US fiscal relief plan set to be costliest since Depression

THE BUSH administration's plan to rescue the US financial system promises to be the costliest and most sweeping government intervention in financial markets since the Great Depression.

Treasury secretary Hank Paulson and Federal Reserve chairman Ben Bernanke are hoping that Congress will approve the rescue package by the end of next week but Senate banking committee chairman Chris Dodd said yesterday that he still was not sure what they had in mind.

"We're anxious to hear the specifics, none of us have any idea what the details are," Mr Dodd said. "We understand the gravity of the moment."

What is already clear is that the plan will put huge sums of taxpayers' money on the hook - "hundreds of billions", according to Mr Paulson. The treasury secretary said that after acting on a case-by-case basis in response to troubles at Fannie Mae and Freddie Mac, Lehman Brothers and AIG, it was time for a more comprehensive government approach to the financial crisis.

"The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy," he said.

"The federal government must implement a programme to remove these illiquid assets . . . The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars."

During the last US banking crisis in the late 1980s and early 1990s, Washington set up the Resolution Trust Corporation (RTC) to manage distressed assets of banks and savings and loan institutions the government had taken over. Between 1989 and 1995, the RTC closed or otherwise resolved 747 savings and loans associations with total assets of $394 billion, using "equity partnerships" with private sector institutions.

The current crisis could require a more complicated mechanism than the RTC because the distressed assets this time are not commercial real estate but mortgages on people's homes.

One option could be for the government to buy up the troubled mortgages at a steep discount and eventually sell them back into the financial system. Another model might be the Depression-era Reconstruction Finance Corporation, set up by President Herbert Hoover in 1932 to lend money to banks, mortgage associations and other businesses.

The US government moved yesterday to shore up the financial system, announcing plans to temporarily insure money-market deposits, to inject more liquidity into money-market funds and to ban short-selling in securities.

President George Bush acknowledged that the new measures meant putting "a significant amount" of taxpayer dollars on the line. "This action does entail risk, but we expect that this money will eventually be paid back. The vast majority of assets the government is planning to purchase have good value over time, because the vast majority of homeowners continue to pay their mortgages," he said.

"And the risk of not acting would be far higher. Further stress on our financial markets would cause massive job losses. . . These are risks that America cannot afford to take."

Democrats in Congress are hoping to link the financial rescue package to measures designed to help people threatened with repossession to remain in their homes.

Democratic presidential candidate Barack Obama says he backs giving "broad authority" to the Treasury Department to deal with the credit crisis, but has called for strict limits on the bailout.