The US government is working on a plan to rid Wall Street of hundreds of billions of dollars of toxic mortgage investments, something it hopes will be a once-and-for-all solution to the credit crisis that has crippled global financial markets.
Hank Paulson, Treasury Secretary, and Ben Bernanke, chairman of the US Federal Reserve, were meeting congressional leaders last night to suggest the creation of a standalone investment vehicle into which troubled banks could unload their impossible-to-value mortgage derivatives.
The plan could be similar to the creation of the Resolution Trust Corp that helped to lead the US out of the savings and loan crisis of the late Eighties, by taking over distressed assets.
Wall Street has repeatedly written down the value of mortgage derivatives, called collateralised debt obligations, which are parcels of US home loans, since US house prices began falling and Americans started defaulting on their mortgages in record numbers. More than $500bn has so far been written off, but there is no clarity still on the ultimate value of these derivatives, and the uncertainty lies at the root of the current credit crisis.
With all the banks fearful that their rivals may be financially unsound, activity in the credit markets has been slow and nervous for over a year, and since the collapse of Lehman Brothers at the weekend it has come practically to a standstill.
Indeed, the atmosphere of panic persisted yesterday, even after the world's major central banks injected $180bn into the money markets in an attempt to get things moving again. Signs of nervousness abound: no new corporate bonds have been issued for a week, gold has seen record gains and now sits above $900 an ounce, and US Treasury bills are so popular that investors are accepting negative rewards on them, a phenomenon not witnessed since the Japanese sneak attack on Pearl Harbour in 1941. This "flight to safety" also saw a run on money market funds, supposedly among the leastrisky of all investment vehicles.
The gloom only lifted in the final hour of trading on word that Messrs Bernanke and Paulson were assembling the heads of important committees from both the House of Representatives and the Senate, and the political party leaders. The Dow Jones Industrial Average staged a 410-point rally, its most powerful since 2002, on hopes that the meeting could gain agreement for speedy legislation to create a Resolution Trust-type vehicle.
At the beginning of the day, the Fed agreed to lend other central banks $180bn, which could be pumped into their respective markets in an attempt to kickstart trading activity in dollar-denominated derivatives and other investments. The Bank of England, European Central Bank and the central banks of Canada, Japan and Switzerland were the institutions involved in the co-ordinated plan.
Overnight dollar money market rates did ease, and the damage to the wider stock market seemed to have been contained. However, the "flight to safety" could gather yet more momentum. Money market funds, a $3.5 trillion pool of supposedly ultra-safe investments that are only allowed to invest in short-term debt, saw mass redemptions and one, a $15bn fund called Putnam Investments, said it was shutting down. The
Economists at Dresdner Kleinwort said the central banks' initiative should "stabilise short-term US dollar funding rates and reduce the threat of solvent institutions becoming illiquid". But they added: "The solvency issues remain and it will be difficult to see these measures being able to promote a resurrection in money-market liquidity beyond the very short-term maturities."
Reeling from the unprecedented succession of dramas at Lehman Brothers, Merrill Lynch, AIG and HBOS, the focus moved yesterday to Morgan Stanley and Goldman Sachs. John Mack, chief executive of Morgan Stanley, said he would do everything he could to protect the independence of the historic firm. Since Morgan Stanley shares went into a downward spiral this week, and with credit market disruptions threatening to vastly inflate the cost of raising money to fund operations, Mr Mack has received merger proposals from several US banks.Reuse content