WASHINGTON — Treasury Secretary Henry Paulson confirmed Wednesday what many industry observers had begun to suspect — the government is abandoning its plan to buy troubled assets from banks.
The news brought criticism from several quarters, including lawmakers who saw it as a missed opportunity, bankers who said they have whiplash from the Treasury's about-face, and industry observers who praised the move but openly doubted the professed rationale for it.
Mr. Paulson also raised additional questions by appearing to reject a plan developed by Federal Deposit Insurance Corp. Chairman Sheila Bair to use funds from the Troubled Asset Relief Program to offer loan guarantees to lenders that agree to systematic loan modifications of distressed mortgages. Though praising the idea's merits, Mr. Paulson appeared unwilling to use the $700 billion allocated by Congress to fund it.
The Bair plan is "an important program, but that is a subsidy or spending program," he said. "We have Tarp, which is an investment, not spending. We are continuing to work through that issue."
This angered some on Capitol Hill who said they will push President-elect Obama to offer the program when he takes office next year. "I disagree with one of the major decisions, from my standpoint, which is not to use any of the Tarp [funds] for mortgage foreclosure reduction," said House Financial Services Committee Chairman Barney Frank.
He said his sense from talking to Mr. Paulson was that the Treasury had modified the FDIC plan "to where they think it's OK substantively, but they need the money."
Rep. Frank said he was disappointed that the Treasury had abandoned plans to buy assets directly; doing so would have given the government more leeway to engage in loan modifications, he argued.
"I think he's wrong not to use it that way because the point was, we would buy these assets from lenders at less than 100 cents on the dollar … and then in turn modify the mortgage downward," he said.
Industry representatives, meanwhile, said the shift of the entire purpose of Tarp — which, as its name implies, was sold to Congress as an asset-purchase plan — was disconcerting to the banking industry.
"This program has had more twists and turns than a mountain road, and it is difficult for the industry to keep up," said Ed Yingling, the president and CEO of the American Bankers Association. "One of the things we've been concerned on is, the public is really confused."
Mr. Paulson justified the move by saying capital injections would do more to help the economy.
"Over these past weeks we have continued to examine the relative benefits of purchasing illiquid mortgage-related assets," he said. "Our assessment at this time is, that is not the most effective way to use Tarp funds."
The Treasury is focused on expanding the capital program, including to nonbank financial institutions, he said, but he did not say which industries would be helped. It is widely assumed that insurance companies will get Treasury funds.
Mr. Paulson also said his department, along with the Federal Reserve Board, would create in coming weeks a liquidity facility for AAA-rated, asset-backed securities.
A change in market conditions necessitated the focus on capital injections, he said. "The facts changed, and the situation worsened, and given the situation we confronted we said the right way to use taxpayers' money … would be through an investment program."
But Karen Shaw Petrou, the managing director of Federal Financial Analytics Inc., said there had been no change in market conditions — the Treasury just realized that an asset purchase program was too difficult.
"If the plan wasn't going to work, that was as foreseeable on Sept. 19 as it was on Oct. 10 ," she said. "They rushed out the asset-purchase program without considering how complicated it was."
Some lawmakers and industry observers praised the Treasury's move, however, saying it was overdue. "It was the worst-kept secret in Washington that the auctions wouldn't work and were likely to be scrapped," said Sen. Charles Schumer, D-N.Y., the chairman of the Joint Economic Committee. "It was clear from the beginning that capital injections were the way to go."
Where the Treasury will focus next remains open to question. Mr. Paulson said the agency might require future applicants to prove they can raise private-sector capital. "We are carefully evaluating programs which would further leverage the impact of a Tarp investment by attracting private capital, potentially through matching investments," he said. "We will also consider capital needs of nonbank financial institutions not eligible for the current capital program; broadening access in this way would bring both benefits and challenges."
Though Democratic lawmakers are discussing a bill that would require Treasury to give $25 billion from Tarp to the auto industry, Mr. Paulson appeared to rule that out. "The intent of the Tarp was to deal with the financial industry," he said.