Here’s a link that talks about the powers of the Fed, Treasury, and FDIC:

http://marketplace.publicradio.org/display/web/2008/09/30/feds_toolkit/

“Still, in theory, the Fed even has authority to do just what the congressional bailout authorizes — take bad debts off the hands of struggling banks.”

http://www.msnbc.msn.com/id/20218020/

This decline in value has led to the need for cash because banks are required to maintain specified levels of capital. Hence they have been required to raise cash (by selling assets, issuing stock, or floating bonds or preferred stock) to meet these requirements.

If accounting rules were changed to reflect values other than current market prices, then there would be a lot of stress taken off the financial system. However, the risk in that approach was exemplified by Japan, whose banks carried inflated values of their underlying assets, which prolonged a recession which lasted over a decade.

One approach which has been suggested is to let the Fed or some other government agency determine what the assets are worth based on a comparison between current asset prices and a projection of long term value.

a. mortgage holders are required to state the asset value of these mortgages based on today’s market price (mark to market, i think?).

b. the resulting decline in value of mortgage backed securities has led to falling portfolio values, illiquidity, and the need for cash & credit.

If we were to change the accounting such that the mortgage value was based on their ‘real’ long-term value (whatever that is and assuming it is different and more than today’s market value), how much of the crisis would pass?

The Treasury seems to be authorized to inject liquidity into the financial system, but not authorized to buy toxic securities (especially when their value is unknown). Am I getting close?

http://www.motherjones.com/kevin-drum/2008/09/solvency_vs_liquidity.html

It’s true that the Bernanke/Paulson bailout is aimed at illiquid debt instruments. And those instruments are illiquid largely because they contain lots of toxic mortgage securities and nobody knows how much this stuff is really worth. It’s unlikely that the toxic sludge makes these instruments literally worth nothing, but who knows? The mere possibility that they’re worthless means that any bank who owns them might be insolvent, and since everyone owns at least some of them, this in turn means that everyone might be insolvent. Result: no one is willing to loan money to anyone else, because who wants to loan money to a bank that might never pay it back? And since huge flows of overnight interbank loans are the oil that lubricates the credit markets, when this flow seizes up, the entire credit market seizes up. (What’s more, if this WSJ tick-tock is correct, the seizure became critical on Wednesday, which is why B&P changed their minds midweek about pursuing a systemwide bailout that they’d opposed earlier.)

The purpose of the bailout, then, isn’t to recapitalize the banks, it’s to put a firm value on the toxic sludge once and for all. Maybe it’s a dime on the dollar, maybe it’s 50 cents on the dollar. Whatever. When that’s done and the feds have purchased the sludge, some banks will turn out to be insolvent, and perhaps they’ll be allowed to fail. Others will turn out to be in bad shape but still solvent, and they’ll continue doing business. Once that’s sorted out, the commercial paper market will loosen back up since everyone will know who it’s safe to loan money to and who it’s not.

A capital injection helps liquidity, but it doesn’t dispose of the ‘toxic assets’ (i.e., the mortgage related debt instruments) that are causing people to question the solvency of many lending institutions.

But the Treasury needed Congressional approval to actually purchase these assets, thus removing them from the balance sheets of troubled institutions.

Anyone else? Did I get close?…