WASHINGTON — The financial rescue plan unveiled Tuesday offers important moves to spur consumer lending, experts said, but it fails to answer key questions about how it would attack fundamental causes of the deepening economic crisis.
Drawing praise is an expansion of a program announced last December to have the Federal Reserve backstop loans to consumers. The Fed and Treasury Department will provide up to $100 billion in loans to private investors willing to purchase pools of loans for cars, students, credit cards, small business and nonresidential mortgages
The original plan envisioned using $20 billion to leverage $200 billion worth of purchases of these asset-backed securities. Treasury Secretary Timothy Geithner instead unveiled a bolder proposal: Use $100 billion to leverage $1 trillion worth of purchases.
For the past two decades, Americans enjoyed expanded access to finance because loans no longer were held on banks' books but instead sold to investors in a secondary market. This process is called securitization, and while vital to expanding credit and economic growth, it's virtually dead at the moment. Securitization declined by more than $1.2 trillion from 2006 to 2008.
The Fed's lending to investors willing to buy new top-rated securitized loans puts it squarely in a role usually reserved for the private sector. This bold action should spur more consumer lending, said Lyle Gramley, a Fed governor from 1980 to 1985.
It could build on budding success. There are already signs, he said, that previous Fed efforts to facilitate the purchase of commercial paper — promissory notes issued by corporations — not only has reduced the cost of borrowing for large American corporations, but also reduced the costs for companies issuing corporate bonds.
"If we get the downward momentum to begin easing off with a stimulus package right away, and we get some response from consumers in the second quarter and the infrastructure projects (in the stimulus plan) kick in during the second quarter, the downward momentum will be braked a bit and we've got a shot of seeing confidence return," Gramley said.
On the negative side of the ledger, however, Geithner's plan offered little detail on how the government will use $50 billion to prevent foreclosures and modify troubled mortgages. Shoddy lending fueled a housing boom and run-up in prices that's proved unsustainable. Mortgage finance created what now are considered distressed mortgage bonds and triggered the wider financial crisis. Geithner's plan essentially asked markets and citizens alike to do little more than stay tuned on this front.
The plan also lacked details on the expected purchases of billions of dollars worth of "toxic" assets on bank balance sheets that investors won't touch. Last October, Congress gave the Bush administration authority to purchase these assets, but the effort shifted instead to injecting capital into troubled banks.
These assets have a new name: legacy securities. Yet the problem of what do about them is unchanged. Banks could crumble if forced to unload them too cheaply, and taxpayers will grumble if government buys them at inflated prices.
"It's not as if you can magically make that issue go away," said Hays Ellisen, an expert on securitization for Katten Muchin Rosenman LLP in New York.
Although lacking details such as how purchase prices would be set, the Treasury plan calls for using taxpayers' money alongside private capital to encourage investors to snap up these assets at low prices in hopes of earning profits when markets revive.
The effort would seek to leverage private capital on a scale of $500 billion initially, potentially expanding to $1 trillion. Yet tough decisions await.
"In order to make it work, the government is going to have to make a decision about how much finance to provide and on what terms," Ellisen said. "How much risk are they willing to take on? And how much risk do they want taxpayers" to take on?"
Geithner's plan offered only silence on whether troubled assets should be priced at current market prices, versus what they might fetch once they mature. Some critics think anything other than present-day pricing will cloud the true amount of bad assets on bank books and sustain uncertainty in financial markets.
Some experts question the utility of the plan's call for a uniform "stress test" on banks to determine their health amid deteriorating financial conditions, especially since bank CEOs don't seem able to make this determination.
"What makes you think you can go in there with an Excel spreadsheet and a uniform stress test to figure these things out? We wouldn't be where we are if these were not complicated balance sheets, opaque and holding complex instruments," said Vincent Reinhart, a former top economist for the Fed's rate-setting Open Market Committee. "I would have thought over the last year we've come to distrust (financial) models."
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