Thursday, April 2, 2009

What Was Going on Inside the Paulson Treasury?

Voltron says: WSJ on how the previous administration's Treasury Dept was
extremely conflicted and in one case, based decisions on data that was three
years old!

Excerpts:

The Treasury predicted in May 2007 that "we were nearing the worst of it in
terms of foreclosure starts" and the problem would subside after a peak in
2008. "What we missed is that the regressions didn't use information on the
quality of the underwriting of subprime mortgages in 2005, 2006 and 2007,"
Swagel said - Federal Deposit Insurance Corp. staff pointed that out at the
time.

The ill-fated 2007 Treasury proposal to create a privately funded entity -
called MLEC, or Master Liquidity Enhancement Conduit - to buy up toxic
assets from the banks was developed by the Treasury's Office of Domestic
Finance and shared with market participants without involvement from other
Treasury senior staff. "The MLEC episode looked to the world and to many
within Treasury like a basketball player going up in the air to pass without
an open teammate in mind - a rough and awkward situation," he said. He
notes, though, that some elements of MLEC are present in the Obama
administration's Public Private Investment Partnership plan to joint venture
with big money investors to buy loans and securities "though with the (huge)
advantage of being able to fund the purchases through low cost government
financing and with taxpayers assuming much of the downside risk."

On the housing front, the Paulson Treasury staff did develop, though it
never proposed, a plan to offer a federal subsidy to lenders willing to
lower interest rates to reduce monthly payments for at-risk borrowers. A
similar plan eventually was embraced by the Obama administration. Federal
Reserve staff wanted to do more than the Paulson Treasury to aid homeowners
who were underwater - that is, with mortgages greater than the value of
their homes. "Among the White House staff in particular, but also within
Treasury. there was no desire to put public money on the line to prevent
additional foreclosures," Swagel said. "The cynical way of putting this was
that spending public money on foreclosure avoidance would be asking
taxpayers to subsidize people living in McMansions they could not afford
with flat screen televisions paid out of their home equity line of credit."
Swagel argued that - at least in late 2007 and early 2008 - there wasn't
much congressional interest in voting to spend money on foreclosures. "There
were constant calls for Treasury and the administration to do more on
foreclosure prevention, but this was just rhetoric." Housing policy, he
added, was "essentially static" until Congress passed the $700-billion
Troubled Asset Relief Program, and the FDIC offered ways to tap that fund to
avoid foreclosures, proposals that the Treasury considered badly flawed.

Treasury staff had "distinctly mixed feelings" about Secretary Paulson's
move towards "hardening the heretofore-implicit" government guarantee of
Fannie Mae and Freddie Mac's debt in July 2007. "Treasury Departments across
administrations had sought to remove the implicit guarantee, not to harden
it..[M] any people expressed to me their misgivings about what looked like a
bailout in which GSE bondholders and shareholders won and taxpayers . It was
hard to disagree," he said. Paulson soon shared those misgivings and
immediately set Treasury staff to work on the next step, the August move to
put the companies in conservatorship.

The surprises to the Treasury on Monday, September 15, after Lehman Brothers
filed for bankruptcy, were two-fold: "the breaking of the buck by the
Reserve Fund [a money market fund] and the reaction of foreign investors to
the failure of Lehman." Swagel says it was impossible for the Treasury to
anticipate that the Reserve Fund had so much Lehman paper, but, "We could
have known better that foreign investors were not prepared for Lehman to
collapse."

Full WSJ article:
http://blogs.wsj.com/economics/2009/04/02/what-was-going-on-inside-the-paulson-treasury/

Full source document:
http://www.brookings.edu/economics/bpea/~/media/Files/Programs/ES/BPEA/2009_spring_bpea_papers/2009_spring_bpea_swagel.pdf

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