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The Plan

Mon, Sep 22 2008, 08:31 GMT
by Yapi Kredi Bank Economic Research Department

UniCredit Group

The Treasury acted swiftly, and Paulson’s plan has been unveiled and sent to Congress over the weekend. Paulson’s plan is beautifully simple and clear in its core structure and goals, reassuringly ambitious in scope, and claims an extremely high degree of discretion in the implementation—a sort of carte blanche that would allow the Treasury to deal flexibly with the devilish complexities ahead. The proposed plan envisions an unprecedented intervention by the government into the economy: the Treasury would have sweeping powers to purchase at auction a wide range of assets from both US and foreign institutions over the next two years, and then hold them to maturity or sell them on the market if and when appropriate. Qualifying assets would initially be mortgage-related securities and whole loans, but the range could be broadened if needed to stabilize markets. The cap on the program would be set at USD700bn. The huge size of the plan and its flexibility should reassure investors that the Treasury has both the firepower and the discretion needed to effectively address the problem—its determination has already been proved beyond doubt. Controversial issues have already been tagged on to the proposal, including direct support to homeowners and limits to executive pay—the urgency of the issue is acknowledged by all parties involved, however, and I expect this will enable a rapid Congressional approval, possibly by the end of this week. The plan implicitly calls for similar measures in other countries: the global dimension of the problem is clear, and Paulson’s plan will encompass foreign financial institutions with substantial operations in the US. It is not clear if these calls will be heeded, however. I expect the market’s reaction to the proposal to be positive—this is a broad-ranging and convincing plan to address the daunting problems in the financial sector and support the housing market. As such, it significantly improves the odds for a gradual stabilization and economic recovery ahead. Volatility will remain high, however, and sell-offs will occur again as we get renewed bouts of concern on the plan’s implementation risks and on the already fragile global economic outlook. The USD will likely come under more pressure out of concern for the envisaged increase in public debt, but I remain of the view that the positive impact on the US macro and financial outlook will dominate, supporting a moderate USD strengthening over the next 15 months.

According to the information released by the US Treasury and media appearances by Paulson yesterday, the key features of the plan are:

The Treasury would have the authority to purchase up to USD700bn in assets, financed by an equivalent issuance of government bonds, and with the public debt limit increased correspondingly to USD11.3 trillion—a 6.6% increase. (Debt currently stands at USD9.6 trillion). The size of the program is therefore huge—it exceeds the over USD500bn in write-downs worldwide seen in the last twelve months.

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Published on  Mon, Sep 22 2008, 08:35 GMT