Treasurer Paulson Defends Actions; Says There’s ‘No Playbook’ for Crisis

November 18, 2008

U.S. Treasury Secretary Henry M. Paulson, Jr. told members of the House Committee on Financial Services that there is “no playbook” for dealing with the current financial crisis and defended the government’s recent emphasis on deploying capital to troubled financial firms instead of purchasing their troubled assets as originally planned.

“I am very proud of the decisive actions by Treasury, the Fed and the FDIC to stabilize our financial system. We have done what was necessary as facts and conditions in the market and economy have changed, adjusting our strategy to most effectively address the urgent crisis and preserving the flexibility of the President-elect and the new Secretary of the Treasury to address the challenges in the economy and capital markets they will face in the coming months,” he said.

He said Treasury’s shift from buying up troubled assets to injecting capital into financial institutions was necessary to keep up with the deepening crisis.

“There is no playbook for responding to turmoil we have never faced,” he told Congress. “We adjusted our strategy to reflect the facts of a severe market crisis always keeping focused on Congress’s goal and our goal – to stabilize the financial system that is integral to the everyday lives of all Americans.”

Paulson said the financial rescue law passed by Congress has helped prevent the collapse of the financial system but cautioned that “more needs to be done.”

“We have not in our lifetime dealt with a financial crisis of this severity and unpredictability,” he said, citing the failures, or the equivalent of failures, of Bear Stearns, IndyMac Bank, Lehman Brothers, Washington Mutual, Wachovia, Fannie Mae, Freddie Mac, and AIG – institutions with a collective $4.7 trillion in assets when this year began.

The financial crisis worsened even as the financial bailout package was being debated, he noted. He said the Bush Administration needed the financial rescue package in order to intervene, stabilize the financial system, and minimize further damage to the economy.

But he stressed that the rescue package has its limitations.

“The rescue package was not intended to be an economic stimulus or an economic recovery package; it was intended to shore up the foundation of our economy by stabilizing the financial system, and it is unrealistic to expect it to reverse the damage that had already been inflicted by the severity of the crisis,” he said.

He said the initial focus was on the credit markets because they provide the “basic economic fuel – borrowing and lending capital – that supports and creates jobs.”

By the time legislation had passed on Oct. 3, the global market crisis was so broad and so severe, Paulson said his team determined that it had to move quickly to get credit flowing again.

“Our initial intent had been to strengthen the banking system by purchasing illiquid mortgages and mortgage-related securities. But by this time, given the severity and magnitude of the situation, an asset purchase program would not be effective enough, quickly enough,” he said.

So Treasury exercised the authority granted by Congress in the legislation to develop and quickly deploy a $250 billion capital injection program, fully anticipating that this would be followed by a program for troubled asset purchases.

He said that initial actions did help stabilize the financial system by mid-October.

But by then, the economy had worsened even further. On Oct. 31, third quarter GDP showed negative 0.3 percent growth. Jobs data showed a rise in the unemployment rate to a level not seen in 15 years, and a loss of 240,000 jobs in October alone. Data released on October 28 showed that through August, home prices in 10 major cities had fallen 18 percent over the previous year, demonstrating that the housing correction had not abated.

As bad as things were in the U.S., the slowing of European economies has been even more dramatic, he said.

He said that the Administration continued to assess how best to use the remaining federal bailout (TARP) funds, given the uncertainties around the deteriorating economic situation in the U.S. and globally, and the continuing financial market stresses.

He said they came to recognize that a troubled asset purchase program would require “a massive commitment” of TARP funds and that, while in mid-September, before economic conditions worsened, $700 billion in troubled asset purchases would have had a significant impact, half of that sum, in a worse economy, simply was not going to be enough firepower.

“If we have learned anything throughout this year we have learned that this financial crisis is unpredictable and difficult to counteract. So early last week, we concluded it was only prudent to reserve our TARP capacity, maintaining not only our flexibility, but that of the next Administration,” he said.

By investing only a “relatively modest share” of TARP funds in a Federal Reserve liquidity facility, the government can improve securitization in this market and have a significant impact on the availability of consumer credit, he maintained.

He also said the government needs to continue to use a variety of authorities to reduce avoidable foreclosures but advised against using the TARP funds for this purpose. He argued that the initiatives already underway to stem foreclosures– including HUD programs, the FDIC’s program with IndyMac, the HOPE NOW Alliance, and the new GSE servicer guidelines — will do more to prevent foreclosures than might have been achieved through very large purchases of mortgage-related securities through the TARP.

Paulson said there is no plan to initiate another capital program beyond those already announced. The current Capital Purchase Program for banks and thrifts has already dispersed $148 billion, and Treasury is processing more applications. Treasury is also developing terms for participation by non-publicly traded banks, as well as a matching program for banks and/or non-bank financial institutions.

“More capital enables banks to take losses as they write down or sell troubled assets. And stronger capitalization is also essential to increasing lending which, although difficult to achieve during times like this, is essential to economic recovery,” he explained.

Paulson asked and answered the two questions he said have been raised most often recently about the bailout efforts:

“First, Congress gave you the authorities you requested, and the economy has only gotten worse. What went wrong and why won’t you use this authority for other industries? Second, if housing and mortgages are at the root of our economic difficulties, why aren’t you addressing this?

“The answer to the first is that the purpose of the financial rescue legislation was to stabilize our financial system and to strengthen it. It is not a panacea for all our economic difficulties. The crisis in our financial system had already spilled over into our economy and hurt it. It will take a while to get lending going and repair our financial system, which is essential to an economic recovery. This won’t happen as fast as any of us would like, but it will happen much, much faster than it would have had we not used the TARP to stabilize our system. Put differently, if Congress had not given us the authority for TARP and the Capital Purchase Program and our financial system had continued to shut down, our economic situation would be far worse today.

“The answer to the second question is that the most important thing we can do to mitigate the housing correction and reduce the number of foreclosures is to increase access to lower cost mortgage lending. The actions we have taken to stabilize and strengthen Fannie Mae and Freddie Mac, and through them to increase the flow of mortgage credit, together with our bank capital program, are powerful actions to promote mortgage lending. We are also working actively to reduce preventable foreclosures.”

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