Capital Markets

Paulson: Exorcise the Bad Assets from the System

In another government bailout, Treasury Secretary Paulson will work with Congress this weekend to find a legislative fix that will likely remove il...
Marie LeoneSeptember 19, 2008

The U.S. government is working to come up with a plan to remove “troubled assets from the financial system,” according to Treasury Secretary Henry Paulson. This likely means that the federal government will devise a plan to remove illiquid assets from the balance sheets of banks and other financial institutions to give them room to operate under their current regulated capital regime. Under current regulation, banks and financial institutions have to meet stringent capital ratio requirements to make sure they have a cash cushion to cover bad debt.

In a short press briefing held Friday morning, Paulson announced that he would be working with members of Congress this weekend to thrash out a legislative solution that would remove the frozen assets from the system. Paulson noted that the Treasury Department will propose its own legislative solution, and he hopes to have Congress take action next week to allow companies weighed down by bad mortgages to jettison them from their balance sheet.

Although the plan will likely cost taxpayers “hundreds of billions” of dollars, this latest government bailout is expected to “cost far less” than having Americans face financial failures and frozen markets that would hamper future expansion, asserted Paulson. The troubled asset relief program is “sufficiently large” and “big enough to make a real difference,” he added.

Reaction from CFOs is bound to be mixed as they reconcile the desperate need to stabilize the markets with a tendency to eschew government regulation and market intervention. Responding to Paulson’s plan, David Rickard, CFO of CVS/Caremark Corp., told, “In principle, I don’t like it at all, but in practice, he’s doing a hell of a job. He’s doing just the right thing to put it back together. I wish he didn’t have to do it. I’m glad we have somebody as strong as Paulson.”

Paulson said that once the troubled assets are exorcised from the financial system, the government will focus on improving financial regulation and structures as a way of stopping a replay of the situation in the future. He called current regulations “suboptimal, duplicative, and outdated,” and said the key to restoring strength to the financial markets is a “modernized financial oversight structure” that Treasury is currently working on.

The Treasury Secretary blamed the current credit and financial crisis on “lax lending practices that led to irresponsible lending and borrowing” in the mortgage markets, which has since resulted in 5 million American homeowners being either delinquent on mortgage payments or in foreclosure. Paulson said the ripple effect is not only that frozen or illiquid assets are on the books of banks and mortgage companies, but that securitized and repackaged mortgages are being held by all levels of investors.

Paulson also announced that the government would provide “critical additional funding” to the mortgage market to allow home-loan lenders Fannie Mae and Freddie Mac to increase their purchases of mortgage-backed securities.

Also on Friday, in other efforts to bring stability back to U.S. financial markets and boost liquidity, the Securities and Exchange Commission put a temporary ban on short-selling the stocks of 799 financial companies, the Treasury Department pledge $50 billion to guarantee the money market and mutual fund market, and the Federal Reserve Board announced it would buy short-term debt from Fannie Mae and Freddie Mac.