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Paulson Announces Major Steps to Restore Mortgage Liquidity

Paulson says GSEs, Treasury to step up MBS purchases

September 19, 2008

By MortgageDaily.com staff

The Bush administration announced major steps in unclogging mortgage securities in the U.S. financial system and said legislation may be passed as early as next week to relieve financial institutions of illiquid mortgage assets.

Mortgage assets are tying up the entire U.S. economy, U.S. Treasury Secretary Henry M. Paulson Jr. said at a press conference this morning. He noted that he, along with Federal Reserve Chairman Ben Bernanke and Securities and Exchange Commission Chairman Christopher Cox, met with congressional leaders last night to discuss a comprehensive legislative plan to deal with mortgage-related securities that are depriving financial markets of liquidity.

Paulson said talks with members of Congress will continue through the weekend.

He noted that the government has addressed problems with Fannie Mae and Freddie Mac, worked with market participants to prepare for the failure of Lehman Brothers, and made loans to AIG so it can sell assets in an orderly manner. He also highlighted a temporary guarantee program announced today for the U.S. money market mutual fund industry.

photo of Henry Paulson
Henry M. Paulson

"Despite these steps, more is needed," Paulson said. "We must now take further decisive action to fundamentally and comprehensively address a root cause of our financial system stresses.

"The underlying weaknesses in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded," he continued. "These illiquid assets are choking off the flow of credit that is so vitally important to our economy."

He explained that troubled loans have been frozen on the balance sheets of banks and financial institutions, preventing more lending in other areas. Meanwhile borrowers, securitizers and investors are also being choked.

"The normal buying and selling of nearly all types of mortgage assets has become challenged," Paulson stated. "These illiquid assets are clogging our financial system and undermining the strength of otherwise sound financial institutions."

Paulson said the federal government must take major steps to remove these illiquid assets from financial institutions, though taxpayers must still be protected. While a significant amount of taxpayer dollars will be involved, the cost will be far less than the alternative.

In addition to legislation that will be passed over the next week involving hundreds of billions of dollars, the secretary talked about two immediate steps the administration will take.

The first step to be taken includes an increase by Fannie and Freddie in purchases of mortgage-backed securities to provide critical additional funding to mortgage markets.

"These two enterprises must carry out their mission to support the mortgage market," he said.

In addition, the Treasury will expand its MBS purchase program announced earlier this month.

The Treasury announced on Sept. 7 that it would begin investing in new GSE MBS until December 2009, noting at the time, "Given that Treasury can hold these securities to maturity, the spreads between Treasury issuances and GSE MBS indicate that there is no reason to expect taxpayer losses from this program, and, in fact, it could produce gains."

"These two steps will provide some initial support to mortgage assets, but they are not enough," he added.

He explained that many of the mortgage assets clogging the system do not qualify for purchase by the government sponsored enterprises or the Treasury program, and the legislation currently under discussion is needed to remove them from the financial system.

"These measures will require us to put a significant amount of taxpayer dollars on the line. This action does entail risk," President Bush said in a White House statement. "The vast majority of assets the government is planning to purchase have good value over time, because the vast majority of homeowners continue to pay their mortgages."

Bush said not acting could place further stress on the financial markets, causing massive job losses, devastating retirement accounts and pushing home values lower.

Once the current crisis is under control, Paulson called for an overhaul of the "sub-optimal, duplicative and outdated" financial regulatory structure.

"Until we get stability in the housing market, we are not going to get stability in our financial markets."

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