Washington Steps In, Takes on Debt Crisis

So much for letting financial markets sort themselves out. A series of events unveiled Friday established three-part response from lawmakers and federal regulators to a financial crisis that has spun further out of control this past week. First, the Securities and Exchange Commission banned all short selling of all financial stocks on Friday morning, citing a need to “protect the integrity and quality of the securities market and strengthen investor confidence.” The move follows an emergency order earlier this week that banned naked short selling on certain stocks, and helped propel most stocks significantly higher on Friday. SEC chairman Christopher Cox characterized short selling of financial stocks as “market manipulation that threatens investors and capital markets.” The SEC also said that it felt that “unbridled short selling” was causing trading counterparties to lose confidence, and that short selling activity in the current market was unrelated to the true valuation of key companies in question. The move was cheered by the markets — the Dow Jones industrials were at 11,356.12, up 336.43 points, when this story was published — but others expressed a more reserved outlook. “If investors cannot sell short financial stocks, they will sell short something else as a proxy for financial stocks, including companies in other sectors that remain vulnerable to a credit crisis and a recession,” aid Martin Weiss, chairman at Weiss Research, in a letter distributed this afternoon. “If investors feel those proxy hedges are not adequate, they will simply resort to outright liquidation of their securities, making the next stock market decline that much worse.” Second, the U.S. Treasury moved Friday morning to insure money market funds, after a few funds “broke the buck” earlier this week. The government plans to use as much as $50 billion from the country’s Exchange Stabilization Fund to protect investors from losses — temporarily, of course, lest taxpayer dollars be at real risk. “Maintenance of the standard $1 net asset value for money market mutual funds is important to investors,” the Treasury said in a press statement. “If the net asset value for a fund falls below $1, this undermines investor confidence. The program provides support to investors in funds that participate in the program and those funds will not ‘break the buck.'” The Fed piggybacked the move by the Treasury, and said it would extend non-recourse loans to banks to finance the purchases of asset-backed commercial paper from money-market mutual funds. “This should assist money funds that hold such paper in meeting demands for redemptions by investors and foster liquidity in the ABCP markets and broader money markets,” the Fed said in a statement announcing the program. Third — and perhaps most relevant to the mortgage markets — Treasury secretary Henry Paulson confirmed that Washington will look to create what he called “a troubled asset relief program.” And make no mistake about it, this is a bail out, and one that will cost us dearly, Paulson warned. “The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars,” he said in a press conference Friday. “I am convinced that this bold approach will cost American families far less than the alternative — a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.” Which means that after months of insisting that the U.S. economy is fundamentally sound, administration officials are being forced to admit that the economic condition we face is more dire than originally described. The “troubled asset relief program” was already being referred to as TARP on Friday by many market participants; it’s essentially a revamped version of the Resolution Trust Corp. that was used by the government to dissolve bad assets out of the S&L crisis in the early part of the 1990s. Following up on a Thursday HW report, which noted a lock-up in the secondary mortgage market, Paulson also said the GSEs — now controlled by the government — would begin large-scale MBS purchases to unlock a frozen secondary market, as well as expanding the Treasury’s own purchase of MBS. “The financial security of all Americans –- their retirement savings, their home values, their ability to borrow for college, and the opportunities for more and higher-paying jobs –- depends on our ability to restore our financial institutions to a sound footing,” Paulson said. In other words: yes, this is worse that we thought. The fate of much of the capital markets is now in the hands of Washington. Disclosure: The author held no relevant positions when this story was published; even if he wanted to, he couldn’t, thanks to the SEC. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.