Paulson Going to Congress with Significant Taxpayer Bailout Plan

Return of the Resolution Trust Corp

Rumors have been swirling around a potential Resolution Trust Corp (RTC) like solution to challenges with illiquid mortgage assets. These portfolios of cancerous mortgages plague banks, mortgage companies, investment banks, and are now causing contagion effects in money market funds and other financial service venues.

This has pushed support for removing these, impossible to price and trade, mortgage assets from the markets all together.

This morning that approach was all but confirmed by Paulson. He called for a "significant taxpayer investment" in a comprehensive recovery plan. This plan, when asked the question of how much it would cost, was loosely framed at "hundreds of billions," in Paulson's brisk reply.

The Paulson Plan

Paulson, and later affirmed in President Bush's statements, is prepared to bring a comprehensive proposal to Congress over the weekend. This plan is expected to include a massive purchase of these troubled mortgage assets off the balance sheets of banks and out of the financial markets.

Obviously, this would be a direct impact to taxpayers--requiring an estimated $500 billion to $1 trillion in investment to effectively execute.

Speculation is rampant and the details are slim; however, expectations are that the plan will be similar to the RTC in structure and process. This agency was responsible for successfully solving the Savings and Loans crisis of the early 1990s.

Bill Siedman, former head of the RTC, brought caution in highlighting critical differences in the two historical scenarios. During a brief interview on CNBC he pointed to key element of risk in using an RTC-type plan in our current crisis--properly pricing the acquired, distressed assets.

Siedman reminded us that the Savings and Loan bailout essentially handed the RTC impaired assets and institutions. These assets were then patched and packaged up and sold back into the markets. In this scenario the government would have to buy the impaired assets, making proper pricing critical. Buying too high, being unable to buy at all, or being unable to sell at a premium back to the market could stall or tailspin the plan.

Siedman pointed to the Japanese government's attempt to create a similar plan to rescue their financial markets, which failed at the hands of improper pricing of the troubled assets.

Short-term Relief

Wall Street, rallying more than 5% in the opening minutes this morning, took confidence even in the rumors. Still lacking any substantive details on the plan and understanding weekend legislation is required to take even initial steps--confidence is back in a significant way.

In addition, Paulson in his morning statement said that Fannie Mae, Freddie Mac, and the Treasury would aggressively begin to buy mortgage-backed securities (MBS) to support their objective of keeping mortgages affordable. Estimates are that they will raise their MBS buying targets from $5 billion to $10 billion.

Homebuyers and Homeowners

The bottom line for the mortgage consumer--you have an unprecedented opportunity. The US government is bringing the full leverage of the national balance sheet to keep mortgages affordable, homeowners in their homes, and paying their mortgages.