How $700 billion Paulson-Bernanke plan may help house prices
Economists hope the proposed bailout will boost confidence and end the cycle of falling real estate values.
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That sign has been popping up with rising frequency in front yards across America as banks unload foreclosed homes. Moreover, the distressed real estate market is causing housing prices to drop further, prompting yet more sales. It's been a vicious circle of falling real estate values.
Now the federal government is hoping to break the cycle – in essence end those foreclosure sales.
Will it be enough to turn around the real estate market and keep the US economy from heading into a deeper trough?
It has a good chance of getting the job done, assuming Congress can get the rescue plan passed quickly, economists say.
"We were in a vicious circle where large institutions were taking large losses on mortgage-backed securities, and when they booked those losses it involved depleting capital," says Richard DeKaser, Washington-based chief economist at National City Corp. "They either needed to raise new capital or reduce their assets further, and in this environment they were selling assets, which depressed prices further. The thrust of Paulson's plan is to mitigate the degree of write-downs." The hope, too, is that the plan will help to keep the crisis on Wall Street from further choking off Main Street.
"This should help prevent the problem from totally spilling over to Main Street," says Mark Vitner, a senior economist at Wachovia Securities in Charlotte, N.C. "The biggest threat to the economy was that more businesses were denied access to credit and it would slow overall growth even more. That is less likely now."
The cost to the taxpayer, while likely to be sizable, is not yet knowable.
"It depends on whether the securities purchased by the government [from the financial institutions] are undervalued or overvalued, and it depends on the fate of the housing market," says Mr. DeKaser.
Still, the government's plan is also likely to yield practical public benefit. A major one could be "making mortgages more affordable," DeKaser says.
News that the government was crafting a wholesale rescue plan for the financial system, rather than continuing to help firms on a case-by-case basis, turbocharged investors. On Thursday and Friday, the Dow Jones Industrial Average rose 778 points. Key interest rates have dropped, indicating that at least some lenders believe prospects have improved for getting back their loans.
"It was a necessary and positive development," says Mark Zandi, chief economist at Moody's Economy.com, of the federal plan. "It shows they will do whatever it takes to shore up the financial sector."
According to a draft obtained Saturday, the proposal would:
• Give the Treasury secretary broad authority to buy up to $700 billion in mortgage-related assets from any financial institution in the United States.
•• Give the government power to designate financial institutions as "financial agents of the government" and require them to carry out any "reasonable duties" that entails.
• Require the government to report to congressional budget, tax-writing, and financial services committees within three months of using the authority and every six months thereafter.
• Instruct the Treasury secretary to consider both providing market stability and protecting taxpayers.
• Expire two years after enactment.
– Associated Press