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Will the $700 billion government bailout work?

The credit crunch and volatile stock markets haven't abated by press time, albeit the historic Congressional and presidential actions on Oct. 3 in passing the Emergency Economic Stabilization Act of 2008, which itself had sparked debate.

By way of explanation of why the bailout was needed, Christopher G. Brown, with the Westport, Conn, law firm Begos Horgan & Brown LLP, says it was needed because credit had all but dried up with evaporation of the market for residential and commercial mortgages and the securities backed by them. Institutions that held mortgages or mortgage-backed securities had no buyers for their inventory and thus could not convert the assets into cash to lend.

The bailout enabled the federal government to make a $700 billion market for these assets. The act gives the Secretary of the Treasury broad discretion to determine which mortgages and mortgage-related instruments to buy and which institutions to deal with. The assets may be purchased through an auction, reverse-auction or direct purchase.

It also authorizes the Secretary, upon the request of any institutions, to guarantee mortgages and mortgage-backed securities, perhaps to provide an incentive for others to bid at any auction of the guaranteed assets. The Secretary may also buy mortgages and mortgage-related securities from retirement plans.

Also, the act increased the Federal Deposit Insurance Corp. insurance for deposits from $100,000 to $250,000 per account to encourage depositors to increase their deposits, or to leave cash that had exceeded the previously lower insurance limit. The intended result was an increase in the deposit base in those banks and therefore the capital available to the institutions for loans.

While the "$700 billion is likely to help," says Brown, he believes the Secretary needs to make purchases carefully.

"A lot of businesses got involved in buying and selling mortgages, not because they were lenders but simply because it seemed like an easy place to make money," he points out. If the government 'cashes them out,' I don't know how many will be returning that capital to the credit market."


The servicing relationship is another issue that Brown believes will require close examination. The act requires the Secretary to "encourage" servicers, (those who collect and distribute mortgage payments) to take advantage of programs to minimize residential foreclosures. Servicing agreements vary, but certain contractual obligations can actually make foreclosure attractive to a servicer. The government needs to be careful that it does not find itself party to a servicing agreement that allows the servicer to commence foreclosure actions entitled "United States of America v. Homeowner the Act was Supposed to Protect," says Brown.

He also believes that the outcome of the present crisis and bailout is very much up in the air. "Something had to be done, but it remains to be seen if this was the something." He expects a very different environment for both businesses and individuals "when this thing shakes out".

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Title Annotation:ECONOMY
Author:Heffes, Ellen M.
Publication:Financial Executive
Geographic Code:1USA
Date:Nov 1, 2008
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