U.S. Plans to Clean Up Finance System
As Part of Widening Effort to Stem Crisis
Major Central Banks Offer Credit as Investors Flee Money Funds; Stocks Rise on Bailout Talk, Fresh Moves Against Short Sales
By DEBORAH SOLOMON, KARA SCANNELL and DAMIAN PALETTAArticle
The federal government, acknowledging the need to take a more comprehensive approach to the financial crisis, is working on a sweeping series of programs that would represent perhaps the biggest intervention in financial markets since the 1930s.
At the center of the potential plan is a mechanism that would take bad assets off the balance sheets of financial companies, according to people familiar with the matter, a device that echoes similar moves taken in past financial crises. It's size could reach hundreds of billions of dollars, one person said.
Another proposal would create federal insurance for investors in money-market funds, something akin to the deposit insurance currently available for regular bank accounts. The move is designed to stem an outflow of funds as consumers start to worry about even the safest of investments, a worrying sign of how the crisis is spreading to Main Street.
In addition, the Securities and Exchange Commission is set to propose banning short selling temporarily. It's not clear how broadly the ban might apply, but is expected to apply to financial stocks.
All told, the moves are an effort to stop the bleeding on Wall Street as the spiral of bad debts, credit downgrades and tumbling stocks has taken its toll on venerable names from investment bank Lehman Brothers Holdings Inc. to insurance giant American International Group Inc.
Treasury Department officials have studied a structure to buy up distressed assets for weeks but have been reluctant to ask Congress for such authority unless they were certain it could get approved. The intensified market turmoil may have changed that political calculus, even with less than two months left until the November elections.
A Treasury spokeswoman said: "Treasury Secretary Paulson joined Federal Reserve Chairman Bernanke in a meeting with House and Senate Republicans and Democrats to discuss current market conditions. They began a discussion with them on a comprehensive approach to address the illiquid assets on bank balance sheets that are at the underlying source of the current stresses in our financial institutions and financial markets. They are exploring all options, legislative and administrative, and expect to work through the weekend with Congressional leaders to finalize a way forward."
A vote on the plan could come as soon as next week.
Exactly how such an entity might be structured isn't yet clear. The possible plan isn't expected to mirror the Resolution Trust Corp., which was created two decades ago during the savings and loan crisis to hold and sell off the assets of failed banks. Rather, a new entity might purchase assets at a steep discount from solvent financial institutions and eventually sell them back into the market.
Messrs. Paulson and Bernanke briefed top lawmakers Thursday evening on recent developments. The two made a similar trip to Capitol Hill on Tuesday evening to discuss the takeover of insurer American International Group Inc.
The briefing discussed potential solutions to the financial crisis, including such a mechanism to buy distressed assets, according to people familiar with the matter.
Talk of the asset-purging idea came on a day of dramatic action by global financial authorities and Wall Street executives aimed at stemming the broadening crisis.
The world's major central banks joined forces Thursday to flood global markets with U.S. dollars. The U.S. Securities and Exchange Commission, the New York State Attorney General and U.K. financial authorities -- encouraged by the British government -- separately took aim at short sellers, who are blamed by some for the stock market's volatility.
The net effect was to send the stock market soaring in one of its sharpest reversals in recent memory. The Dow Jones Industrial Average ended up 3.9%, the index's biggest percentage gain in nearly six years, on record New York Stock Exchange volume. The blue-chip index finished more than 560 points above its intraday low and reclaimed about 90% of its Wednesday losses. Nasdaq composite trading also saw trading volume set a new single-day high at 3.89 billion shares.
All 30 Dow component stocks closed higher, but financial companies were the biggest winners, racking up double-digit percentage gains after weeks of selling off.
The government efforts went hand in hand with aggressive moves from private players, including Morgan Stanley Chief Executive John Mack and Goldman Sachs Group Inc. Chief Executive Lloyd Blankfein. Both men had spoken to numerous government officials in the past few days to discuss how to reduce the influence of short-sellers, people familiar with the matter said. The two CEOs have also spoken five or six times about the issue in recent days, one of these people added.
Calpers -- California Public Employees' Retirement System, the largest U.S. public pension fund -- is no longer lending out shares of Goldman, Morgan Stanley or Wachovia. Lending of shares is an essential step in the short-selling process, and the move could help limit negative bets on those stocks.
The flurry of moves might have bought the markets some breathing room, but they didn't offer much in the way of long-term solutions to the complex financial problems sweeping the market.
"The market wants to see a more systemic solution that doesn't leave us wondering day after day about the next institution that's the weakest link in the chain," said former Fed Board member Laurence Meyer, vice chairman of Macroeconomic Advisers, an economic research firm.
Markets worldwide have been rattled as the consequences of the housing downturn cascaded through the financial system, felling Lehman Brothers Holdings Inc. and prompting a government takeover of insurer American International Group Inc. Banks have grown unwilling to lend to one another, a sign of extreme stress, because financial markets work only when institutions have faith in each other's ability to meet their obligations.
In Russia, officials suspended stock-market trading for the second-straight day as the Russian government promised to inject $20 billion to halt a collapse in share prices. In China, government officials directed purchases of bank shares and encouraged companies to buy their own shares in efforts to prop up a falling market.
President George Bush met with Mr. Paulson, Securities and Exchange Commission Chairman Christopher Cox and Federal Reserve Chairman Ben Bernanke for 45 minutes Thursday to discuss "the serious conditions in our financial markets," said White House spokesman Tony Fratto.
A series of veteran policy makers, including former Treasury Secretary Lawrence Summers and former Fed Chief Paul Volcker, has pushed in recent weeks for a government agency that would attempt a comprehensive solution to the markets crisis.
The idea behind a debt-purging entity would be to steady the market so that investors regain confidence in financial institutions and resume conducting business normally with them. "By stepping in here and getting the markets to function again, the government could deliver the Sunday punch to this financial turmoil," said former Comptroller of the Currency Eugene Ludwig, who is now chief executive of Promontory Financial Group, and a big proponent for the idea. "By taking the first step and making a market the new government entity could take fear out of marketplace," he added.
Until recently, Congress appeared unwilling to act on such an idea quickly. But the near-panic of the past 10 days might have changed their calculation, should Congressional approval be needed. Rep. Paul Kanjorski, (R., Pa.) said lawmakers should extend their session to finalize a plan.
But House Majority Leader Steny Hoyer said that's unlikely. "I don't think it's going to happen in the next 14 days," Hoyer told reporters at a press conference. "Speaker Pelosi and I are both focused on the Sept. 26 adjournment."
Yesterday, Republican nominee Sen. John McCain sought a broad expansion of government regulation over financial institutions, including the formation of a body to both assume distressed mortgages and help failing investment banks.
Saying the government cannot "wait until the system fails," Sen. McCain called for the creation of an entity that would essentially help companies sell off bad loans and other impaired assets. It is unclear how the body, dubbed the Mortgage and Financial Institutions trust, would operate, including whether or not institutions would seek help or whether the government would intervene on its own behalf.
His rival, Democratic Sen. Barack Obama of Illinois was less specific about what steps he would take, offering broader outlines of policy proposals that included a "Homeowner and Financial Support Act." The measure, which would inject capital and liquidity in the financial system, is designed to provide a more coordinated response than "the daily improvisations that have characterized policy-making over the last year."
Both government and the financial industry ganged up on short sellers Thursday. Short selling is a legitimate investment tactic that bets on the future decline of a stock. In recent weeks, banks and government officials have blamed short sellers for driving down stock prices, thereby damaging financial firms' ability to raise capital.
Thursday, the U.K.'s market regulator, the Financial Service Authority, banned short selling in financial stocks until January. U.K. Treasury Chief Alistair Darling was involved in the FSA's discussion.
In a statement Thursday, Mr. Darling said he welcomed the FSA's "decisive action," saying that in current market conditions, it was in the "interests of financial stability." Some British politicians have blamed hedge funds for the plunge in the share price of the country's largest mortgage lender, HBOS PLC, which led to the bank being taken over by fellow U.K. lender Lloyds TSB Group PLC in a rescue encouraged by the UK government.
Meanwhile, New York State Attorney General Andrew Cuomo said he opened investigations into short-sellers who he believes are trafficking in false rumors to manipulate the market.
"No one is saying short selling caused this crisis," Mr. Cuomo said in an interview. "I believe it's possible that it's been aggravated by illegal short selling -- people passing on fraudulent information and conspiring to drive down the value of a stock."
The developments came a day after the U.S. Securities and Exchange Commission announced three new trading rules aimed at curbing abusive short sales and plans to require hedge fund managers to disclose more information about their short positions. The SEC also said it was expanding on already extensive investigations into false rumors.
The actions increase pressure on the SEC to take more aggressive steps to curb short-sales, including possibly a ban similar to what the FSA has instituted. Lawmakers, including Democratic Sen. Charles Schumer of New York, have pitched the idea to Mr. Cox to extend a ban on certain financial companies for 30 days.
The SEC wouldn't say if it would follow London's steps, although that is one of several ideas the staff has drawn up for the commission to consider.
Richard Baker, head of the Managed Funds Association, a hedge fund lobbying group, downplayed the role of short-selling in the volatile market saying that said hedge funds short because they identify fundamental problems with a company.
"If in fact a company does fail," he said, "it will have nothing to do with the fact that someone from the outside noticed these deficiencies."
Action in Private Sector
Meanwhile, the private sector took action against short sales. The California State Teachers' Retirement System, the nation's second-largest pension fund with a securities lending program of $29 billion, on Wednesday said it was halting lending of Goldman Sachs and Morgan Stanley shares. On Thursday, the pension fund added State Street Corp. and Wachovia to the list.
Calstrs Chief Investment Officer Christopher Ailman said he sent out a note to 60 other pension funds urging them to take similar steps. "It's quite clear you can see where the enemy is hiding and you can prevent it from being armed," Mr. Ailman said, referring to the short sellers who were borrowing shares to push their prices lower.
—Joellen Perry, Craig Karmin, Aaron Lucchetti, Amir Efrati, Laura Meckler, Alistair MacDonald, Michael M. Phillips and Damian Paletta contributed to this article.