Paulson, Bernanke Consider Plan to Stem Deepening Credit Crisis

By Alison Vekshin


Sept. 18 (Bloomberg) -- Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke are considering immediate steps to address the deepening credit crisis in advance of possible legislation that would inject new capital into troubled financial institutions.

Paulson and Bernanke will speak with congressional leaders this evening on current market conditions, Treasury spokeswoman Michele Davis said. Lawmakers warned this week the legislative calendar makes it difficult for Congress to act quickly enough to address a plunge in confidence in U.S. financial markets.

Democratic Senators Christopher Dodd and Charles Schumer have said the Federal Reserve, which is getting $200 billion in special funding from the Treasury this month, has the authority to take on a broader role.

``The Federal Reserve and the Treasury are realizing that we need a more comprehensive solution,'' said Schumer, who today proposed an agency to pump capital into troubled banks. ``I've been talking to them about it,'' Schumer, a Democrat who chairs the congressional Joint Economic Committee, told reporters in Washington today.

Schumer urged forming an agency to inject funds into financial companies in exchange for equity stakes and pledges to rewrite mortgages and make them more affordable.

Schumer advocated a Great Depression-era Reconstruction Finance Corp. model, different from the Resolution Trust Corp.- type plan others have floated. Another RTC, which was a 1990s agency that sold devalued assets in the Savings and Loan Crisis, would ``simply transfer excessive risk to the U.S. government without addressing the plight of homeowners,'' he said.

Stronger Response

An increasing number of lawmakers are advocating a stronger response to the crisis sparked by record homeowner defaults. The turmoil swept Lehman Brothers Holdings Inc. into bankruptcy three days ago and prompted government takeovers of Fannie Mae, Freddie Mac and American International Group Inc. this month.

The Fed's role expanded further when the central bank agreed on Sept. 14 to accept a broader range of collateral, including equity, in exchange for loans to investment banks. The central bank today said loans to securities firms soared to a record $59.8 billion yesterday.

At the Fed's request, the Treasury yesterday instituted a supplemental funding program for the central bank allowing it to expand its balance sheet. The Treasury has announced a total of $200 billion of bill auctions so far under the program.

``Right now, we're working with the tools we have,'' Paulson said in remarks at the White House Sept. 15. Treasury and regulatory officials are ``all working together and we're going to do what's necessary to protect this system with the tools we have,'' he said.

Congressional Calendar

Setting up an RTC-type of fund would require an act of Congress. House Majority Leader Steny Hoyer said Sept. 16 a proposal to have the U.S. create an agency to buy distressed debt won't be considered before Congress adjourns ahead of the Nov. 4 elections.

Fed spokeswoman Michelle Smith declined to comment.

Discussions with the Treasury and Fed focus on ``trying to do something more permanent'' after the series of government interventions, the New York senator said. For the Fed, ``it's hard for them to do monetary policy, which is their primary task, and then run all these businesses,'' he said.

Fed officials announced an $85 billion takeover of AIG two days ago, hours after leaving their benchmark interest rate unchanged in a decision that rebuffed some investors' calls for a cut.

``There is some preliminary discussions about how to sort of encapsulate and separate the two -- both to keep focus on monetary policy by the main Fed leaders, but also to prevent any conflicts of interest,'' Schumer said.

Ad Hoc Actions

Lawmakers are weighing responses to a crisis that prompted Paulson to seize Fannie and Freddie and caused the bankruptcy of Lehman Brothers Holdings Inc. in the past two weeks. The Fed's takeover of AIG followed its March agreement to take on $29 billion of Bear Stearns Cos. assets to secure the company's takeover by JPMorgan Chase & Co.

``The series of ad-hoc interventions in the market over the past 10 days were important to avoid a systemic disaster,'' Schumer said. ``But we cannot continue to act in such an uncoordinated and ad-hoc fashion.''

Under Schumer's RFC plan, ``the government would come first,'' he said. ``The government would get repaid before the others in the financial chain.''

House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, this week proposed Congress create a federal entity to buy bad loans. Senator Hillary Clinton of New York, a former candidate for the Democratic nomination for president, proposed resurrecting a 1930s-era agency to stem foreclosures.

`Quarantining' Needed

``We need a modern day Home Owners' Loan Corporation,'' Clinton said in remarks at the Senate today. ``There will not be any semblance of a normal or orderly market'' without ``quarantining'' the devalued loans outstanding, she said.

The HOLC bought up outstanding mortgage and issued new, more affordable loans that helped people stay in their homes, Clinton said.

White House spokeswoman Dana Perino yesterday indicated the White House is open to options.

Senate Democrats huddled at the U.S. Capitol today with former Treasury Secretary Lawrence Summers, who urged Congress to consider legislation to provide a short-term stimulus to the economy, said North Dakota Democrat Kent Conrad, who attended the meeting.

Summers, a Harvard University economist who served as President Bill Clinton's last Treasury secretary, recommended such a stimulus because ``now there is a loss of confidence and there is a significant decline in borrowing and spending, therefore a reduction in demand,'' Conrad said.