Treasury plan to create new government entity comes under question

Some management and economic observers on Friday questioned whether the creation of a proposed new government entity to remove bad assets from the marketplace would help solve the country's financial crisis.

The details of how such an entity would function remained unclear, but several lawmakers and media outlets speculated that it would be similar to the Resolution Trust Corp., which was established in 1989 to handle the snowballing savings and loan crisis. But others disputed the validity of this analogy, noting that the crucial difference between the RTC and the expected Treasury Department plan could create a moral hazard and cost taxpayers billions of dollars.

RTC took over the assets of already failed savings and loan institutions, while the new proposal would set up an RTC-like agency that would buy troubled assets from institutions to prevent them from failing.

"RTC did not purchase nonperforming or troubled assets from savings and loans to keep those institutions from failing," said James Barth, former chief economist of the Office of Thrift Supervision and the Federal Home Loan Bank Board, now a senior finance fellow at the Milken Institute, an independent economic think tank. "What troubles me somewhat is to be reading about or hearing about an agency set up basically to save institutions from failure."

Lawrence White, Arthur E. Imperatore Professor of Economics at New York University's Leonard N. Stern School of Business, said under RTC, the federal government already was in possession of the bad assets when the corporation took them over to be resold, "whereas this new organization is going to be going out and buying stinky assets."

"We're just going to create a whole $500 billion of additional Treasury debt and exchange it for $500 billion in stinky assets," White said.

Early Friday Treasury Secretary Henry Paulson said the federal government must implement a program to remove troubled illiquid assets that "are weighing down our financial institutions and threatening our economy." While acknowledging the program would require significant taxpayer investment and should be large enough for "maximum impact," Paulson said the alternative inevitably would cost taxpayers far more. He did not put a specific price on the proposal, but said it was likely to cost hundreds of billions of dollars.

Paulson, who met with key lawmakers from both parties Thursday night, said he was confident that members of Congress agreed with the need for the new federal organization and would work with him to "examine approaches to alleviate the pressure of these bad loans on our system, so credit can flow once again to American consumers and companies." Lawmakers expect to introduce legislation next week.

Eugene Ludwig, former comptroller of the currency and now chief executive officer of Promontory Financial Group, echoed Paulson's belief that the benefits may outweigh the costs of standing up a new federal finance program. "Taking action is an expensive proposition, but the alternative is a potentially catastrophic economic collapse," Ludwig said.

The key to the plan's success, if it's passed by Congress, lies in the price at which the government buys troubled assets such as mortgage loans and securities. White cited 10 cents on the dollar as an excellent price for taxpayers, while 100 cents on the dollar would be an excellent price for financial institutions.

"If [the assets] are bought at a high price, the financial institution selling them will make out like bandits and the taxpayer will suffer," White said. "If they're sold at a low price the financial institution will suffer and the taxpayer will make out like a bandit. Which do you think is the more likely outcome?"

Don Kettl, political analyst and professor at the University of Pennsylvania, said he would expect the new entity to be staffed by hundreds of employees pulled from other government agencies, the Federal Reserve and the private sector.

"My guess is it'll begin with a kind of rounding up of the usual suspects who would be doing this, people who are old hands at the recovery business," Kettl said. "I would guess within a week to 10 days we'll see congressional approval of a new bailout agency in the quasi-governmental realm, like the RTC ... headed by somebody whose name everybody would recognize and give everybody some confidence."

Kettl and other analysts marveled at Wall Street's dramatic response to the proposal, the official details of which remain to be announced. "One of the administration's great feats over the last week was convincing people that the problem was being solved without being clear about what the solution is going to look like," he said. Ludwig said markets thrive on information and confidence -- both of which a new government body could provide.

In speeches on Friday, the presidential candidates avoided getting out ahead of the specifics of the Treasury plan, focusing instead on what they would do as president to avoid such economic crises in the future. They both, however, highlighted elements they thought should be included in the Bush administration's proposal.

Republican nominee Sen. John McCain of Arizona said the plan must be temporary and coupled with stronger oversight and regulation of financial institutions.

"There must be a clear process to wind down this plan and restore private sector assets into private sector hands after restoring stability to the system," McCain said during a speech in Green Bay, Wis. "Taxpayers must share in any upside benefit that such stability brings."

Democratic nominee Sen. Barack Obama of Illinois said the program should not reward particular companies, executives or irresponsible borrowers or lenders.

"As taxpayers are asked to take extraordinary steps to protect our financial system, it is only appropriate that those who benefit be expected to contribute to the protection of American homeowners and the American economy," Obama said after meeting with top economic advisers in Florida. "Just as support is not designed to pay off egregious executive compensation, it should not reward those who are ruthlessly foreclosing on American families."