Details have yet to be fully released regarding a massive U.S. market intervention plan announced earlier today by U.S. President George W. Bush. We expect more details to follow shortly. Congressional leaders on both sides of the aisle have already signed off on the Treasury’s plan, so the process of making the deal formal should be hammered out in days, if not hours. The biggest piece of the plan that we do know is that Congress will empower the Treasury to purchase distressed mortgage assets for rehabilitation. We expect the Treasury to set up a holding company for these mortgages based on the precedent of the Resolution Trust Co. (RTC), an entity that the government formed to dispose of the savings and loan crisis of the 1980s and 1990s. The RTC took into receivership financial institutions that had overextended themselves and made poor lending choices. It pooled all of the assets of all of the affected institutions into a single pool, separated them by quality and then sold them off in tranches by auction. The disposal process took six years, but at the end of the day, far from taking a massive financial hit, the government walked away with a profit for its efforts. Today, the total value of all subprime mortgages, including the 80 percent that are not delinquent, is approximately $540 billion, or 3.8 percent of gross domestic product — approximately the same percentage of GDP involved in the savings and loan crisis. But in many ways the problems this time around are less dramatic than they were for RTC. In the savings and loan crisis, many institutions made loans to build structures that were not needed, and some of the loans were simply stolen. This time around, every mortgage is linked to a specific house. There may be a housing surplus, and property values may fall, but even in the worst case scenarios there will be a recouping of the asset. That just leaves the question as to why the government waited so long. The answer is probably punishment. The Federal Reserve and the U.S. Treasury wanted to ensure that the firms that caused the problems were destroyed. All of the myriad mortgage brokers who gave birth to subprime are already out of business. Iconic firms who securitized the mortgages and so fed the problem — names such as Bear Stearns, Lehman Brothers, Merrill Lynch and Morgan Stanley — are either bankrupt, reduced to being subsidiaries of more wisely-run firms, or nervously eyeing those two options. The only issue remaining is what will be the broader international impact. The subprime imbroglio has contributed to market runs the world over. With the American government in essence taking the assets off the table, the stage is cleared for everyone else the world over to succeed or fail on their own merits.
Global Market Brief: The Biggest Piece of the Plan