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Troubled Mortgage Asset Purchases Curtailed

TARP purchases of distressed assets put on hold

November 12, 2008

By staff

The U.S. Treasury secretary said today that the Troubled Asset Relief Program will not be used to purchase troubled mortgage assets. He said the $700 billion fund would be better utilized for capital investment.

H.R.1424, the Emergency Economic Stabilization Act of 2008, which became law on Oct. 3, created TARP to purchase $700 billion in illiquid mortgage assets. The plan offered hope to a distressed mortgage market.

But today, Treasury Secretary Henry M. Paulson Jr. said the plan has changed.

During the two weeks when Congress legislated the financial rescue package, market conditions deteriorated significantly. Paulson said the initial plan to purchase troubled assets would take too much time to implement given the severity of the problem.

So in early October, he signaled his decision to use the financial rescue package to purchase equity directly from financial institutions. He explained that this was the fastest and most productive way to stabilize the financial system.

The revised strategy was implemented with the purchase of $125 billion in preferred stock of nine of the largest U.S. financial institutions. A total of $250 billion was targeted for similar investments.

He noted that by strengthening banks' capital bases, they would be more inclined to increase lending (though participating banks have recently shown more of an inclination to acquire other banks than to increase lending.) Improving banks' capital bases will also enable them to better manage illiquid assets.

Paulson said the investments, along with other moves, prevented a broad systemic event.

"Our system is stronger and more stable than just a few weeks ago," the secretary stated.

photo of Henry Paulson
Treasury photo of Henry M. Paulson

He said that actions taken in October by the Federal Deposit Insurance Corporation, the Federal Reserve and the Treasury -- as well as their international counterparts -- helped avert a global catastrophe, according to a Treasury statement.

"Credit markets were largely frozen, denying financial institutions, businesses and consumers access to vital funding and credit. U.S. and European financial institutions were under extreme pressure, and investor confidence in our system was dangerously low," he stated.

But the financial system is still fragile and financial institutions are still holding significant illiquid assets on their balance sheets.

Priorities for deploying the remaining TARP funds include providing further stabilization for the financial system, providing support for the securitization market and reducing the risk of foreclosure.

"Over these past weeks we have continued to examine the relative benefits of purchasing illiquid mortgage-related assets," Paulson said. "Our assessment at this time is that this is not the most effective way to use TARP funds."

But a plan is under consideration to use TARP funds to encourage private investors to return to the troubled securitization market. One possibility would be to provide federal financing for mortgage securities.

TARP Gives Hope to Mortgage Sector
Combined with a recent improvement in subprime performance, the $700 billion plan for the U.S. Treasury Department to buy up mortgage assets has the potential to significantly help the mortgage business.

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