AIG to U.S.: Keep the Change

The Wall Street Journal

Insurer Sees Taxpayer Profit in Pending Repayment Deal; Greenberg Weighs In

 

The board of American International Group Inc. and the company's federal overseers were locked in discussions Wednesday night to finalize a plan that would boost the government's stake in the giant insurer to about 92%, and eventually allow the giant insurer to extricate from U.S. ownership.

AIG Chairman Robert "Steve" Miller, at a conference in New York on Wednesday morning, said that U.S. government could end up earning a profit on its investment in AIG. More than $120 billion in taxpayer aid committed to the bailout of the insurer currently remains outstanding.

AIG officials are hoping that providing clarity on the plan will enable the company to raise money from the financial markets on its own again in six to 12 months, Mr. Miller said.

The exit plan principally addresses the government's $49 billion investment in AIG from Treasury's Troubled Asset Relief Program, which was set up two years ago to provide capital infusions to institutions during the financial crisis. Treasury plans to convert all the preferred shares it holds into AIG common shares, which would raise the government's stake in AIG to around 92% from 79.8% currently, according to people familiar with the matter. Treasury would then sell the shares over time to exit the investment.

The Federal Reserve Bank of New York is separately trying to recoup $19.7 billion in secured debt from AIG and $26 billion from sales of the company's two largest overseas life insurance businesses.

Determining the price at which to exchange its preferred shares for AIG common shares has been a sticking point in strategy discussions, people familiar with the matter say.

Converting at a discounted price could position taxpayers to reap a profit, but it also could put pressure on the stock price, making it harder for the government to sell its shares. Converting at a higher price—such as one above the current market price for AIG shares—would result in the government taking a smaller stake in AIG and would potentially generate profits for private shareholders at the expense of U.S. taxpayers.

Treasury officials, including chief restructuring officer James Millstein, have told company officials they don't want to set a price that would present a bonanza for hedge funds or other private investors including former chief executive Maurice R. "Hank" Greenberg, according to people familiar with the matter.

"I think that's disgraceful to say they don't want me or shareholders to make money," said Mr. Greenberg, AIG's longtime leader who left in 2005 amid an accounting probe.

Mr. Greenberg remains one of the company's private shareholders and most-vocal critics of AIG's government bailout.

He also challenged the view, held by some federal officials, that it will take around a year and a half for the U.S. government to completely dispose of its stake.

"I think it's going to take years, maybe a decade or more, for [the government] to sell down over 90% of the company," Mr. Greenberg said in an interview.

"As soon as they try to sell the stock it will go down," making further sales more difficult, he predicted on Wednesday.

Analysts acknowledged Treasury's dilemma.

"They don't want to damage the stock yet again, as that could hurt the company's value and introduce additional uncertainty, but they also cannot look like they are protecting private shareholders," says Angelo Graci, an analyst at Chapdelaine Credit Partners in New York. He says that many steps that AIG and the government have taken in the past two years have been aimed at improving AIG's value in the eyes of investors, to facilitate future sales of the government's shares.

On Wednesday, AIG shares closed up 13 cents to $37.45 a share.

Behind AIG and government officials' optimism is what they see as an improving outlook for the insurance businesses that will form the core of the company after it completes sales of its major overseas life-insurance units and non-core assets in the coming months.

AIG and Prudential Financial Inc. are expected to announce as soon as Thursday a sale to Prudential of two Japanese life-insurance units for a combined $4.8 billion, according to a person familiar with the deal.

AIG is holding on to a global property- and casualty-insurance business and a U.S. life-insurance and retirement-services business, both of which were hit hard by customer and employee defections in the wake of the bailout two years ago, but have since stabilized in some part.

The government's ability to sell its AIG shares will depend on how a large number of outside investors view AIG's value as a smaller insurance company, and their willingness to invest in an entity that will be majority owned and controlled by the government for some time.

The company has a relatively small shareholder base which holds $5 billion worth of shares, and few equity analysts have been covering AIG since its 2008 government bailout. AIG and its representatives also need to convince major credit-rating firms that the company can achieve a strong rating on its own without government support.

Watchdog: Small Banks Struggling despite Bailouts

Associated Press

 

To the list of economic woes squeezing small banks, add another one: government bailouts.

The Treasury Department's bailout program was designed with Wall Street megabanks in mind, according to a new report from a congressional watchdog. The "one-size-fits-all" program may actually be hurting small banks that are struggling to repay the money or even deliver quarterly dividend payments, the report says.

The main bank bailout program anticipated banks springing back from the crisis and raising fresh funds to repay the government, the report says.

That's exactly what happened to most of the big banks that took the most bailout money. Yet small banks continue to struggle, dragged down by souring loans for commercial real estate and high unemployment. Hundreds more small banks are expected to fail by the end of next year.

The 690 small banks that took bailout money are even worse off, according to a report Wednesday from the Congressional Oversight Panel, which monitors the $700 billion financial bailout. Already, one in seven has failed to pay a quarterly dividend due to Treasury. They can't afford the payments, which will nearly double in 2013.

Treasury spokesman Mark Paustenbach disputed the findings, saying in a statement that the bailouts helped many of the banks "weather the storm and continue to extend credit in the economy."

But the bailouts' costs are troubling because of small banks' crucial role in lending to small businesses and supporting economic recovery, said Elizabeth Warren, who chairs the panel.

The program "was not intended as a bailout for Wall Street," said Warren, who also is a professor at Harvard Law School. "It was intended to support ... homeownership, retirement savings and banks across the country."

Warren said the bailout bill, known as the Trouble Asset Relief Program, did stabilize the financial system. But she said that was only one of the program's goals. She said efforts to boost lending and support consumers have been less successful.

"There is very little evidence to suggest that the (bailouts) led small banks to increase lending," the report says.

In the end, that could mean that the biggest banks get even bigger, the report says. Dozens or hundreds of bailed-out banks could collapse or consolidate because they can't afford their obligations to taxpayers, it says. That would leave the handful of biggest banks with an even larger share of the banking system.

"The result could be that 'too big to fail' banks grow even bigger," Warren said.

The Congressional Oversight Panel was created by Congress to report on whether the bailouts are meeting their goals. The law also requires regular audits by the Government Accountability Office and creates a special inspector general to investigate fraud and other problems.

Financial Bailout Extended To October

Fox News

WASHINGTON -- Treasury Secretary Timothy Geithner announced Wednesday that the administration will extend the government's financial bailout program until next fall.

In a letter to House and Senate leaders, Geithner said the extension is "necessary to assist American families and stabilize financial markets."

Money from the $700 billion taxpayer-funded bailout program has helped rescue big Wall Street firms, auto companies and others. That's angered many Americans, who feel the government hasn't provided them with relief from high unemployment and rising home foreclosures.

Geithner said the Troubled Asset Relief Program that Congress passed in October 2008, will be extended until Oct. 3, 2010. He has the authority to extend the TARP simply by notifying lawmakers.

"The recovery of our financial system remains incomplete," Geithner told lawmakers. "And, near-term shocks to that system could undermine the economic recovery we have seen to do."

The Treasury secretary said new commitments bankrolled by the bailout fund will be limited to three areas next year.

One focus is stepping up efforts to curb record-high home foreclosures, a move necessary to stabilize the housing market and support a lasting economic recovery.

Another will be providing capital to small banks, which play a crucial role in providing credit to small businesses -- normally a leading engine of job creation. But small banks have been weighed down by problem commercial real estate loans, which has made them reluctant to lend and hurt the ability of small businesses to expand and hire.

In a third area, Geithner said the government may boost its commitment to a program aimed at sparking lending to consumers and small businesses. Run by Treasury and the Federal Reserve, the Term Asset-Backed Securities Loan Facility, or TALF, started in March.
Geithner said he didn't expect any new commitments to the TALF would result in additional costs to taxpayers.

Bailed Out Companies Spend Millions On Lobbying
Story from the Washington Post

Top recipients of federal bailout money spent more than $10 million on political lobbying in the first three months of this year, including aggressive efforts aimed at blocking executive pay limits and tougher financial regulations, according to newly filed disclosure records.

The biggest spenders among major firms in the group included General Motors, which spent nearly $1 million a month on lobbying, and Citigroup and J.P. Morgan Chase, which together spent more than $2.5 million in their efforts to sway lawmakers and Obama administration officials on a wide range of financial issues. In all, major bailout recipients have spent more than $22 million on lobbying in the six months since the government began doling out rescue funds, Senate disclosure records show.

The new lobbying totals come at a time of mounting anger in Congress and among the public over the actions of many bailed-out firms, which have bristled at attempts to cap excessive bonuses and have loudly complained about the restrictions placed on hundreds of billions of dollars in government loans. Administration officials said this week that top officials at Chrysler Financial turned away a $750 million government loan in favor of pricier private financing because executives didn't want to abide by new federal limits on pay.

The reports revived objections from advocacy groups and some lawmakers, who say firms should not be lobbying against stricter oversight at the same time they are receiving billions from the government through the Troubled Assets Relief Program, or TARP.

"Taxpayers are subsidizing a legislative agenda that is inimical to their interests and offensive to what the whole TARP program is about," said William Patterson, executive director of CtW Investment Group, which is affiliated with a coalition of labor unions. "It's business as usual with taxpayers picking up the bill."

But several company representatives said yesterday that none of the money borrowed from the government has been used to fund lobbying activities — though there is no mechanism to verify that. Financial firms have successfully quashed proposed legislation that would explicitly ban the use of TARP money for lobbying or campaign contributions.

'Very complicated policy debates'
GM spokesman Greg Martin said that maintaining a lobbying presence is vital to ensure that the automaker has a say when major policy decisions are made. "We are part of what is arguably one of the most regulated industries, and we provide a voice in very complicated policy debates," Martin said.

According to quarterly lobbying reports that were due Monday, more than a dozen financial firms and carmakers that have received TARP assistance spent money on lobbying during the first three months of this year. After Citigroup and J.P. Morgan Chase, top lobbyists included American Express, Wells Fargo Bank, Goldman Sachs and Morgan Stanley.

Most of the companies spent less on lobbying this year than they did during the first quarter of 2008. J.P. Morgan, for example, spent $1.43 million in early 2008, compared with $1.31 million this year. Others, however, showed increased spending, including Capital One Financial, which doubled its quarterly lobbying expenditures to more than $400,000.

The lobbying records do not yet include campaign contributions by corporate lobbyists. Bank of America, for example, which spent $660,000 on lobbying in the first quarter, also gave more than $218,000 in campaign contributions through its PAC, according to the Federal Election Commission.

The Citigroup lobbying report provides a glimpse of the troubled company's interests in Washington, including credit card rules, student loan policies, and patent and trademark issues. Citigroup chief executive Vikram S. Pandit and other company officials lobbied fiercely against a House bill approved in March that would have placed a 90 percent tax on bonuses for traders, executives and bankers earning more than $250,000 at firms that had been bailed out by taxpayers. The proposal stalled in the Senate.

Citigroup spokeswoman Molly Meiners said the company "specifically prohibits the use of TARP funds for lobbying-related activities" and said the funds "are subject to an oversight and approvals process."

Owning Citi is No Party, Partner
From CNN Money

Citigroup's health is slowly improving, but the bank's owners are stuck paying for its costly rehabilitation.

The New York-based financial giant returned to the black Friday after five quarterly losses, saying it swung to a $1.6 billion profit. Citi cited stronger trading results and a 23% drop in operating costs, driven by 13,000 job cuts during the latest quarter.

But common shareholders, who are the ultimate owners of the struggling bank, are still waiting to enjoy the fruits of CEO Vikram Pandit's turnaround push.

That's because as accounting rules dictate, Citi calculated its profit before deducting the costs related to preferred shares. The bank has issued these in droves in recent years, to the government and private investors alike, in a bid to bolster its capital cushion against souring loans and trading bets gone bad.

Paying for the preferred shares has gotten expensive, as a look at Friday's earnings statement shows. In the first quarter alone, Citi paid out $1.2 billion in preferred stock dividends. It also took a $1.3 billion hit when the price on some convertible preferred shares it sold in January 2008 reset.

Those costs come out of common shareholders' pockets - which is why the bank ended up posting a loss of 18 cents a share in a quarter that was otherwise profitable.

The unusual split - a profit for the bank but a loss for the shareholders - highlights the cost of the blizzard of preferred stock Citi has issued since Pandit took over at the end of 2007.

In his first two months at the bank's helm, Citi issued $30 billion in preferred shares to private investors around the globe. Since last fall, the bank has issued an additional $45 billion of preferred stock to the government.

Despite the huge sums raised by Citi via the preferred share sales, investors have continued to fret about the health of the bank's balance sheet as real estate prices tumble and more consumers fall behind on their auto and credit card payments.

In hopes of quelling worries about the bank's capital and ending talk of nationalization, the government announced a plan in February to convert the bulk of Citi's preferred shares to common shares.

Citi said Friday that the conversion, which had been scheduled to take place this month, will be delayed until regulators complete their stress tests on the 19 biggest U.S. banks. Results are expected by early May.

As a result of the swap, private sector holders of existing preferred shares will end up owning 38% of Citi and taxpayers will own 36%.

The conversion will reduce Citi's preferred dividends. That should mean that when Citi posts a profit in future quarters, common shareholders will share in them.

But the downside for current shareholders is that the preferred-to-common conversion will result in the issuance of billions of new common shares - which will reduce their stake in the company by three-quarters.

Still, given how poorly Citi has done since the collapse of the credit boom nearly two years ago - it had rung up $28 billion in losses since its last profit back in the third quarter of 2007, and saw its shares dip below a dollar each earlier this year - investors and taxpayers will gladly take even modest progress.

And there were signs Friday that Citi is, like the other giant financial institutions that have posted their first-quarter numbers this month, enjoying the benefits of cheap government-backed funding and less competitive financial markets.

Thanks to federal programs that allow big financial companies to borrow at low, subsidized rates, Citi's net interest margin - the difference between the bank's lending rates and its borrowing costs - rose half a percentage point from a year ago, to 3.3%.

Like its rivals JPMorgan Chase and Goldman Sachs, Citi posted a strong quarter in its trading business. The bank's securities and banking unit posted a first-quarter profit of $2 billion, reversing the year-ago loss of $7 billion, which was driven by writedowns of Citi's exposure to subprime mortgage securities.

Citi said revenue at its fixed income markets business hit $4.7 billion, "as high volatility and wider spreads in many products created favorable trading opportunities."

But as with its peers, there are questions as to whether Citi will be able to replicate that trading performance in coming quarters.

More than half of the first quarter's fixed income revenue - $2.5 billion worth - came from a valuation adjustment on Citi's derivatives books, mostly due to a widening of the bank's credit default swap spreads.

Credit default swaps are insurance-like contracts. Widening spreads reflect a greater belief that a company may not be able to pay back its debt. So in a sense, Citi was profiting from increased bets that it and other banks were in danger of failing. Those fears may subside a bit following the release of the stress test results.

Consumer credit headaches loom

Perhaps more alarming for Citi -- as well as JPMorgan, Wells Fargo and Bank of America, which will report its first-quarter results Monday -- is just how high losses on consumer loans such as credit cards could go later this year.

Citi's North American cards business swung to a $209 million loss in the first quarter, reversing the year-earlier $537 million profit. Credit costs - reflecting loans gone bad and expenses tied to reserving against future losses - nearly doubled.

The surging losses reflect "rising unemployment, higher bankruptcy filings and the housing market downturn," Citi said - national trends that show few signs of slowing any time soon.

Altogether, credit losses on the global cards business rose to 9.49% in the first quarter from 5.39% a year ago.

But consumers also appear to be doing a better job of keeping their cards in their wallets. The company reported an 18% decline in North American credit card purchase sales during the quarter. This drop will add to the pressure on the company's card portfolio.

Those declines were mitigated somewhat, however, by a rise in interest and fee revenue, as already debt-laden consumers ran bigger balances on their cards and made smaller payments.

So no matter how you look at the results, it seems that the taxpayer -- especially those who also happen to be Citi customers -- still have little reason to celebrate with the bank's return to profitability.

Wagoner's Eviction from GM Serves Notice to Other CEOs
Story from the Wall Street Journal

If any U.S. banks need more cash from the government, they might have to sacrifice their chief executive to get it.

The Obama administration's ouster of General Motors Corp. CEO Rick Wagoner under the threat of withholding more bailout money underscored the potential pressure on top executives of large banks being evaluated by Treasury Department stress tests to see if they need additional capital.

Treasury Secretary Timothy Geithner said Sunday that some financial institutions would be found lacking as a result of the examinations. If those banks can't raise the money from private investors and so turn to the government, the jobs of some chief executives could be on the line, according to some bank analysts and lawyers.

Asked whether another round of government help following the stress tests would trigger regulatory encouragement to fire executives, Jeff Davis, the director of research at Howe Barnes Hoefer & Arnett Inc. said: "Emphatically, yes."

"You've got to figure it is coming," Mr. Davis said.

Banks are much more tightly regulated than automobile manufacturers, and it isn't unusual for bank regulators to demand changes in top management. But those changes are usually done discreetly, by pushing the board to fire the CEO, said Sanford Brown, a managing partner with law firm Bracewell & Giuliani LLP who served in the Office of the Comptroller of the Currency during the late 1980s.

"Regulators usually don't make overt demands," he said.

In addition, while CEO dismissals might satisfy public outrage at bankers, such moves could deepen concerns among investors, said Kip A. Weissman, a partner at Luse Gorman Pomerenk & Schick PC. "It would be a massive vote of non-confidence " in the banking industry, he said.

Among the bank CEOs considered vulnerable by some analysts and investors are C. Dowd Ritter, chairman and chief executive of Regions Financial Corp., a regional bank based in Birmingham, Ala. Regions is struggling with rising losses tied to commercial and residential real-estate loans.

A bank spokesman said Monday: "Regions remains well capitalized and we do not see a correlation with what is going on with the U.S. auto industry."

Like Mr. Wagoner of GM, Mr. Ritter led his company during the period leading up to its financial troubles.

Government Will Back Some GE Loans

General Electric Co. said its GE Capital financial-services arm would participate in the federal government's new debt-guarantee program, making it the first company with significant industrial operations to tap the program.

Joining the program could make it easier for GE to issue new debt in coming months. In recent months, investors have worried about GE's liquidity, and the price it has to pay to borrow money.

"It allows us to source our debt competitively with other financial institutions that are eligible," said Russell Wilkerson, a GE spokesman. GE said it expects to qualify for the program by Friday.

CEO Jeffrey Immelt, seen last year, plans to shrink GE's finance unit.

GE said Wednesday that under the program, the government will guarantee as much as $139 billion in long- and short-term debt through next June. But, Mr. Wilkerson added, "This does not mean that GE intends to issue this amount of debt."

With roughly $600 billion in assets, GE Capital is as big as some large banks. The finance unit last year supplied almost half of GE's profit. But GE Chairman Jeffrey Immelt this September said he would shrink the unit in response to the credit crisis. GE Capital issues loans for everything from aircraft engines to commercial real estate and restaurant equipment.

The debt-guarantee program is the second major federal initiative prompted by the credit crisis that GE has tapped. The company also participates in a program under which the government buys short-term debt known as commercial paper.

Until September, GE relied on selling commercial paper to obtain more than 15% of the funding of the finance unit. But investors began shying away from commercial paper after Lehman Brothers Holdings Inc. filed for bankruptcy protection and several other big financial players struggled. GE has said it would reduce its reliance on commercial paper, but it wasn't clear how the company would replace that funding.

Nigel Coe, an analyst at Deutsche Bank, said in a note that GE had "retained a greater degree of strategic and operational flexibility" by taking advantage of the government's debt guarantee. But Mr. Coe said it could cost GE as much as $1 billion to tap the full guarantee. He also said that the fact that GE feels the need to join the program could "amplify" that the credit market remains under stress.

Keith Sherin, GE's chief financial officer, said that even after paying for the insurance, it would still be cheaper for GE to issue debt backed by the federal program.

Stock investors had little reaction to the news, which was announced in midafternoon. GE shares changed hands at $16.29 in 4 p.m. composite trading on the New York Stock Exchange, down $1.52, or 8.5%.

"I think it will take a little time for this info to be understood by the market," Mr. Sherin said.

GE said it was eligible to participate in the Federal Deposit Insurance Corp.'s Temporary Liquidity Guarantee Program because it owns a federal savings bank and a Utah industrial bank whose deposits are insured by the FDIC.

U.S. Auto Makers Seek Bailout for Bad Car Loans

Relief Plan, Part of Original Wall Street Rescue Package, Could Free Up Loans for Car Dealers as Well as Their Customers

As Congress revises a bailout plan for Wall Street, U.S. auto companies hope the new package will stem a growing credit crisis that threatens to further crimp their industry.

The original $700 billion Wall Street deal, which was rejected by the House on Monday, included a substantial bailout for auto lenders. These companies hold a stable of bad auto loans that could shrink in value and hurt both the lenders and the vehicle makers. This bailout would have been separate from the $25 billion in low-cost loans for U.S. auto makers that President Bush signed into law Tuesday.

Unsold Ford pickup trucks sit at a dealership in Centennial, Colo. Ford is among big auto makers seeking a bailout for car loans that went bad.

Because of constrained capital, GMAC LLC, partially owned by General Motors Corp.; Ford Motor Credit; and Chrysler Financial, which finances Chrysler LLC's vehicles, have tightened lending standards in recent months. The tightening happened just as the lenders decided to pull out of the risky practice of leasing vehicles, which had long represented about 20% of new-vehicle financing arrangements. The combination of tougher-to-get loans and absence of leasing stung auto makers during the summer selling season.

A Washington bailout of bad car loans could loosen the flow of financing for potential car buyers and spark demand for new cars and trucks. It likely would free up funds that could be invested in securities backed by auto loans, bringing down borrowing costs for auto lenders.

In August, tight credit caused General Motors to lose sales of roughly 10,000 to 12,000 vehicles, the car maker said. When extrapolated across the entire U.S. industry, that was the equivalent of 40,000 lost sales, or about $1 billion in revenue.

The growing credit crunch in the auto industry is expected to have wreaked havoc on September vehicle sales, which will be reported Wednesday. Research firm J.D. Power & Associates expects a 26% volume decline compared with the same month in 2007.

"There are still quite a few deals getting done, but they require a lot more work and a lot more back-and-forth between the bank and the dealer," said Earl Hesterberg, chief executive of Houston-based dealer chain Group 1 Automotive Inc. "It's become significantly more difficult, particularly in the last month."

John Bergstrom, owner of the Bergstrom Automotive Group dealership chain in Wisconsin, said the buyers having the most trouble are those who are trading in a car they have owned for just a few years. Because they don't have much equity in their vehicle, or may even owe more on the loan than the car is worth, banks increasingly are requiring these buyers to produce hefty down payments.

"The challenge is affordability," Mr. Bergstrom said. "People's bills are getting higher, and then they're squeezed on gasoline and they're squeezed on milk and so forth. When they look at a car, they say they can't really afford them."

The tightening also has hit dealers as the car makers' finance arms raise the cost of the "floor plan" credit they offer dealers to buy cars for their inventory. Dealers typically repay lenders for these loans as each vehicle is sold.

Existing bonds made up of floor-plan loans of the three auto-finance arms total $25.8 billion, according to data provider ABSNet. Ford Motor Credit and GMAC lead with $12.7 billion and $10.6 billion, respectively. Both companies have had unprecedented trouble attracting investors in floor-plan assets in recent months, people familiar with the matter have said.

That has prompted the finance companies to get tougher on dealers with weak finances, raising their rates and fees for some. This makes it costlier for dealers to buy cars, eroding their margins. In addition, dealer inventories are getting leaner, meaning potential car buyers have fewer options to choose from.

And since GMAC and Chrysler Financial are both controlled by private-equity group Cerberus Capital Management LP, each is now being run to maximize profits, not auto sales. Last week, one of GM's largest Chevrolet dealers, Bill Heard Enterprises, closed all 14 of its dealerships after GMAC canceled the dealer's credit line.

By: Aparajita Saha-Bubna
Wall Street Journal; October 1, 2008

Rescue May Not Revive Economy

Recession Is Likely as Pillars of Growth Continue Erosion

The plan to bail out the U.S. financial system Congress hammered out over the weekend offers a much-needed salve to ailing credit markets, but it is unlikely to prevent the economy from sliding into recession.

"There will be some benefits of this plan, but we think the economy's already gone too far to prevent enough damage," said J.P. Morgan chief economist Bruce Kasman.

Recent news on the economy has been bleak. In a sign that the housing market continues to deteriorate, sales of new homes dropped sharply last month, the Commerce Department reported last week. Another report showed sales of big-ticket items also fell in August, pointing to deterioration in the factory sector and a drop in business spending.

"The business sector has been probably the most important source of resilience through the last year," Mr. Kasman said, and as companies slash spending layoffs could worsen. His firm now says a U.S. recession began during the second half of this year.

Economists polled by Dow Jones Newswires expect that this Friday's employment report will show the economy shed 105,000 jobs in September. Meanwhile, consumer confidence is weak and weekly readings on retail sales show that shoppers are cutting back on spending.

Consumer spending is also under serious strain, and is poised to decline during the third and possibly fourth quarter of this year, which would mark the first quarterly spending drop since the 1990-91 recession. Americans are grappling with rising unemployment and higher prices on fuel and food. In the midst of a financial crisis centered on falling home prices and fractured mortgage markets, a 2001-style mortgage refinancing boom isn't in the cards.

"The plan cannot prevent a recession," said Brookings Institution senior fellow Douglas Elmendorf. "What matters for people is how long and deep any economic slowdown is."

Until this point, the government response to the crisis has been ad hoc rescues of financial institutions that didn't do enough to prevent fears in the credit market from spreading, Mr. Elmendorf said. Without a more comprehensive move from the government, credit market participants would have been absorbed with worrying over which institution was going to fail next, leading to a sharp slowdown in lending that could cause a prolonged recession. The rescue is aimed at restoring confidence to the market.

While the plan may help heal the financial markets, it may not be a direct boon to the ailing U.S. economy. The major pillars of economic growth -- consumer and business spending, government spending, and exports -- are already crumbling. Foreign demand for U.S. goods, which has helped the factory sector avoid a deeper downturn this year, is expected to dry up as the world's major economies flirt with recession and fast-growing nations like China and India lose momentum.

The bailout includes a plan for the government to facilitate loan modifications and lower the number of foreclosures next year. That could help slow the swelling inventory of unsold homes that continue to depress the housing market. But it does not resolve the more fundamental problem of home prices that, relative to rents, still appear too high.

"The housing market still has further to fall, regardless of what we do with credit-default swaps and mortgage securities," said University of California, Berkeley economist Barry Eichengreen.

Further home price declines could bring more trouble to the financial markets as more loans go sour. Even under the best circumstances, Mr. Eichengreen expects a recession that will bring the unemployment rate to 8% from the current 6.1%.

Still, the bailout could act as a defibrillator, jolting activity in financial markets back to life and hopefully preventing a deeper exacerbation of the economy's woes. It could give would-be investors a sense that they should buy now, said Wrightson ICAP economist Lou Crandall.

Under the plan, hundreds of billions of dollars-worth of mortgage-related assets that were being sold at fire-sale prices are going to be drained out of the system by the Treasury. Buyers who were on the sidelines, opportunistically waiting for undervalued securities to get even cheaper will now have to act.

"This may restart the market for these kinds of assets," Mr. Crandall said.

By: Justin Lahart and Kelly Evans
Wall Street Journal; September 29, 2008

Bailout Gives Fed, Bernanke Key Roles

The government's planned $700 billion bailout for the financial sector is likely to give the Federal Reserve an important oversight role and accelerate plans to change the way the Fed manages interest-rate policy.

Fed Chairman Ben Bernanke is expected to play a key role in implementing the $700 billion bailout.

Fed Chairman Ben Bernanke, who lobbied Congress for the rescue package, almost certainly will play a key role in its implementation. Early drafts of the law being considered Sunday would place the Fed chairman on an oversight board meant to monitor the new program, a role Mr. Bernanke effectively invited last week in testimony to Congress.

"I think it's very appropriate, indeed essential, for Congress to have very tough oversight over this program and that there be a set of principles under which the program operates and that there be close oversight," Mr. Bernanke said.

It's not uncommon for lawmakers to turn to the Fed for other government duties because of the Fed's reputation for nonpartisanship and technical skill. Former Fed chairman Alan Greenspan served on the oversight board of the Resolution Trust Corp., the 1990s program created to sell off assets of failed thrifts. And after Sept. 11, 2001, then-Fed Governor Edward Gramlich was named chairman of the Air Transportation Stabilization Board to oversee federal loan guarantees to airlines that suffered losses during the terrorist attacks. Fed Vice Chairman Donald Kohn later became the board's chairman.

Under the rescue plan, lawmakers also sought to give the Fed more flexibility in how it runs its operations. According to drafts circulating on Sunday, lawmakers would accelerate the date the Fed could begin paying interest on the reserves banks leave on deposit with the central bank, something it doesn't do now. Such a step would give the Fed more flexibility, by making it easier for the central bank to keep short-term interest rates at their targeted level.

Congress had planned to allow the Fed to begin paying interest on reserves in October 2011, but the draft of the rescue law permits that to happen next week instead.

Currently, the Fed manages interest rates through transactions with banks using its stockpile of Treasury securities holdings. In recent months, the Fed has put that stockpile to other uses -- including lending out those Treasury securities to Wall Street firms in need of reliable collateral to fund their operations. By paying interest on reserves banks leave with it, the Fed would be able to keep short-term interest rates where it wants them, and potentially widen its use of its balance sheet for other purposes.

Central bank officials return to work Monday with short-term bank funding markets still in deep distress, something that last week prompted the Federal Reserve Bank of New York to inject repeated rounds of cash into the global financial system, through arrangements with other central banks to send dollars oversees and through its own direct market operations.

The $700 billion rescue plan will help to alleviate pressure on the Fed in other ways. By helping banks to take bad assets off of their own balance sheets, it lowers the likelihood of the kind of market chaos that shocked officials in the past two weeks. Through its lending operations, the Fed has taken riskier assets on to its own balance sheet in recent months.

"This plan uses fiscal policy to help fix a balance sheet problem in America's financial system and provides a capital infusion for the system itself, which is something that the Fed really could not do," said Richard Berner, Morgan Stanley economist.

The continuing Fed role in the $700 billion bailout is also bound to keep Mr. Bernanke in the political spotlight. Throughout the crisis, Fed officials sought to let the Treasury and Congress handle cases that might involve the direct use of taxpayer funds. Even when the Fed had the lead role, such as dealing with potential financial-system disruptions from Bear Stearns's failure, the Fed deferred to Treasury Secretary Henry Paulson and consulted with lawmakers before acting.

But Treasury officials made sure to keep the Fed close at their side. When Treasury officials planned their initial response to Fannie Mae and Freddie Mac in July, seeking greater congressional authority over the two firms, Mr. Paulson included a provision giving the Fed a "consultative role" with another regulator in setting the two firms' capital requirements.

The Fed chairman joined Mr. Paulson at emergency meetings with President Bush and congressional leaders 10 days ago to urge quick action. Over the course of the following week, he participated in numerous conference calls and private meetings along with three long hearings.

By: John Hilsenath and Sudeep Reddy
The Wall Street Journal; September 30, 2008

Pandora's Bailout

"Clean and quick," whistled Henry Paulson past the mortgage crematoria. The Treasury secretary's hope for expedited passage of his bailout plan may be realized, but clean and quick won't describe its implementation. You wanted a bailout; you got a revolution.


This column has advocated injecting the money at the level of the collateral -- buying and demolishing the least-wanted, market-souring homes in the subprime hot zone of Florida and the Southwest. This solution really would be clean, quick, would minimize the subsidy to bad actors, could be turned off as soon as it had served its purpose, and would involve no sticky issue of whether to bail out foreign banks along with U.S. ones.

Instead, Treasury's plan is to enter the market at a higher level, buying the depressed mortgage securities supported by these houses. In brief and eye-opening remarks in the Senate yesterday, Ben Bernanke spun a scenario in which derivative mortgage debt would be boosted in market value closer to the value of the underlying cash flow, restoring the banking system to solvency. Then why not just let banks value them that way on their books now, so they aren't teetering on insolvency? Wait for it. We'll get there, but not now apparently.

Nor does the Paulson plan have the Occamite virtue of cutting to the heart of the problem, the housing market. So many mortgage cash flows have been sliced and diced and spread over different kinds of securities owned by holders all over the world -- a big stumbling block to the private sector trying to manage its way out of a hole. It's not clear the new agency offers a solution to this problem. It would probably have to buy the entire outstanding stock of questionable mortgage debt before it would have any hope at getting at the underlying collateral, i.e., houses. But then it would become the world's biggest, most troubled landlord and biggest forecloser on homes. Politics would intervene -- and any potential taxpayer gains would likely be frittered away to keep nonpayers in houses they can't afford.

"No bailouts" makes a nice slogan, but taxpayers are already on the hook for half the nation's mortgages through Fannie, Freddie and the FHA. And nobody wants to find out what total meltdown of confidence in the financial system feels like. But with Chris Dodd ready to nationalize the banks and Barney Frank to dictate executive pay -- and with Clement Attlee Obama waiting in the wings to pile on his own big-government plans in the name of compensating "the middle class" for its sacrifices on behalf of Wall Street -- a more minimalist approach than Treasury's suddenly has a lot to recommend it.

Here it is: Let the government be a buyer of last resort for mortgage derivatives for a set price (say, 25 cents on the dollar), hoping others will gain confidence to step in. Hope, too, that this whets the appetite again for investors to recapitalize hurting banks. If banks continue to falter even with the option to dump their mortgages on government for a deep discount, deal with those challenges as they occur, with forbearance where possible. Meanwhile, use taxpayer dollars to clean up the housing mess in the Southwest and Florida -- the surprisingly confined source of all our troubles.

Every time we mention demolishing houses, somebody slaps us over the head with Bastiat -- the French economist who'd say you don't increase wealth, you reduce it, by destroying some houses to make the value of others go up.

True -- but we're in a situation today where responsible homeowners will pay one way or another for the acts of irresponsible lenders and buyers. The cheapest bailout would be one that weeds out enough surplus housing to stop the free fall in a handful of overbuilt markets, whose foreclosure epidemic is dragging down the entire securitized mortgage market. We're talking about buying thousands of houses, not millions of mortgages. And yet the resulting higher mortgage debt prices automatically would help to recapitalize the banks, while (knock wood) leaving some Paulson powder dry for future contingencies.

The fine print of the Paulson plan includes sweeping authority to buy "other assets." Going after houses and knocking them down would fit this commodious garment -- and would let the agency wrap up its work quickly and go away in the natural course of things, whether everyone was satisfied with the result or not.

That's a virtue not to be sneezed at. All the monumental interventions of recent months will have unintended consequences. Once the panic dissipates and the political class returns to form, we'll have a hell of a time unwinding the cure.

By: Holman Jenkins
Wall Street Journal; September 24, 2008

Paulson, Bernanke Describe Mechanics of Auction Proposal

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke labored Tuesday to describe the mechanics of an auction in which the government would buy as much as $700 billion of assets from financial institutions -- a plan raising questions ranging from the prices taxpayers will pay for the assets to potential conflicts of interest among the asset managers the Treasury plans to hire.

At a five-hour Senate Banking Committee hearing, skeptical senators pressed Messrs. Paulson and Bernanke for details, and the two officials pleaded for maximum flexibility. Mr. Bernanke, early in the hearing, distinguished between what he called fire-sale prices -- which he defined as "the price a security would fetch today if sold quickly into an illiquid market" -- and a hold-to-maturity price, or the value of a loan if the borrower eventually pays it off.

"If the Treasury bids for and then buys assets at a price close to the hold-to-maturity price," he said, "there will be substantial benefits."

That produced speculation that Mr. Bernanke was advocating the purchase of assets at prices other than market-determined values, a development that could benefit banks at the expense of taxpayers. In answering subsequent questions, however, Messrs. Bernanke and Paulson appeared to indicate otherwise, arguing -- in effect -- that a well-designed auction process would lift the market prices of the assets above today's fire-sale values by restoring liquidity.

Establishing those new prices in the market would be a big plus. "Where there is some value that the market can look at, then private capital will come in," Mr. Paulson said.

"The holders have a view of what they think it [the asset] is worth. It's hard for outsiders to know," Mr. Bernanke said. The point of an auction is to reveal those prices. "If you have an appropriate auction mechanism... what you'll do is restart this market," Mr. Bernanke added. "Just as when you sell a painting at Sotheby's, nobody knows what it's worth until the auction is over," he said.

The two men vowed to consult outside experts to design an auction mechanism that would minimize the cost to taxpayers and encourage financial institutions to compete to reduce the prices at which they offer to sell.

Under one scenario being discussed, Treasury would put out a list of specific securities it is willing to buy and would hold auctions for a preannounced quantity of each security or class of security. Holders of securities who wanted to sell them would compete with one another to offer them to Treasury at attractive -- that is, lower -- prices. Treasury would rank the bids from cheapest to highest and buy as many as it seeks at the cheapest price.

"This is not going to be a normal auction, because the Treasury is going to be there with a $700 billion checkbook," said Sen. Bob Bennett (R., Utah).

If the prices set in the auction are very low, financial institutions that hold those securities -- both those selling at the auction and those that aren't -- may have to take deeper write-downs than they have already. But if the prices are high, then banks are benefiting at taxpayer expense.

One concern raised by members of Congress and others is the potential conflicts of interest among the asset managers who would be hired to run the program. Some critics worry that the program would create incentives for asset managers -- or a future Treasury secretary -- to benefit institutions with which they have financial or personal ties.

"To the extent that any of the people that they hire or institutions they hire have clients or affiliates that are on the buy side or the sell side of these same assets, there is huge potential for conflict," said Cornelius Hurley, director of Boston University's Morin Center for Banking and Financial Law.

Senate Banking Committee Chairman Christopher Dodd (D., Conn.) has suggested giving a role in the management of these assets to the Federal Deposit Insurance Corp., which manages and disposes of assets it takes on after bank failures. Mr. Dodd said the FDIC has experience dealing with many of the issues that asset managers for Treasury's potential program might face. FDIC Chairman Sheila Bair has been in close talks with policy makers in recent days, but it is unclear what role her agency might play, if any. She was unavailable for comment Tuesday.

Treasury plans to solicit bids from asset managers with experience in handling large portfolios -- managers who likely have related assets already in their portfolios. That could create a conflict, as the manager would essentially be using the government's money to buy and sell assets in which it has a financial stake.

Another wrinkle, says Douglas Elmendorf of the Brookings Institution, a former Treasury official, is that many of the assets are highly concentrated in one or two financial institutions. Choosing to buy certain assets could benefit an individual bank, essentially giving the asset managers -- and the Treasury secretary -- the ability to reward individual firms.

Mr. Paulson said he was "very conscious" of potential issues regarding conflicts of interest. "We have procedures that are designed to mitigate against conflicts, but we need to move very quickly here, so we can't go through all the normal processes or it won't work for the markets," he told the Senate committee.

Mr. Paulson said Treasury is expected to buy assets in phases, but asked that Congress give him the authority to pull the full amount, so he or his successor wouldn't have to come back to Congress for more authority, a prospect that would reduce the chances of stabilizing markets.

The Treasury secretary said Treasury probably would begin with simpler assets, such as mortgage-backed securities, and then move to collateralized-debt obligations and other more-complex securities.

By: Damian Paletta and Deborah Solomon
Wall Street Journal; September 24, 2008