JIM LEHRER: We begin our coverage of the financial crisis with the day’s events in Washington. Ray Suarez reports.
RAY SUAREZ: A little more than 12 hours after he briefed members of congress, Treasury Secretary Henry Paulson publicly outlined the latest and widest-reaching government action to stem the financial crisis.
HENRY PAULSON, U.S. Treasury Secretary: The normal buying and selling of nearly all types of mortgage assets has become challenged. These illiquid assets are clogging up our financial system and undermining the strength of our otherwise sound financial institutions.
As a result, Americans’ personal savings are threatened, and the ability of consumers and businesses to borrow and finance spending, investment, and job creation has been disrupted.
To restore confidence in our markets and our financial institutions so they can fuel continued growth and prosperity, we must address the underlying problem.
The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy.
I am convinced that this bold approach will cost American families far less than the alternative, a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.
You said this needs to be a significant size. Are we talking hundreds of billions, a trillion dollars?
HENRY PAULSON: We’re talking hundreds of billions. This needs to be big enough to make a real difference and get at the heart of the problem.
RAY SUAREZ: Just minutes after his appearance at the Treasury, Paulson appeared at President Bush’s side. Federal Reserve Chairman Ben Bernanke and Chris Cox, the chair of the Securities and Exchange Commission, were also there.
Mr. Bush laid out other details of the government’s plan to help reassure Americans and the markets.
GEORGE W. BUSH, President of the United States: The Department of Treasury is acting to restore confidence in a key element of America’s financial system, money market mutual funds.
In the past, government insurance was not available for these funds. And the recent stresses on the markets have caused some to question whether these investments are safe and accessible.
The Treasury Department’s actions address that concern by offering government insurance for money market mutual funds. For every dollar invested in an insured fund, you’ll be able to take a dollar out.
The Federal Reserve is also taking steps to provide additional liquidity to money market mutual funds, which will help ease pressure on our financial markets.
The Securities and Exchange Commission has issued new rules temporarily suspending the practice of short selling on the stocks of financial institutions. This is intended to prevent investors from intentionally driving down particular stocks for their own personal gain.
RAY SUAREZ: The broader rescue plan for dealing with bad debt needs congressional approval.
One model that could appeal to nervous investors and banks: a new federal institution, like the one created during the savings and loan crisis in the late 1980s. The Resolution Trust Corporation, or RTC, bought, and eventually sold off, hundreds of billions of dollars of real estate assets to end the savings and loan crisis.
On Capitol Hill, members of Congress said they’d try to act quickly. Minority Whip Roy Blunt.
REP. ROY BLUNT (R), Minority Whip: Putting a floor under these — under the financial markets in securities particularly is an important thing to do, and it doesn’t necessarily have to be something that impacts taxpayers in a negative way, but it all depends on how you put that structure together.
RAY SUAREZ: Senate Banking Committee Chairman Chris Dodd, who warned this morning the country was “days away from a complete meltdown of our financial system,” told reporters Congress would work quickly to prevent that.
SEN. CHRIS DODD (D), Connecticut: That’s why all of us are prepared to do whatever we can this weekend, working with the administration as they present their plan to fashion a proposal here that will get us out of this mess.
RAY SUAREZ: Lawmakers said they believe they could pass a bipartisan bill by the end of next week.
Factors behind the federal plan
JIM LEHRER: Now, more on what's behind the big bailout idea, and to Margaret Warner.
MARGARET WARNER: And for that, I'm joined by two journalists who have been covering the story closely: Krishna Guha, U.S. economics editor of the Financial Times; and Steven Pearlstein, business and economics columnist for the Washington Post.
And it's good to have you both back.
Krishna, on Monday, Hank Paulson let Lehman Brothers go belly-up. By Friday, he and the president are announcing this cosmic bailout. What drove them to this so quickly?
KRISHNA GUHA, Financial Times: Well, this has been an extraordinary week in finance. The world's markets have been shaken to a degree really no one has seen in at least half a century. That's forced everybody to re-think their positions.
The government has gone from trying to resist bailouts where possible and dealing with things on a case-by-case basis to realizing they've got to get ahead of the curve, try and find a way of putting out a comprehensive plan that will deal with the stress in the system.
MARGARET WARNER: Steve, is that how you see it, that they just had to stop this meltdown?
STEVEN PEARLSTEIN, The Washington Post: Yes. You know, finance is a confidence game, Margaret, and this is really not about fundamentals. This is about people losing confidence in all sorts of markets, in all sorts of securities, and they needed to do something to bolster the confidence.
MARGARET WARNER: And, Steve, staying with you for a minute, so describe in broad outlines what it is they're looking at here. In other words, what are they going to do? What models are available for the government to create to assume these troubled mortgage-backed assets?
STEVEN PEARLSTEIN: So they're going to use a model that's not unlike that as your report said that was used in the savings and loan crisis. And right now, there are many institutions that want to sell their asset-backed securities, their mortgage-backed securities, but there are very few buyers.
And that means that the price on the few transactions that are going on are very low. They're at fire sale prices.
And because of the way accounting works, every bank -- or anyone that holds these things -- has to value them at what the last sale was, which is at a very low price.
So the theory is that, if the government goes in now and buys them at the discounted prices, it will at least put a floor under this so that investors will know that the situation will not get any worse for the banks that sell them to the government.
The government will hold them for a longer period of time, until the economy and the markets presumably get better, and they'll sell them at what is a more reasonable price once it becomes clear that they're really not as toxic as everyone perhaps fears and thinks.
At least that's the good -- that's the good scenario.
Challenges of attracting capital
MARGARET WARNER: And, Krishna, the theory is then, what, that the banks and investment houses that right now are saddled with them will then have -- be able to raise more capital and be able to resume normal lending or investing?
KRISHNA GUHA: That's the theory. The idea is that, if they get rid of the toxic assets, the stuff that people are scared stiff of -- these are the credit products that are ultimately founded on mortgages that people think are going to go bad with the housing bust -- if they can get rid of that toxic stuff, the idea is they'll have clean balance sheets, they can go back to the market, and raise some more capital, get back to business, more business as usual.
The problem here, though, is if the assets are transferred at these knock-down prices that our other commentator was talking about, the banks will still have a big capital hole. They'll need to fill that somehow.
MARGARET WARNER: Meaning what?
KRISHNA GUHA: They'll still have much less capital than they'd like to have to back their businesses. So if they want to grow, they'll have to attract new capital. And it's likely that, even once they've got rid of the really poisonous stuff, investors might be wary for some time to come.
MARGARET WARNER: Now, Steve, you made the analogy with the Resolution Trust Corporation of the '80s, the S&L meltdown. But there wasn't it quite different? I mean, there were actual tangible pieces of property that were pretty easy to identify, weren't there?
STEVEN PEARLSTEIN: Well, they were easy enough to identify because the difference there is that, in the case of the RTC, the assets -- it didn't really buy them.
It took them over from the FDIC, which had taken over the banks, or the thrift -- the equivalent of that. They'd taken over the thrifts and the banks. They had insured the deposits. And in exchange for that, they took over the assets, including a lot of commercial property.
The problem with the RTC was that they sold it too fast. There was the feeling that, oh, the government shouldn't be in this business, that the markets might go down further, let's get rid of all of this stuff, and they really dumped it on the market, which had two effects.
Number one, it made the commercial real estate recession worse, because all this stuff was dumped. And, secondly, many people who bought it made a fortune within five, six, seven years, because the real value of it became apparent and they made a killing.
And if the government had simply been patient and held on a little longer, we could have actually made money rather than losing maybe $80 billion to $100 billion.
MARGARET WARNER: And one other question about this, Krishna. We're told that these mortgage-backed securities are so complicated, they've been sliced and diced and repackaged, so that even the banks and investment houses don't really know what's there or how to value them, so how is the government going to disentangle the, quote, unquote, "toxic" items, and take those over, and separate them from everything else?
KRISHNA GUHA: Well, as you say, this stuff is terribly complicated. What they're going to do is they're going to take these mortgage-backed securities as a block, and then they have to figure out whether they want to disentangle them or just sit on these, if you like, as sort of packages of loans.
But they don't get any simpler just because the government is holding them rather than a bank.
MARGARET WARNER: Steve, back to you. You mentioned what the Resolution Trust Corporation ultimately lost or the government lost. What is the potential liability here? I mean, we heard Hank Paulson say hundreds of billions of dollars.
STEVEN PEARLSTEIN: Well, hundreds of billions is what this new entity will be given -- it's borrowed money, of course, but will be given in order to buy these assets.
But if you buy -- assets that you think are valued or are currently valued at $500 billion, it doesn't mean that they're worth nothing and so you lose $500 billion. We don't know the difference. You may lose $100 billion; you may lose $150 billion; but you may make $100 billion.
Nobody really knows that, because to know that you'd have to know what percentage of mortgages ultimately default and then what you recover on the defaulted mortgages. Do you recover 50 cents on the dollar or 70 cents? And since nobody knows that, Margaret, no one can really value them.
But the feeling, I think, is that, in many of these instances, these mortgage-backed securities have been driven down in price much below what is even a pessimistic view of those future for the real estate market.
An opportunity for government help
MARGARET WARNER: Krishna, the other -- there were two other announcements by the president today, as Ray's report says, and dealing with money market funds and short selling. Let's at least cover the first.
Treasury said it is now going to insure money market funds. Is that all money market funds?
KRISHNA GUHA: It will be all money market funds that join the program. And in order to do that, they have to pay a fee. The government doesn't want to give them something for nothing here.
It's a very important move. There's about $3,500 billion dollars sitting in these money market mutual funds...
MARGARET WARNER: For $3.5 trillion, as we would say?
KRISHNA GUHA: Yes, $3.5 trillion. And, you know, a lot of this money is money that people assumed was in low-risk investments. They didn't think this was a punt on the stock market or a punt on complex securities.
And the prospect of breaking the buck, of getting less than 100 cents back for every dollar you put in, has started to terrify retail investors. And if they start pulling their funds from those money market mutual funds, the ramifications for the financial markets could be very disturbing, indeed.
So the government is trying to get ahead of the game, has said, "Don't worry. Your money is safe. We stand behind it."
MARGARET WARNER: And was that already happening yesterday?
STEVEN PEARLSTEIN: Oh, yes.
KRISHNA GUHA: Oh, yes, this was beginning to happen in the markets. I mean, in the week up until Thursday, this sector shrank by something like $150 billion, $170 billion, so people were starting to panic.
MARGARET WARNER: Steve?
STEVEN PEARLSTEIN: Yes, this is what they were deathly afraid of, Margaret, this perhaps more than the other thing. This was their big initiative, because if this had started to come unwound, they -- not only would there be a sense of panic, you'd have this bank run situation we haven't seen since the New Deal.
But more importantly, this market, this money market is where most large corporations get their day-to-day working capital. And if that were to break down, it would really leak into the real economy very quickly.
So they needed to regain control of this situation. And, again, we don't know that necessarily money will be lost.
Unlike the case of the mortgages, this is not a case where there was a lot of bad loans that need to be recognized. This was just a case of too many people going to the money markets, or potentially, wanting their cash back at a time when the people -- the money markets didn't have the cash, because they had used it to buy what's called commercial paper, or short-term IOUs.
So that was a liquidity problem that often is a good opportunity for government to help out, as opposed to a solvency problem, which is much more difficult.
MARGARET WARNER: All right, Steve, thank you so much, and Krishna Guha, Steve Pearlstein, thank you both.