By Rebecca Christie and Jody Shenn
Sept. 24 (Bloomberg) -- Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke signaled that their priority is shoring up the nation's banks even if it means they don't get taxpayers the cheapest prices for the devalued assets the government buys.
Bernanke told lawmakers yesterday the government won't pay ``fire-sale prices'' for the mainly mortgage-related securities Paulson aims to buy in a proposed $700 billion rescue. Instead, officials want to set a long-term value on assets, intending to hold them until they mature or markets improve.
Insisting on paying higher prices may increase complaints from legislators, who will pepper Bernanke and Paulson with questions in a second day of hearings today, that the government is bailing out Wall Street at the expense of Main Street. At the same time, setting values too low may roil financial markets further and tip the economy into a deep recession.
``If the prices are too low, nothing will happen; if the prices are too high, you're going to end up with horrible losses for the taxpayer,'' said L. William Seidman, a former chairman of the Resolution Trust Corp., the agency that liquidated failed thrifts after the savings-and-loan crisis of the 1980s. ``I'm equally concerned in both directions.''
Three days after the first draft of the plan was released, Bernanke told the Senate Banking Committee yesterday that policy makers still don't know the ``best design'' for executing it. The Fed chief testifies on the economic outlook from 10 a.m. at the congressional Joint Economic Committee, then appears at 2:30 p.m. with Paulson at the House Financial Services Committee.
Economy Warning
The government can help restore liquidity to the banking system by buying depreciated assets at ``a price close to the hold-to-maturity price,'' rather than the price they would fetch in the market today, Bernanke said. He also warned the economy will contract ``if the credit markets are not functioning.''
Seidman, who also served as Federal Deposit Insurance Corp. chairman, said a 1990s attempt by Japan to halt that nation's banking crisis failed because the government offered prices that would have drained companies' capital.
Paulson said the plan needs to be large, have few restrictions and leave open what the government would buy in order to have the biggest impact on stabilizing markets. Lawmakers balked at accepting Paulson's terms.
``I agree we need to act'' but ``I am not going to be stampeded into rubber-stamping this proposal,'' Democratic Senator Robert Menendez of New Jersey said at yesterday's hearing. Richard Shelby, the top Republican on the Senate banking panel, told reporters Paulson understood his plan wouldn't speed through Congress.
Democrats to Gather
House and Senate Democratic staff plan to gather tomorrow to work out a counter-proposal to Paulson's presentation. Democratic Senator Charles Schumer of New York, who chairs the Joint Economic Committee, suggested an initial investment of $150 billion, rather than approving Paulson's full $700 billion.
Lawmakers yesterday also questioned Paulson and Bernanke on how the government would make the purchases. The Treasury chief said the fund would probably start with ``something simple like mortgage-backed securities'' and a ``smaller'' amount.
The Treasury plan would use ``market mechanisms'' to set prices as fairly and accurately as possible, Paulson said, in part through consulting with outside experts. One option is a reverse auction system, where the government would accept the lowest price offered by banks selling a type of asset.
`Biggest Problem'
``Right now, our biggest problem in this industry is that no one really knows what anything is worth,'' said Tim Ryan, head of the Securities Industry and Financial Markets Association and former director of the Office of Thrift Supervision. ``People don't sell assets because they think the price is significantly different than they have it marked, or they just don't know what the price is.''
The Treasury would almost certainly pay more than ``bottom feeders,'' who right now represent the only market for many kinds of mortgage assets, said Alfred DelliBovi, president of the Federal Home Loan Bank of New York, who served on the RTC's five- member oversight board. The prices the government pays may end up better reflecting some assets' underlying values, because most borrowers are still paying their loans on time, he said.
With mortgage-bond prices at record lows amid the credit crisis, yields on the securities have risen to between 15 percent and 25 percent, according to Merrill Lynch & Co. That leaves room for taxpayers to make a profit buying the bonds, even at higher prices.
Dodd Proposal
Senate Banking Committee Chairman Christopher Dodd has proposed that the Treasury potentially receive equity stakes in some companies that sell assets to the government. The stakes would ``vest'' in an amount equal to the 125 percent of the dollar value of the loss realized by the Treasury on the sale of the assets.
That type of ``loss participation'' proposal would endanger companies' ability to raise private capital afterwards, Jeffrey Rosenberg, head of credit strategy research at Bank of America Corp. in New York, wrote in a report yesterday. The consequence of a program seeking the lowest upfront prices is the program may be of little use to many banks, he wrote earlier this week.
Lawmakers insisted on strict oversight of the fund, a sentiment echoed by Seidman and DelliBovi. Scrutiny will need to extend to when the Treasury eventually sells off any assets, DelliBovi added.
``All of the crooks on Wall Street are still alive; they haven't all been shot,'' he said. ``They'll probably go into new businesses and try to pick up assets and you'll have to worry about that.''
To contact the reporter on this story: Rebecca Christie in Washington at Rchristie4@bloomberg.net; Jody Shenn in New York at jshenn@bloomberg.net.
Last Updated: September 24, 2008 09:17 EDTSource: http://www.bloomberg.com/apps/news?pid=20601109&sid=a2SIJqKu58Co&refer=home
