U.S. tackles consumer debt market

Puzzanghera and Hsu are Times staff writers.

The federal government’s new $800-billion initiative to revive the nation’s credit markets and reverse the deepening economic crisis propels the government into risky territory -- the uncertain world of credit cards, student borrowing, auto loans and cash-strapped small businesses.

Most of the money in the plan announced Tuesday is aimed at making home loans cheaper and more readily available. To that end, the Federal Reserve plans to buy as much as $600 billion in debt and mortgage-backed securities held or issued by government-sponsored lenders such as Fannie Mae and Freddie Mac.

But on a separate front, the Fed will commit as much as $200 billion to help loosen lending for consumer goods, including everything people can buy with their credit cards. The move is intended to make it easier for ordinary Americans to get credit, but it also carries greater risk that tax dollars might not be repaid.


In part, that’s because as federal officials reach further out for ways to ease the credit freeze-up that’s hogtying the overall economic recovery, they have little choice but to adopt strategies carrying greater risks.

“They have to reach further and further out on that risk scale in order to have any effect because what they’ve done so far . . . hasn’t solved all the problems,” said Timothy Yeager, a finance professor at the University of Arkansas and a former Federal Reserve economist.

Also, because credit card debt and student loans are largely unsecured -- unlike home loans or auto purchases, which have tangible assets behind them -- they represent a higher risk that the money might not be repaid.

Despite the risk, the move was necessary, said Sen. Charles E. Schumer (D-N.Y.), who has been pushing the administration to take actions to loosen credit for student, car and small-business loans.

“The arteries of the financial system are still clogged, and as a result, too much of the economic activity on Main Street is slowing to a crawl,” he said.

Many working people can’t get the credit they need, said Richard Pittman, a counselor with the nonprofit ByDesign Financial Solutions, which offers personal credit counseling in Los Angeles.

“We’re crossing our fingers that this will work,” he said. “If we don’t get the market moving again, the biggest industry is going to be soup lines.”

Credit card companies have not only increased interest rates on outstanding balances but also rolled back credit limits for many consumers, said Travis Plunkett, legislative director for the Consumer Federation of America.

“Credit card companies can suddenly and sharply double or triple your interest rate on the existing balance. What kind of effect does that have on a household that is barely making it?” Plunkett said.

Federal officials said they would reduce the risk to taxpayers by covering only securities with the highest ratings. Those securities would contain new or recently issued loans that reflect the higher lending standards of the current crisis.

Treasury Secretary Henry M. Paulson said the aim was to get money flowing again to allow people to buy homes and cars, to attend college and to expand their small businesses.

The market for securities backed by such lending declined sharply this summer, and all but dried up in October.

“As a result, millions of Americans cannot find affordable financing for their basic credit needs. And credit card rates are climbing, making it more expensive for families to finance everyday purchases,” Paulson said. “This lack of affordable consumer credit undermines consumer spending [and] as a result weakens our economy.”

The federal action sent both the Dow Jones industrial average and the Standard & Poor’s 500 index higher for a third straight day, the first time that has happened in more than two months. The tech-laden Nasdaq index declined.

The consumer program, in the form of loan guarantees to holders of highly rated, consumer-asset-backed securities, will be run by the Federal Reserve. Paulson stressed that it would take a while to get underway and that the program could grow over time.

The Treasury Department will cover up to $20 billion in losses with money from the federal government’s $700-billion financial rescue fund.

“The problem is the market is so wary of asset-backed securitizations that people aren’t willing to buy,” said Jaret Seiberg, a financial services analyst with Stanford Group Co.

David Resler, chief economist for Nomura Securities, said that the government was taking steps to reduce risk and that the program was big enough to help loosen credit in the $2.6-trillion consumer credit market.

“It essentially ensures an investor market for these new loans,” he said. “It will help.”

Car dealers, struggling with the worst sales market since 1991, welcomed the federal aid and the prospect of lower rates for car loans.

“The credit market has maybe slowly started to thaw, but this package will help unfreeze it more quickly,” said John Sackrison, executive director of the Orange County Automobile Dealers Assn. “It’s great news for consumers and auto dealers alike.”

The new government initiatives came as President-elect Barack Obama continued his preparations to take office, promising to cut wasteful government spending as the country gears up for a major economic stimulus package.

Only last week, Paulson seemed to indicate the administration would leave any major new initiatives to Obama’s incoming economic team.

But Tuesday, with fresh signs of deeper economic trouble, Paulson vowed to keep devising ways to combat the crisis until he handed off the baton in January.

“Well, I tell you, I am going to run right to the end, OK?” Paulson told reporters. “And we’re going to continue to develop programs, deploy them when they’re ready to go and work on having a very seamless, very seamless transition here.”

To loosen up the tight mortgage loan market, the Federal Reserve said it would buy as much as $600 billion in debt and mortgage-backed securities of Fannie Mae and Freddie Mac, the government-sponsored lenders that were taken over by federal officials this fall, as well as Ginnie Mae and the Federal Home Loan Banks.

By buying Fannie and Freddie securities -- now viewed as risky by many investors -- the Fed hopes to drive down yields on that debt, which in turn should help lower mortgage rates.

“Nothing is more important to getting through this housing correction than the availability of affordable mortgage finance,” Paulson said.

The government is not looking to buy toxic mortgage-backed securities issued by banks, the initial purpose of the $700-billion rescue fund that officials have since abandoned in favor of buying stakes in banks and other measures. But the new aid plan should help the housing industry by making it easier for Americans to get the loans they need to buy homes.

Government data released Tuesday highlighted the economic troubles. The Federal Deposit Insurance Corp. said the number of “problem banks” rose to 171 in the third quarter from 117 in the second quarter. And the Commerce Department said the economy shrank more than expected in the third quarter. It revised its estimate, saying gross domestic product contracted at an 0.5% annual pace rather than 0.3%.

“The problems facing the financial services industry, combined with the general economy, have dried up lending in all areas,” said Scott Talbott, senior vice president for government affairs at the Financial Services Roundtable, which represents large banks, investment houses and insurers. “The Fed actions are a double-barreled shotgun: One barrel is pointed squarely at mortgages, one barrel is pointed at all other loans.”

The small businesses that rely on loans to stay open desperately need to see more liquidity in the credit markets, said Scott Hauge, president of Small Business California.

“There have been situations where a guy went to have his credit line increased, but instead, they cut it in half,” he said. “I’ve also heard about people who don’t even know their lines or credit cards have been cut until they try to use it. It’s a mess.”

As a result, small businesses have had to make sharp cuts -- often slicing expenses, laying off employees and sometimes closing temporarily, Hauge said. They’re hoping for a lifeline, but are wary.

“As for predicting when things will change, nobody knows,” he said. “It’s not clear to a lot of these business owners how Paulson’s announcement today will translate into them getting money into their hands.”




$600 billion

- The amount to be used to buy mortgage-backed securities held by government-sponsored lenders Fannie Mae, Freddie Mac and Ginnie Mae, and debt held by Fannie Mae, Freddie Mac and the Federal Home Loan Banks.

$200 billion

- The amount to be used for loan guarantees to holders of AAA-rated asset-backed securities containing consumer loans such as credit card, auto and student loans. The Treasury Department will cover up to $20 billion in losses on those loans.