Treasury Secretary Paulson, Federal Reserve Chairman Bernanke, SEC Chairman Cox and FHFA Director Lockhart testified today before the Senate Banking Committee. Paulson and Bernanke made it clear that the $700B plan should not be designed to punish the participants, unlike the Bear Stearns (JPM) and American International Group (AIG) efforts. Purchases need to be priced high enough to attract participation by healthy (not just desperate) institutions, so that lending will be reinvigorated.
Bernanke explained that “hold to maturity” valuations are greater than the current fire sale market values. Paulson detailed that the Treasury would experiment with reverse auctions and other pricing mechanisms for instruments that are both complex and not interchangeable. They want to prevent further price erosion, and bringing in healthy institutions could actual push up the prices of mortgage securities. Paulson explained the difficult balance between promoting higher pricing to support financial institutions and causing tax payer losses by being excessively generous.
Price determination is so difficult that the Treasury will be contracting a slew of outside consultants and portfolio managers. There no time to build internal expertise.
Paulson further explained that his proposal is focused more at the mortgage securities than the individual financial institutions. The objective is price discovery in order to jumpstart market liquidity. Financial institutions will be helped indirectly through a more robust market.
The clear purpose of the Paulson plan is to boost the prices of mortgage securities and no more. It is up to Congress to determine whether taxpayers will be safe and foreclosures will be stemmed. Being as Paulson will be paying retail prices, he must add value to his purchases – not just trade them.
Lockhart predicted the GSE conservatorships for Fannie Mae (FNM) and Freddie Mac (FRE) will last about a year, or maybe longer. It could be a few years before preferred dividends are restored. Lockhart said his thoughts were contingent on any potential changes in the GSE structure by Congress. I found this refreshingly optimistic.
Cox addressed questions on short selling and mark to market accounting. He provided no new information.
Overall, I found what I heard today beneficial for troubled banks such as Washington Mutual (WM), and the GSEs. WaMu would be more attractive to an acquirer if its mortgages can be sold based on “hold to maturity” pricing, and might even survive on its own. If bad mortgages are priced high, the GSE good mortgages will be worth even more.
Disclosures: Author is long AIG, FNM, FRE, JPM and WM.
This article is tagged with: United States
