directly in banks instead of buying up their troubled assets will allow for a faster deployment of money the U.S. Treasury Department was authorized to borrow under the rescue package approved by Congress and signed into law by President Bush Oct. 3.

That could help ease fears banks have had in recent weeks about lending money to each other, which has pushed up short-term interest rates that are tied to adjustable-rate mortgages. Most subprime and alt-A adjustable-rate mortgage (ARM) loans are tied to the six-month dollar London Interbank Offered Rate, which has risen dramatically in recent weeks (see Inman News story).

In addition to investing in banks, the Bush administration has instructed the Federal Deposit Insurance Corp. to insure loans between banks and provide full coverage of non-interest-bearing accounts such as business payroll accounts above the current $250,000 limit. The program will be funded through special fees and does not rely on taxpayers, the FDIC said.

LIBOR for three-month dollar loans fell 12 basis points to 4.64 percent today, down from a high for the year of 4.82 percent on Oct. 10 — a sign that the plan by the U.S. and other major economic powers to provide money directly to banks is already having an effect.

But if Congress blocks Treasury from accessing the remaining $350 billion of the $700 billion envisioned for TARP, the plan detailed today by the Bush administration today leaves only about $100 billion to buy up troubled assets like mortgages and mortgage-backed securities.

That could mean the government will have less influence to prevent foreclosures by arranging workouts and loan modifications for troubled borrowers whose debt it owns or has an interest in — a goal outlined by the Treasury Department Monday (see story).

If the government scales back purchases of troubled assets, it may also take longer to unfreeze secondary markets where mortgage-backed securities not backed by Fannie Mae and Freddie Mac are traded — meaning jumbo loans will continue to be harder to find and more expensive than conventional, conforming loans.

Objectives unchanged

The thinking behind the program revealed by Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke today is “a little different than the reasons they (gave Congress in September about) why they needed the $700 billion,” said Lawrence Yun, chief economist for the National Association of Realtors.

But Yun said the overall goal of the program remains the same — to provide capital to the financial system to restore the flow of credit. Instead of buying troubled assets like mortgage-backed securities from banks and financial institutions, the new strategy is to buy preferred stock in the banks, providing them with a cash infusion in exchange for an ownership share for taxpayers.

“The goal was, the financial market was clogged, and the way to unclog it is provide capital to the system,” Yun said. Originally, Paulson and Bernanke emphasized plans to purchase troubled loans and other assets so banks and financial institutions could take them off balance sheet. “Now the strategy seems to be give them the money directly in exchange for ownership,” Yun said — a power granted to Treasury by the legislation authorizing the TARP program.

The government is expected to take ownership stakes totalling $125 billion in nine of the nation’s largest banks, with Citigroup, JPMorgan Chase, Bank of America and Wells Fargo each receiving $25 billion. The government will buy another $125 billion in preferred stock of hundreds or thousands of small and mid-size banks by the end of the year.

In announcing the plan, President Bush called the shift in strategy an “essential short-term measure to ensure the viability of America’s banking system.” He said the program “is carefully designed to encourage banks to buy these shares back from the government when the markets stabilize and they can raise capital from private investors.”

Partial authorization

The Emergency Economic Stabilization Act of 2008 gave the Treasury Department initial authorization to borrow up to $350 billion to fund the Troubled Asset Relief Program, with $250 billion available immediately and the remaining $100 billion available if the president certified it was needed. Congress reserved the right veto the final $350 billion of what was envisioned as a $700 billion program.

The president today certified that Treasury needs the authority to borrow the full initial $350 billion authorization. With $250 billion earmarked for purchasing preferred stock in banks, it appears that for the moment only $100 billion is left for the TARP program to purchase mortgages and mortgage-backed securities.

“One impact of the prior plan (as originally pitched by the administration to Congress) was the potential of working out loans so foreclosure pressure is lessened,” Yun said. “Just providing capital to the system does not do that.”

Dick Lepre, a loan agent for San Francisco-based Residential Pacific Mortgage who writes about economic issues and mortgage markets, said that the numbers put forward by the administration today may merely be posturing to convince Congress not to block Treasury from borrowing the final $350 billion.

“They will probably need the whole $700 billion, and I think Congress should go back and say, ‘You seem to know what you’re doing, here’s the whole thing,’ ” Lepre said.

Structuring the TARP bill so that Congress has veto power over the remaining $350 billion debt authorization is like “having to decide to increase the budget for the fire department while the fire is still burning,” Lepre said.

The Treasury Department said it remains committed to moving forward with plans to purchase troubled assets, and announced today that it had hired Bank of New York Mellon to provide accounting, auction management and other services needed to portfolio of troubled assets it will purchase.

Other companies vying for TARP contracts include LandAmerica Financial Group Inc., which said today it wants to provide whole loan asset management services for portfolios of troubled mortgage-related assets.

LandAmerica says its eZLoanOptimizer service could help the Treasury Department project the future performance of a portfolio, identifying loans with the greatest potential for loss while recommending specific steps to reduce losses and retain borrowers.

Will it work?

But the administration’s plan may have been to make direct investments in banks all along, Lepre said. Buying troubled assets at less than their face value would still have left banks without the capital ratios needed to expand lending, he said.

The plan outlined today addresses two problems, Lepre said: It provides liquidity while preserving capital, and also includes protections for taxpayers by giving them an interest in the banks that receive a capital injection.

Taking an ownership stake in the banks will make it easier for them to raise capital from private sources, Lepre said, because instead of depleting banks’ capital by buying their assets at a discount, the government is building it up.

“It makes the whole thing (investing in banks) more attractive,” Lepre said. “If you are a hedge fund or a Warren Buffet wanting to take an investment in a bank, now you’ve got the Fed’s capital working with you, not against you.”

The big question is whether banks will use the additional capital they are getting to make loans, Lepre said.

“(The government) can’t say that if you don’t lend the money, we’re going to take it back,” Lepre said. But banks can’t make money without making loans, Lepre said, so they have an economic incentive to use their new capital the way the government intends them to.

Yun said that because the government has placed mortgage financiers Fannie Mae and Freddie Mac in conservatorship and provided a financial backstop, the market for residential mortgage loans eligible for purchase and guarantee by Fannie and Freddie has remained stable. That means home buyers eligible for conventional, conforming loans can find them at affordable rates.

But the credit crisis has restricted the availability of commercial mortgages — something the new plan to recapitalize banks should help, Yun said.

“The fundamentals (in) commercial real estate are doing much better than residential, but credit flow into commercial is frozen because of the global credit crisis,” Yun said.

Not only do banks need to lend money to businesses, but money market funds need to get back into the commercial paper market to get the economy healthy, Lepre said. Businesses issue commercial paper to fund their short-term operations, and money market funds have traditionally been big purchasers of such debt because it was considered a safe investment.

But the failure of Lehman Brothers generated losses that threatened to “break the buck” at some mutual funds — an almost unheard of situation in which mutual fund investors faced the prospect of getting back less than $1 out for each $1 they put into such funds, which are uninsured.

To stop a run on mutual funds, the Treasury Department on Sept. 19 created a fee-based program to guarantee existing deposits for one year. But with mutual fund managers still wary of buying commercial paper, the Federal Reserve today announced it would begin buying commercial paper beginning Oct. 27.

“I think they are on the right track — they are getting liquidity into the market in such a way as to preserve net bank capital,” Lepre said of the government’s plan to take an ownership stake in banks.

As for the long-term impact on mortgage rates, Lepre thinks that while yields on Treasurys could rise, the “spread” — the difference in rates between bonds that fund mortgages and Treasurys — may come down. With the government standing behind Fannie Mae and Freddie Mac’s debt, there’s no reason for investors to expect to be rewarded for a risk that’s not there.

“When the dust settles, here, there are some serious reasons that Treasury yields should be higher,” Lepre said. “I don’t know how mortgages will relate to that, because mortgages are overpriced with regard to Treasurys. But we could see Treasury yields rise, and the (spread) between (Treasurys and bonds backing mortgages) return to more classic levels.”

That, along with the reduced risk of inflation posed by the slowdown in the global economy, is why Lepre sees rates for 30-year fixed-rate mortgages staying in the range of 6 3/8 percent for the near future.

Restoring confidence

David Crow, who is in charge of regulatory and housing policy for the National Association of Home Builders, said that financial markets “seem to be taking this as a reasonable way to restore confidence in the banking system.” But home builders still want to see the government begin buying up troubled assets, he said.

In the past, Paulson has argued that once the government started buying up mortgage-backed securities and other troubled assets that investors don’t know how to value, the private sector would follow suit. With the precedent set by competitive reverse auction purchases, investors would have a better idea what such troubled assets would be worth to “buy and hold” — an alternative to their fire-sale value, Paulson has said.

Even if Treasury used the entire $700 billion debt authorization to purchase troubled assets, that would not be nearly enough to buy all such investments that are out there, Crowe said. But it might spark a “free market resolution” to the credit crunch.

“If the reasonable presumption is that one reason these assets are sitting on the banks’ books is because no one knows what they are worth, and the government can establish that … that could induce the markets to say, ‘That’s reasonable,’ and begin trading again,” Crow said of the theory.

Restoring investor confidence in mortgage-backed securities not backed by Fannie Mae and Freddie Mac could make jumbo loans more available and affordable again.

For now, jumbo loans are funded almost exclusively by “portfolio lenders,” such as banks, who make loans against their deposits and hold the mortgages for investment, rather than securitizing them for sale on Wall Street.

As long as that’s the case, home buyers seeking jumbo loans shouldn’t expect to see much relief from the rescue package, Crowe said. “You would hope this unlocking (of credit markets envisioned by Paulson) would move to that sector, but I feel lending institutions are also concerned about (falling) house prices,” Crowe said. Lenders “are afraid of moving outside the avenue (of loans) securitizable by Fannie, Freddie or FHA. I think we need a recovery in the housing market to see a recovery in the jumbo-loan market.”

Susan Woodward, who has served as a chief economist for both the U.S. Department of Housing and Urban Development and the Securities and Exchange Commission, says that better valuations of troubled assets will also help restore investor confidence in banks that can demonstrate they have “truly adequate capital.”

In a Washington Post opinion piece today, Woodward said there’s simply no point in the Treasury buying stock in insolvent banks “only to have it gobbled up by losses.”

The Treasury could better control the cost of the rescue plan if it began with the best available estimates of mortgages’ “hold-to-maturity” values, she said — recommending that experts at Fannie Mae be employed to do just that.

Source Inman News

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