WASHINGTON — The Bush administration swung for the fences Friday with an unprecedented bailout of the financial sector that will cost taxpayers "hundreds of billions of dollars." It jolted markets back to life for the day, but questions remained about whether the bold effort would actually work.
Truth is, no one knows. America and its financial markets haven't been down this road before.
A deeply troubled housing market is at the root of the nation's financial problems, and the plans announced by Treasury Secretary Henry Paulson address some elements of this problem.
But the plan is silent on many other important areas.
The urgency behind Paulson's plan, say experts, comes from fears that what started as a problem in housing finance would spread to other areas of the economy in a way not seen since the 1930s.
"We are in danger of not having the money to finance auto loans," Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, said Friday as he discussed the deepening crisis on C-Span. "We were in danger of there being enormous damage to the financial system."
Congressional leaders from both parties agreed to work through the weekend to craft legislation that would authorize the Bush administration's plan to buy up all of the mortgage-backed securities at the root of the problem and get them off the books of banks and other lenders.
Paulson announced the plan Friday, saying he would work with Congress to craft a "mechanism" to take responsibility for the securities, which are made up of mortgage loans that have been packaged together, then sold to outside entities that earn their profits through the mortgage payments made against the individual loans.
No one knows, however, precisely how much money is tied up in those securities. Paulson estimated that the cost of buying them will be in the "hundreds of billions of dollars." Others said the cost could be more than a half a trillion dollars. For comparison, the total size of U.S. debt is estimated at around $10 trillion.
Certainly, the plan's cost will dwarf the $124 billion taxpayers spent in the 1980s during the savings-and-loan crisis when a government entity, the Resolution Trust Corp., was created to take possession of and then sell off the bad assets of failed thrifts.
Analysts, however, said the risks of doing nothing were growing daily as other economic woes combined with the deep slump in home prices to push the already high mortgage default rate even higher.
"Now we're looking at higher unemployment, the economy stalled, and that could by itself lead to another wave of foreclosures that nobody has anticipated yet," said Rick Sharga, vice president of RealtyTrac, research company in Irvine, Calif., that provides widely followed statistics on foreclosures nationwide.
How bad is it? RealtyTrac expects about 2.8 million mortgages to be delinquent or in default by the start of 2009. And, said Sharga, there's likely to be 1 million bank-owned properties by the end of this year — independent of the Treasury plan — "which will make it difficult to keep prices from plummeting further."
"If we then layer on top of that a recession, or just significant job losses, then it is going to increase delinquencies ... then we will see things get worse," said Jay Brinkmann, chief economist for the Mortgage Bankers Association in Washington, D.C.
This will likely be the argument Democrats make over the next week as they push for another economic stimulus plan to help stave off recession. The key to avoiding recession, however, may be the degree to which Paulson can thaw frozen credit markets.
Paulson announced Friday several steps intended to shore up those markets.
■ The Treasury Department tapped a Depression-era tool, the Exchange Stabilization Fund, to provide $50 billion in insurance for investors who are in the $2 trillion money markets. Money-market mutual funds are considered among the safest of investments, but a big player in this market was unable to meet requests for redemptions Wednesday, and regulators feared the equivalent of a bank run on money-market funds.
■ The Federal Reserve announced that it was providing emergency loans to help commercial banks purchase asset-backed commercial paper from money markets. This move is important because it seeks to unfreeze the bank-to-bank lending that's vital for corporate America to fund its short-term cash-flow needs.
■ The Securities and Exchange Commission announced a temporary ban, for 10 days but extendable another 30 days, on short sales of 799 financial stocks. Short selling is a common practice in which investors bet that a stock is likely to decline in value. Banks and other finance companies have complained that short sellers were contributing to a sharp decline in their share prices.
■ Treasury and the Federal Housing Finance Administration will seek to grease the gears of mortgage lending by having Fannie Mae and Freddie Mac double, to $10 billion, the amount of mortgage-backed securities — mortgage bonds — that they can purchase. The government took over these two mortgage companies on Sept. 6, and they will be crucial to ending the housing slump.
But the biggest step — and the least concrete — was the decision to set up a way for the government to take over the risk of mortgage-backed securities.