What is the Rescue Plan?

Without getting stuck on the intimate details of what was proposed in the initial plan by Treasury Secretary Paulson, that was eventually voted down earlier this week, the proposed plan is best described as one which is aimed at addressing the present critical weakness in the core credit  system of America.  

According to the statistics presented at the US Senate hearings, the good news is that 95% of the US mortgage market is what is called “money-good.”  This means that 95% of the mortgages held in the marketplace are being paid on-time, in full, every month.  The issue is really with about 5% of the mortgage market made of those that are no longer paying, are late paying, are foreclosing, have foreclosed, or are preparing to do so.

In effect, the plan proposed by Treasury Secretary Paulson was basically to create a US federally backed US primary residential distressed real estate fund.  The goal of the plan is to have the US government purchase the distressed assets (i.e. mortgages) from the private and public companies that want to sell them at a discount to what they were worth.   Purchases would be made over time and would likely amount to about $50 Billion per month in the beginning with a cap at about $700 Billion, although it is doubtful that all of this money would be used.

The government would hold the assets and once the market recovered a bit would be able to sell them at a profit much like a distressed asset hedge fund or leveraged buy-out firm (LBO).  Proceeds of the operation would go to the taxpayers whose money is being invested to create the fund.  Of course there are many terms and conditions to the ideology of the plan that are being forced into bill by both democrats and republicans.  Regardless, the mission and object of the plan is the same.

Is the Plan a Wall Street Bailout or Main Street Rescue Plan?

Much of the US public thinks that Secretary Paulson’s efforts and proposed plan are an intention to bail out the Wall Street elite and to keep additional firms from suffering the same fate and some before them.  This would be true if the issue was just with Wall Street Firms and had not been proliferated and extended to many Main Street companies in the form of investment, and if there wasn’t a “Pearl Harbor” like seizure of the credit markets.  Because this has become an attack on the system, it is necessary for the last line of defense, the US Federal Government, to intervene and stabilize the financial credit system in the short and longer term.  For without a credit or lending system, there will be no inventory on retail shelves, cars in lots, money for payrolls, or in ATM machines.  The short term credit markets need to work without the fear and lack of transparency that exists today.  The failure of this system is not an option and its preservation is necessary for people everywhere to maintain a reasonable standard of life as many know it in the United States.  Further, in past instances where the government has intervened when the system has been threatened the plan has worked, achieved it objective and run operationally profitable.   

What will be the effect of the plan?

The effect of the plan will be a couple fold.  First, companies with securitized debt investment products on their balance sheets will have the opportunity to sell these products into the US Federal distressed asset fund, albeit for less than they bought them for.  This will provide these companies the opportunity to clean up their balance sheet and shed the “Anaconda” from their operations, putting them in a position to be able to do business and lend money out to those who require it a reasonable rates and requirements.

Second, the Paulson plan will bring stability and a forced bottom to the US primary residential marketplace. Needed liquidity in the credit markets will slow down and possibly halt the streams of US foreclosure requests that are originating daily by the thousands.  Many people will have the renewed opportunity to stay in their homes and satisfy the terms of a re-negotiated mortgage.   Confidence will return to the buy and sell side of the system and pent up demand (i.e. buyers) will have the confidence and the credit available to return to the marketplace and begin buying again.  Buying in the marketplace will reduce the inventory of homes available on the market and will stabilize prices, inventories levels, and will finally get the market to bottom with better prospects on the horizon. 

The third and equally important thing the plan will do it restore confidence and trust to the marketplace and the US credit financial system overall.  Much of what occurs in economic cycles is as based on trend confidence and momentum of the system itself and how people feel about what is going on and the prospects moving forward.  Right now, many are questioning the US credit system and a system and its ability to work.  Banks don’t trust each other and are afraid to lend each other money because they think the guy across from them will be the next to blow up, and everyone is scared to do anything because it feel like  you reaching out to catch a falling knife.  This is destructive because nobody makes money or makes the right decision in a state of panic, and when everyone is in a state of panic and fear, losses and down cycles extend more severely and unnecessarily.    

Implementation of the plan will relieve the fear in the system and will provide the much needed liquidity to the credit markets to get it flowing in an orderly fashion.  There will actually be an operational, systematic credit market once again in the United States.  At the same time peoples trust and confidence in the system will be re-established and banks will be able to lend to each other and to main street firms with confidence once again.  Once things return to “business as usual” the entire mood of the marketplace and business overall will be restored and everyone will be able to take a deep breath because they will feel better about the direction of things that are so critical to the way that they live their lives.  This will make a monumental difference in the length and severity of this crisis and US residential real estate downturn overall.