White House overhauling rescue plan

By Edmund L. Andrews and Mark Landler, The New York Times

As international leaders gathered here on Saturday to grapple with the global financial crisis, the Bush administration embarked on an overhaul of its own strategy for rescuing the foundering financial system.

Two weeks after persuading Congress to let it spend $700 billion to buy distressed mortgage-backed securities, the Bush administration has put that idea on the back burner in favor of a new approach, which would have the government inject capital directly into the nation’s banks — in effect, partially nationalizing the industry.

While the Treasury department says it still plans to buy up distressed assets, the scope of that plan is unclear. And the federal government meanwhile has directed Fannie Mae and Freddie Mac, the government-controlled mortgage giants, to ramp up their purchases of troubled mortgage bonds, in what could be a speedier and less formal process than the reverse auctions proposed by the Treasury.

The Federal Housing Finance Agency, which last month seized Fannie Mae and Freddie Mac and placed them into a conservatorship, has ordered the companies to buy substantially larger amounts of mortgage securities — mostly subprime or other classes of mortgages in default.

The new plan to buy stock in banks, which has become the administration’s primary focus, comes closer to a partial nationalization of the banking system than at any time since the Depression. In exchange for providing capital, the government would demand some kind of nonvoting minority stake.

The surprising turnaround by Treasury Secretary Henry M. Paulson Jr., announced Friday as part of a coordinated plan to rescue the financial industry, has raised questions about whether he squandered valuable time by trying to sell Congress a plan that he and other administration officials had failed to think through in advance.

It also raises questions about whether the administration’s deep philosophical hostility to government ownership in private companies aggravated the financial crisis by delaying rescue action.

Some experts now say they believe that the Treasury Department’s decision last month not to rescue Lehman Brothers with taxpayer money exacerbated the panic that quickly metastasized into an international crisis.

Underscoring the gravity of the situation, President Bush convened an early morning meeting at the White House on Saturday with finance ministers from the Group of 7 industrialized countries.

“All of us recognize that this is a serious global crisis, and therefore requires a serious global response, for the good of our people,” Mr. Bush said afterward in the Rose Garden, flanked by the ministers, who are in Washington for their annual meeting.

Mr. Bush said the countries had agreed to general principles in responding to the crisis, including working to prevent the collapse of important financial institutions and protecting the deposits of savers. But he offered no details on other measures, suggesting that there were still differences among countries about which steps to take to shore up their respective financial systems.

Like the United States, Britain plans to inject capital directly into banks. But the United States and other countries have not adopted Britain’s proposal to guarantee lending between banks as a way to unlock the credit market. Germany has been reluctant to put state capital directly into banks, though officials said there were signs of movement in the German position on Saturday.

Mr. Bush’s remarks came at the beginning of a day packed with meetings with finance ministers and other officials, as motorcades and limousines with tinted windows clogged downtown Washington.

Among the most closely watched gatherings was a meeting of the Group of 20 nations convened by Mr. Paulson. This group includes major emerging economies like China and Russia, which have enormous foreign reserves and are being viewed as a potential lifeline for smaller countries that run into financial trouble because of the crisis.

With European leaders planning to meet on Sunday, there are growing expectations of a joint announcement of measures to shore up European banks. Germany, which had been reluctant to inject state capital directly into banks, is now moving in that direction, officials said.

Some experts said the delay in carrying out the Bush administration’s $700 billion bailout plan has only hurt its prospects for success.

“Even if it was adequate before, it’s not adequate now,” said Frederic Mishkin, a professor of economics at Columbia University business school who stepped down as a Federal Reserve governor at the end of August. “If you delay and create uncertainty, the amount of money you have to put up goes up.”

As recently as late September, the idea of letting the government acquire part of the banking system had been unthinkable in the Bush administration. To many officials, such intervention seemed like a European-style government intrusion in the marketplace.

As recently as late September, the idea of letting the government buy part of the banking system had been unthinkable in the Bush administration. To many officials, such intervention seemed like a European-style government intrusion in the markets.

“Some said we should just stick capital in the banks, take preferred stock in the banks. That’s what you do when you have failure,” Mr. Paulson told the Senate Banking Committee on Sept. 23. “This is about success.”

Mr. Paulson told lawmakers it made more sense to jumpstart the frozen credit markets with “market measures,” by which he meant buying up assets rather than institutions. He staunchly resisted Democratic proposals to require that the government receive an equity stake in the companies it was helping.

But on Friday, Mr. Paulson not only confirmed his intention to buy stakes in banks but gave the idea central billing. “We can use the taxpayer’s money more effectively and efficiently, get more for the taxpayer’s dollar, if we develop a standardized program to buy equity in financial institutions,” Mr. Paulson said.

Treasury officials said they hoped to make the first capital investments within the next two weeks. That would be earlier than any government purchases of unwanted mortgage-backed securities. One reason for Mr. Paulson’s rapid reconsideration was that global financial markets have been going downhill faster than anyone had seen before.

Credit markets seized up and all but stopped functioning, making it impossible for most companies to borrow money on more than an overnight basis. Bank stocks plummeted, making it much more difficult to shore up their balance sheets by raising more capital from investors.

Investors panicked as the House initially rejected the bailout bill on Sept. 29. They panicked even more after Congress passed a bill on Oct. 3 that was packed with sweeteners that added $110 billion to the price tag.

By the closing bell last Friday, the Standard & Poor’s 500-stock index had suffered its worst week since 1933. A growing number of analysts argue that Mr. Paulson’s original plan, called the Troubled Assets Relief Program, would have been unhelpful and possibly unworkable. Some noted that Mr. Paulson presented Congress a proposal that was only three pages long and that Treasury officials have yet to provide details how the auctions will work.

As envisioned, the Treasury or its agents would hold so-called “reverse auctions” in which financial institutions are invited to compete against each other in offering to sell their mortgage-backed securities at a low price.

Though auctions are common for all sorts of products, including electricity that utilities sell one another, experts said that mortgage-backed securities would pose difficult headaches because they are extraordinarily complex, difficult to value and come in almost limitless varieties.

The bonds for a single pool of mortgages are divided into more than a dozen “tranches,” or slices, which have different seniority, different credit ratings and different rules for being paid off. The performance of the underlying mortgages varies greatly from one pool to another, even if both pools are made up of seemingly similar loans.

“I am not aware that the Treasury Department presented any evidence on auctions that have been successful when they are used for assets that are so heterogeneous,” said William Poole, who retired in August as president of the Federal Reserve Bank of St. Louis.

Because Fannie Mae and Freddie Mac, the mortgage giants, buy and sell mortgage securities every day, they could absorb some of the hard-to-sell securities without going through the untested auction process.

The Federal Housing Finance Agency, which last month seized the companies and placed them into a conservatorship, lifted capital restrictions on them last week and effectively gave them a green light to buy more mortgage securities of all types, including those backed by subprime loans, given to borrowers with weak credit.

The companies have a lot of money; Congress authorized Treasury to lend them as much as $100 billion each as part of the rescue plan created for them. That could free up money in the separate $700 billion bailout plan for injecting capital directly into the banks. People familiar with the early planning efforts for a systemic bailout said the chairman of the Federal Reserve, Ben S. Bernanke, argued that it would be easier and more efficient to inject capital directly into banks. But Treasury officials balked, in part because they were ideologically opposed to direct government involvement in business.

But as the financial markets spiraled further downward during the last 10 days, a growing number of top-tier institutions, including Goldman Sachs and Morgan Stanley, became worried about their survival.

“The crisis in confidence goes way beyond the actual losses that will be incurred from debt securities,” Mickey Levy, chief economist for Bank of America, said in an interview on Friday. “It’s truly incumbent on policy makers to address that crisis.”

Treasury officials began canvassing banks and investment firms about the possibility of having the government buy stakes in them. The new bailout law gave the Treasury the authority to buy up almost any kind of asset it wanted, including stock or preferred shares in banks.

Industry executives quickly told Mr. Paulson that they liked the idea, though they warned that the Treasury should not try to squeeze out existing shareholders. They also begged Mr. Paulson not to impose tough restrictions on executive pay and golden-parachute deals for executives who are fired.

Mr. Paulson heeded those pleas. In his remarks on Friday, he carefully noted that the government would acquire only “nonvoting” shares in companies. And officials said the law lets the Treasury write most of its own restrictions on executive pay, and those restrictions can be lenient if they are applied to a set of fairly healthy companies.