Government To Become Buyer Of Last Resort
The financial system has been choked off by a lack of liquidity in the form of mortgage assets that no one wants to buy. Treasury Secretary Henry Paulson has brought forth a plan for the government to become a buyer of last resort.
These illiquid assets are clogging up our financial system, and undermining the strength of our otherwise sound financial institutions. As a result, Americans’ personal savings are threatened, and the ability of consumers and businesses to borrow and finance spending, investment, and job creation has been disrupted.
The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy. This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible.
The plan would be an unprecedented bailout of the financial system that is estimated at a whopping $800 billion. I think the government finally realizes that monetary policy can only do so much on it’s own and that a fiscal plan was also needed to head off financial disaster.
The problems of the financial services industry is slowly getting worse, this week saw three financial giants brought low. The Fed had to issue an emergency $85 billion loan to AIG to keep it from a disorderly collapse, while in investment banking, Lehman Brothers declared bankruptcy while Merrill Lynch sold itself to Bank of America at a fraction of it’s former value.
The banking system is clearly in big trouble and I’m not sure if the Federal Deposit Insurance Corporation has enough reserves to insure the deposits of Americans from the growing number of banks that are in danger of failing. Credit is being choked off at the source as banks are stuck with assets that they are unable to sell.
Financial institutions raised hundreds of billions of capital to deal with writedowns from the subprime collapse but they are loathe to loan that money out. The big problem is that the financial sector is so intertwined these day that even relatively strong financial institutions are worried about counter party risk so they are hoarding capital to protect themselves for when their weaker brethren start to fail.
This plan definitely puts taxpayer dollars at risk but the alternative could very well be a financial Armageddon that could plunge the world into another Great Depression.
