Paulson and Bernanke Testify to U.S. Senate on Massive Mortgage Markets Rescue Plan

The core of the proposal involves providing $700 billion in funding for a new federal agency that would purchase discounted and distressed assets from the banking system. This will create liquidity and promote price discovery in the markets for these assets, while at the same time reducing investor uncertainty about the balance sheet condition. It will help to restore confidence in the financial system, and enable financial institutions to raise capital and expand credit to support economic growth.

While the comprehensive approach recommended by the Fed and the Treasury has strong merits—the approach is not without successful precedents in the Resolution Trust Corporation that was set up in the late 1908s—Congress has raised a number of concerns about how the plan would ultimately help beleaguered homeowners who may be facing foreclosure, as well as the legal framework under which the new agency would operate so as to ensure arm's length transactions and adequate oversight of activities.

These concerns are legitimate, but they are not deal breakers in and of themselves. As such, the expected legislation from Congress is likely to include quid pro quos from financial institutions that sell distressed assets to provide more assistance in general to homeowners to restructure mortgages to make them more affordable. In addition, we would expect provisions to ensure that there is thorough and independent oversight of the operations of the new agency, with periodic reports to Congress, and stipulations over operations to ensure full arm's length transactions. There may also be provisions in the legislation whereby the federal agency may in certain cases receive rights to equity ownership in the financial institutions that sell distressed assets, as well as limits on executive compensation for the financial institutions that benefit.

Congress is weighing in heavily on the proposal, as it should, and its legitimate concerns need to be addressed. While we do not see these concerns as insurmountable, they will require some careful crafting of the enabling legislation that may delay it for perhaps a week or so. Ultimately, a more refined and comprehensive package is expected to be drafted and moved expeditiously forward through Congress, with passage expected within weeks.