Treasury Secretary Henry Paulson will spend the weekend finalizing a plan to rescue the ailing banking system by buying up toxic assets, at a potential cost of "hundreds of billions of dollars."
"We must now take further, decisive action to fundamentally and comprehensively address the root cause of our financial system's stresses," Paulson said at a press conference Friday.
"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."
The announcement comes amid growing consensus in Washington that the federal response to the credit crisis has fallen short of a solution that would restore confidence and stability in the financial markets. The creation of a new entity to deal with the crisis is just one solution being explored. Paulson said he hoped Congress could act next week on the plan. Markets soared for a second day on the news.
So far, the federal government's tab for propping up Fannie Mae, Freddie Mac, and American International Group is $400 billion. Add the new loan relief entity, plus a smattering of other recent initiatives, and the jumping-off point could be near $1 trillion.
Seem high? It isn't. If history is a guide, the price tag for all this bold action will ultimately outstrip any estimate now being floated. In past bailouts, including the Resolution Trust Corp. formed in 1989 to help resolve the savings-and-loan crisis, the ultimate taxpayer cost was magnitudes larger than originally projected.
When Congress put together the RTC, it funded it with $50 billion and tasked it with taking on the assets of failed thrifts and subsequently working them off. The RTC lasted until 1995 and required additional injections of capital along the way, ultimately totaling more than $100 billion.
The latest announcement comes a day after Paulson and Federal Reserve Chairman Ben Bernanke met with leaders from both sides of the political aisle on Capitol Hill Thursday to begin work on a plan of action to help relieve banks of their toxic assets. Friday, the Treasury said it would use $50 billion to provide insurance to publicly traded money funds.
Paulson's bad-asset rescue plan would join a bunch of other proposals now circulating Washington. The crisis deepened last weekend with the bankruptcy of Lehman Brothers and the $85 billion loan package arranged by the Fed Tuesday to bail out AIG. There are various ways of structuring such an entity.
Presidential candidate Sen. John McCain, R-Ariz., called for the creation of mortgage and financial institutions trust, which would work with the private sector and regulators to identify institutions that are weak and take remedies to strengthen them before they become insolvent. "For troubled institutions, this will provide an orderly process through which to identify bad loans and eventually sell them," McCain said in a speech.
New York Democrats Sens. Charles Schumer and Hillary Clinton had their own ideas.
Schumer proposed the return of an idea from the Depression: a Reconstruction Finance Corp. that would inject capital into banks through stock purchases, leaving it to the banks to dispose of troubled assets. Schumer also proposed resurrecting judicial mortgage modifications, an idea that failed to survive the housing rescue bill passed earlier this summer.
The Mortgage Bankers Association and other banking lobbies campaigned vigorously against the proposal, which would have allowed judges to write down the value of mortgages.
Clinton called for the creation of an entity that would buy up and quarantine mortgage securities that are the bane of the banking industry at the moment. She also calls for a ban on short-selling stocks, saying it would provide breathing room for markets to recover.
Such a ban was initiated in the U.K. starting Friday, and the Securities and Exchange Commission put one in place in U.S. markets Friday. Financial stocks soared, erasing most of the week's losses.