WASHINGTON — The uphill battle to pass the unprecedented $700 billion financial-sector rescue plan was the easy part. A lot of heavy lifting still lies ahead. That was evident Friday when stock markets largely ignored passage of the legislation. The Dow Jones Industrial Average finished down 157.47 points, or 1.5 percent, to 10325.38. The S&P 500 and Nasdaq posted similar percentage drops.
Americans generally aren't any more optimistic than Wall Street investors. A new Ipsos/McClatchy online poll found that almost six in 10 Americans — 59 percent — lacked confidence in the government's ability to restore consumer and investor confidence. Only one in five thought the U.S. economy will be better off six months from now, while 40 percent think it will be worse. While not a scientific random sample, the online poll illustrates widespread public attitudes.
The stock market's continued slide and uninterrupted turmoil Friday in credit markets underscored that passage of the historic legislation is little more than a beginning to what is sure to be a long and complicated process of implementing the Emergency Economic Stabilization Act of 2008.
The rescue plan gives broad, unprecedented powers to Treasury Secretary Henry Paulson. Paulson, who was chairman of investment bank Goldman Sachs until 2006, can now purchase virtually any distressed asset he wants to help troubled banks return order to their balance sheets.
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Critics view these powers as the antithesis of free-market principles, but the Bush administration persuaded lawmakers that having the government purchase distressed assets is the best and quickest way for financial institutions to regain trust in each other's balance sheets and in the companies that borrow from them.
"This is all about banks having confidence that they're going to get their money back," Commerce Secretary Carlos Gutierrez told McClatchy.
In a statement after Congress approved his plan, Paulson warned that it won't be a panacea.
"There is no one-size-fits-all solution to alleviating the stress in our financial system. Each situation will be different, and we must implement these new programs with a strategy that allows us to adapt to changing circumstances and conditions, and attract private capital," Paulson said.
"The broad authorities in this legislation, when combined with existing regulatory authorities and resources, gives us the ability to protect and recapitalize our financial system as we work through the stresses in our credit markets."
With the guidance of a bevy of former Wall Streeters, Paulson must decide how to make the federal government a purchaser of toxic assets no one else wants. Most are bonds, and the mortgages of ordinary Americans form their underlying collateral.
The orphaned bonds are commonly called mortgage-backed securities. Few investors want them so long as home prices keep falling and foreclosures soar, raising doubts about the soundness of bonds supported by mortgages that may go unpaid.
A Treasury official, speaking on condition of anonymity because details of the agency's plans are still being worked out, said it's unlikely that Paulson would begin purchasing distressed assets from Wall Street banks until after the Nov. 4 election.
It could take up to six weeks, said the official, for Treasury to hire about two dozen full-time employees for the effort and to contract anywhere from five to 10 asset-management companies to help purchase and later resell troubled assets. Treasury also will have to publish procurement rules, adding to the delay before bad assets can actually be purchased and relief come to troubled banks.
"We would expect the Treasury to start ramping up the size of auctions over the next several weeks to fund the program — with an initial target of perhaps $100 to $200 billion in the program account by mid-November, but . . . actual purchases of securities are not likely until perhaps the second half of November," said Brian Bethune, an economist with forecaster Global Insight, in a note to investors.
Over the next several weeks, Treasury must convert the legislation — so vaguely worded that it amounted to a virtual blank slate — into an action plan.
"They need to figure out how best to ensure there are no conflicts of interest, they need to think about accounting treatment, how sales affect balance sheets of firms that have like assets," said Travis Larson, a spokesman for the Securities Industry and Financial Markets Association.
What Larson's getting at is this: Current accounting rules require that banks express on their balance sheets the present-day value of these assets that no one wants to buy, which means those assets aren't worth much at all.
Once banks start unloading distressed mortgage bonds to the government, the banks must reflect on their balance sheets not the price they received from government, but the assets' present-day market price. If someone sells similar assets for less, that price must count.
Part of what Paulson hopes to accomplish is to help create a price level in dysfunctional markets for products no one now wants.
"The reality is the markets are frozen today in part because buyers and sellers can't agree on a price, and this process will create price discovery and find a market price," Larson said.
But for that to happen, another important detail will be how Treasury carries out the expected reverse auctions. Instead of offering a starting price for the bad assets and bidding it up, the government will lay out the most it will pay for a particular asset and the companies interested in unloading will race each other down in price.
Treasury must walk a fine line. It can't pay too high a price above what's perceived as fair-market value or there will be public outcry, but it must pay a price high enough to accomplish its goal — to provide banks an infusion of cash large enough to boost their balance sheets so they'll begin lending again.
"Treasury will be buying something higher than the distressed price, but they are not going to buy them at a price so high that it is going to make everyone solvent," said Vincent Reinhart, a former top economist at the Federal Reserve and now a scholar at the American Enterprise Institute, a conservative think tank. "In some ways what the legislation does is help facilitate consolidation" in the financial market.
There's already been tremendous consolidation since the government seized mortgage-finance companies Fannie Mae and Freddie Mac on Sept. 6. That was followed by the collapse of investment bank Lehman Brothers, the shotgun marriage of investment bank Merrill Lynch to Bank of America and the failure and swift sale of Washington Mutual to J.P. Morgan Chase. Meanwhile, the sale of retail bank Wachovia to Citigroup, brokered by the Federal Deposit Insurance Corp., is now uncertain following a higher offer from Wells Fargo.
"One of these days we're going to look back on September 2008 in utter disbelief as to what happened," said Howard Simons, president of economic research firm Rosewood Trading in Glenview, Ill.
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