Wednesday, October 1, 2008

Summary of the Senate Bailout Bill

Today, I reviewed the first 112 pages of the 451 page H.R. 1424, which is the “Emergency Economic Stabilization Act of 2008,’’ also called the Financial Bailout Bill. This is my humble attempt at a summary of the key provisions. I will not address pages 113 through 451 which appear to be a lot of completely unrelated provisions, such as Sec. 503 "Exemption from excise tax for certain wooden arrows designed for use by children,” which I assume is meant to help ensure the bill passes under the huge public support for exempting children's wooden arrows. Maybe if I get super ambitious I will summarize these earmarks tomorrow.

The heart of the bill is the creation of the “Troubled Asset Relief Program” or TARP. This program authorizes the Secretary of the Treasury to set-up a process to purchase “trouble assets” which basically are bad mortgages. The program has certain provisions to attempt to require this purchase to be made at the market value such as requiring the purchase and the sell of the troubled assets to minimize the long term cost and maximize the benefit to the taxpayer and limiting the maximum purchase price to the seller’s cost basis in the asset. In simple words, the Government should try to buy the mortgage for the true market value and is prohibited from paying more than the bank paid for the mortgage. This is designed to prevent fraud and kickbacks.

The bill also creates an insurance program for these assets that base the premium on the individual assets themselves. These premiums will go into a “Troubled Asset Insurance Financing Fund,” although I am not sure who will be paying these premiums. The bill also provides for “foreclosure mitigation efforts” to be made between the government and the mortgagee, which can include a reduction in the interest rate and/or the loan principal balance in order to prevent having to foreclose on the mortgagee.

The bill creates numerous federal agencies to oversee this system including the Financial Stability Oversight Board, the General Accounting Office TARP Oversight Authority, the Office of the Special Inspector General (with $50 million in funding), the TARP Congressional Oversight Panel, as well as a process for Judicial Review and the actual bureaucracy created in the Treasury Department to administer the TARP program.

The bill also has several add-on features that appear to be part of the compromises worked out by various parties. There are limits on and additional taxes to the compensation of executives of the companies who sell their troubled assets in the new program. There is a suspension of the accounting rule FASB 157, which requires financial institutions to “mark-to-market” the value of their mortgages. Numerous disclosure requirements are listed, such as requiring the disclosure of the purchase or sell of troubled assets within two days of the transaction. In addition, the FDIC insurance limit is raised from $100,000 to $250,000.

Finally, the limit on outstanding assets is set at $200 billion immediately, which can be raised to $350 billion immediately upon notification of the President to Congress, and to $700 billion fifteen days after notification of the President to Congress unless they pass a joint resolution of disapproval. Basically, this means that the government has funding to purchase up to $700 billion in bad mortgages.

I do have several thoughts on this bill. It is often misunderstood that this bill will “bailout Wall Street” by giving them $700 billion. This is not the case; rather this greatly expands the role of the Federal Government in the banking system and truly creates a National Bank run by the Treasury Department. (Where is Alexander Hamilton when you need him?) The architects of this plan envision the Treasury purchasing these bad mortgages at market prices by assuming additional national debt, holding these mortgages until the housing market improves, and then selling this mortgage at a profit large enough to cover the costs of the program. This plan depends on many assumptions including: (1) the housing market will improve in the short term horizon, (2) the government will purchase the assets at their true market discounted value, (3) in the aggregate the mortgages will not be renegotiated below their discounted value during their holding period, and (4) the government can sell the mortgages back to the public sector after the current financial crisis is resolved and then discontinue the program. To accept this program, you have to believe that all four of these large assumptions will hold true. I will leave that decision up to you.

1 comment:

Dave Miller said...

Another assumption I would add is (5) if indeed the $700B is recovered, the government will give the money back to the taxpayers.

Based on their track record, there is no way that will happen.