Govt. would buy all bad loans, back money-market funds

Citing Grave Financial Threats, Officials Ready Massive Rescue

Lawmakers Work With Fed, Treasury To Try to Restore The Flow of Money

By Binyamin Appelbaum and Lori Montgomery
Washington Post
Friday, September 19, 2008

http://www.washingtonpost.com/wp-dyn/content/article/2008/09/18/AR200809...

The Bush administration is urgently preparing a massive intervention to revive the U.S. financial system, including a plan to sweep away the unpaid loans that are choking banks and blocking the flow of money to borrowers.

Congressional leaders gave bipartisan support to the administration's efforts after a meeting last night with Treasury Secretary Henry M. Paulson Jr. and Federal Reserve Chairman Ben S. Bernanke.

Paulson and Bernanke presented a "chilling" picture of the state of the financial system, according to a participant in the meeting who spoke on condition of anonymity. Lawmakers were told that the consequences would be grave if they failed to pass legislation by the end of next week. Sen. Harry Reid (D-Nev.) and Rep. Nancy Pelosi (D-Calif.) committed to meeting that deadline.

The plan involves using hundreds of billions of dollars in government funding to buy bad loans, leaving banks with more money and fewer problems, according to two sources familiar with what was said at the meeting.

After the meeting, Paulson told reporters the proposal was "an expeditious solution that is aimed right at the heart of this problem."

Also last night, the Fed was considering offering backing for money-market mutual funds, which have had massive withdrawals in recent days, said a source familiar with the discussions.

And the Securities and Exchange Commission is considering further limits on short-selling, a practice that allows investors to bet on a decline in a company's stock price, according to a person familiar with the matter. Critics of the practice say short sellers are driving down the share prices of financial companies, thereby contributing to their destruction.

The government has already tried three times this month to keep money flowing through the financial system. It took over the two largest providers of funding for mortgage loans, Fannie Mae and Freddie Mac. It created a new source of funding for investment banks. And it took over the insurance giant American International Group.

Now the government is contemplating its broadest -- and perhaps most expensive -- intervention to date.

The urgency has only grown with each successive intervention because the first three tries have not worked. People are withdrawing money from money-market mutual funds. Banks are refusing to lend to one another. Several large financial companies need money to stay in business, including the bank Washington Mutual, which is seeking a buyer.

Regulators and the banking industry are increasingly concerned about customer withdrawals from money-market funds. Crane Data, which tracks the industry, said total deposits in money-market funds fell Wednesday by at least $79 billion, or about 2.6 percent. Financial executives have told government officials in recent conversations that the rising pace of withdrawals is the equivalent of a bank run and that if it continues, it will drain a massive and critical source of funding.

Money-market funds are particularly important because they buy short-term debt, which is used by financial companies and other corporations to finance day-to-day activities.

According to legislative aides, yesterday's meeting was arranged after Pelosi called Paulson's office mid-afternoon to discuss the state of the markets. During that call, Paulson asked to meet with Pelosi, Reid and key lawmakers from the banking committees. That meeting took place at 7 p.m. in Pelosi's office on the second floor of the Capitol.

Paulson and Bernanke did not present lawmakers with a written proposal but are expected to do so by tonight, congressional aides said.

During the meeting, one lawmaker worried aloud that Paulson was asking for "a blank check," according to a participant. There was also a "healthy debate" about whether this action would finally stabilize the markets.

"They couldn't answer yes to that question," the participant said.

Paulson and Bernanke generally have kept Congress at arm's length as they have sought to deal with the financial crisis. Yesterday, however, after meeting with congressional leaders, they exchanged awkward compliments with the lawmakers at a news conference. Lawmakers had been increasingly critical of the Fed and Treasury leaders for failing to consult with Capitol Hill. The administration will need congressional approval to commit taxpayer money to its new plan.

"We'll do this as quickly as we can. We're not talking about a month," said Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, which would probably review the plan before it went to the House floor.

A hearing on the topic that Frank had scheduled for next Wednesday could now become a legislative drafting session, he said.

Also yesterday, Sen. Charles E. Schumer (D-N.Y.), chairman of the Joint Economic Committee, suggested that the government create an entity that would operate much like the Depression-era Reconstruction Finance Corp. -- it would buy "equity and possibly secured debt," providing desperately needed cash to companies while permitting the government to share in any profit.

"The government would get repaid before the others in the financial chain," Schumer said.

If a plan does move forward, Democrats may try to demand concessions from the suddenly humbled industry, Schumer said, including support for a proposal to permit bankruptcy judges to modify mortgages for distressed borrowers. Currently, judges may set new terms for mortgages on second homes but not on primary residences.

That idea is contentious and has been fiercely opposed by the banking industry. Frank said he would instead demand that banks reduce the number of foreclosures.

Still, it's not clear that Democrats would insist on such concessions at the expense of passing the plan quickly.

"The costs of doing nothing are enormous," Frank said. He added that with the recent deterioration in the financial markets, "I think the timetable for something has been greatly sped up."

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