Treasury Sec. Paulson Rejects Systemic Approach to Foreclosures

Treasury Secretary Paulson told us that the government should be reactionary rather than systemic in his speech before the US Chamber of Commerce (3/26/08). He makes it clear that the rate of house price appreciation was unsustainable and a correction was inevitable. The sooner we work through the price declines, the sooner we will reach stability. But, we want to do it in a way that minimizes the disruption to the rest of the economy. All this with no overall plan. Now that’s what I call “free market”.

“But let me emphasize that we do not need a system-wide solution for the vast majority of loans where a homeowner temporarily has negative equity.”

So now that we have established that the homeowners are in free market mode, what about the investment banks? Paulson reminds us that the Federal Reserve has not lent money to a non-depository institution since the 1930’s, but endorsed the Bear Stearns (BSC) solution. He said the Fed should REACT AS NEEDED, creatively, to protect the financial system. Apparently, the financial system includes both commercial and investment banks. Given the protection to investment banks implied in Paulson’s speech and Federal Reserve Chairman Bernanke’s actions, Paulson wants the Fed to be able to peek inside the investment banks. Paulson favors some temporary regulation of investment banks by the Fed; on a look, but don’t touch basis.
Paulson does concede that in the case of the Federal Reserve, some set of rules might be helpful:

“First, the process for obtaining funds by non-banks must continue to be as transparent as possible. The Fed should describe eligible institutions, articulate the situations in which funds will be made available, and the magnitude and pricing structure for the funds.” “Second, and perhaps most importantly, the Federal Reserve should have the information about these institutions it deems necessary for making informed lending decisions.”

After the Bear Stearns (BSC) debacle, Paulson sees that standardized policies and rules will make the market comfortable knowing how the Fed will “react as needed”. However, homeowners are left in an uncomfortable free for all. I am not a bleeding heart for irresponsible borrowers. But, Paulson should realize that millions of loan modifications cannot be processed on an ad hoc basis.

Treasury needs to facilitate a system of policies and rules for homeowners with the same zeal as it is doing for financial institutions. Paulson should not be showing disdain for Congressman Barney Frank’s proposal to trade government guarantees for principal write downs. Bernanke proposed such a plan. Bernanke understands that saving the homeowner is an important component of saving the financial system.

Paulson’s Conclusion:

“I know Members of Congress have outlined other ideas, but most are not yet ready for the starting gate.”

I have previously written about Barney Frank’s proposal in "Trading FHA Guarantees for Write Downs gets Congressional Support", Paulson’s refusal to lay out a clear set of directions for loan modifications in "No Detail too small to Keep Secret", and Bernanke’s support of mortgage principal write downs in "Bernanke’s Harsh Warning". I also wrote about Paulson pushing hard on Fannie Mae (FNM) and Freddie Mac (FRE) in "The Bear Lesson for Fannie and Freddie".

Disclosure: Author is long BSC, FNM and FRE.

Comments

[pochovilla:]

Did Paulson have a good reputation on Wall St? As far as I observe on TV and C-Span his qualification for Secretary of Treasury was Political as in contributions to Bush & Republicans which now are returned as favors to his friends fraternity brothers at GS and on Wall St.

2008 Mar 27 07:35 PM