Capping possibly the wildest week in U.S. financial history, the markets breathed a sigh of relief on Friday, Sept. 19, at the U.S. government's multipronged plan to fight the financial crisis (BusinessWeek.com, 9/19/08), including a bailout fund par excellence to be created by the Treasury Dept. that will buy up bad debt and cleanse financial institutions' balance sheets of the toxic credit derivative products they have been holding. The details of the fund—how much bad stuff it will be authorized to buy and how those assets will be valued, to take two examples—are still to be worked out, and therein lies a host of questions about what negative side effects there potentially will be as a result.
In addition to the bailout fund, which could cost taxpayers up to half a trillion dollars, the government's overhauled playbook includes the Federal Reserve's unprecedented $85 billion bailout of privately owned insurance giant American International Group (AIG), Treasury's $2 trillion backstop of U.S. money market funds, and the U.S. Securities & Exchange Commission's temporary ban on short-selling on nearly 800 U.S. financial stocks.
To borrow the medical metaphor that's been cited all week, with priority given to restarting the patient's heart, less attention has been paid to the possible collateral damage the stress may cause his other vital functions. While survival of the financial system has been at the forefront of people's mind, there are a host of questions that remain to be answered in the weeks and months ahead, from details about how some of the government programs will work to possible unintended effects the cure may have on the way the markets function and how the economy performs over the longer term. BusinessWeek takes a look at some of the potential aftershocks.
Foremost will be how actually to value the assets to be bought by the superfund, a task likely to be neither simple nor quick, given the difficulty the market has had up until now in valuing them amid widespread unwillingness to buy them, says Hank Herrmann, chief executive of Waddell & Reed (WDR) in Overland Park, Kan. "A great deal of consideration has been given to how to value [collateralized debt obligations]" to no avail, he says. "And who's going to value them? Outside professionals?"
Worth the Negatives?
Herrmann also wonders what impact those valuations will have on homeowners across the country when their neighbors' foreclosed houses start being appraised differently and how fair that is to people who have kept up with their mortgage payments. "It's a lot better than the vicious cycle of spiraling down we've been having, so I think you're going to have to put up with some of this stuff," he concludes.
A related question is who exactly will U.S. taxpayers be bailing out? Should the commercial banks struggling with mortgage loans that have gone into default be treated the same way as the broker-dealers who are responsible for helping to create the crisis in the first place, asks David Joy, chief market strategist at RiverSource Investments in Minneapolis.
"It's the banking system you want to help out here. You want to free up credit so lending takes place. I'm not sure that's helped by including the [large financial] institutions in this," says Joy.
Another matter to be clarified: Will the government be buying bad mortgage-backed securities bought by foreign central banks and other overseas investors?
Although the credit crisis has been addressed, the reality of how all these extraordinary measures taken by the government over the past two weeks will play out in the economy is still very fuzzy, says Herrmann at Waddell.