Unpleasant but essential
Unpleasant but essential
Sep 29th 2008 | WASHINGTON, DC
Democratic and Republican congressional leaders agree on a rescue plan
IT MUST be one of the most unpleasant laws that Congress has found itself writing so close to an election. Devoting $700 billion of taxpayers’ money to rescuing the country’s least popular industry is not a vote winner. That Democratic and Republican congressional leaders held their noses this weekend and came up with the Emergency Economic Stabilisation Act is encouraging evidence that they appreciate the gravity of the financial crisis. “This is something that all of us will swallow hard and go forward with,” John McCain said. Barack Obama added that “What we can’t do is do nothing.”
Nancy Pelosi, the Democratic speaker of the House of Representatives, said the chamber should vote on Monday September 29th, and she is counting on support from Republicans, who won late concessions. The Senate should act later in the week. Although misgivings linger, the bill should pass. The concessions that legislators from both parties wrung from Hank Paulson, the treasury secretary, provide necessary political cover. In a USA Today/Gallup Poll conducted on September 24th just 22% favoured Mr Paulson’s proposal while 56% wanted something different; only 11% preferred that no action be taken.
By legislative standards Congress moved at light speed after Mr Paulson and Ben Bernanke, the Federal Reserve chairman, proposed action on September 18th. Yet it may not be fast enough. In the past week the financial crisis has erupted in even more dangerous forms globally. The interbank-funds market has seized up and even the most creditworthy corporate and financial firms are paying punitive rates. Last week Washington Mutual became the largest-ever American bank to fail. In Europe, three countries had to come to the rescue of Fortis, a Belgian banking group, and Britain did the same with a mortgage lender, Bradford & Bingley. And on Monday Citigroup agreed to buy most of the assets of Wachovia, another beleaguered American bank, in a deal brokered by regulators.
The new law does provide the Fed with an additional tool for combating the latest stage of the crisis: from October 1st it may pay interest on reserves that banks maintain at the Fed. This will let it pump almost unlimited cash into the money market without fear of interest rates falling to zero, Japanese-style. It cannot, however, force banks to deploy additional reserves as new loans.
Mr Paulson or his successor will get $250 billion immediately, $100 billion more at the president’s discretion and $350 billion upon Congress’s approval. Investors may fret that this muffles the Treasury’s firepower. But if things get bad enough to require that extra $350 billion, Congress is almost certain to consent. The Troubled Asset Relief Programme, or TARP, can buy mortgage-backed securities, whole loans (those not bundled into pools) and, in consultation with the Federal Reserve chairman, anything else necessary to stabilise the financial system. That includes taking control of entire companies. Mr Paulson said on Sunday that he now has the power to avert “the potential systemic risk from the disorderly failure of a large financial institution,” implying the ability to bail-out a company while punishing its owners, as was done with Bear Stearns, Fannie Mae, Freddie Mac and AIG. Given the frequency with which institutions are collapsing, he may invoke that power sooner rather than later.
The final bill is 110 pages long, compared with the three pages that Mr Paulson started with. Democrats extracted numerous concessions. The programme will be monitored by a five-member oversight board made up of the secretaries of the Treasury and of Housing and Urban Development, the chairmen of the Fed and Securities and Exchange Commission, and the director of the Federal Home Finance Agency. The Treasury will try to modify the mortgages it owns to prevent foreclosures. Firms that sell assets to the programme will have to give the government warrants convertible into non-voting stock. They will also lose tax deductibility on some executive compensation and get limits on pay that encourages “excessive risks” and on fat severance cheques (“golden parachutes”).
Republicans, who balked at a preliminary agreement between the Democrats and the administration, got the Treasury to agree to sell insurance on mortgage assets as an optional alternative for firms who do not sell assets to the TARP. If in five years the programme has lost the government money, the president must find a way to charge the cost to the financial industry.
The Treasury and outside experts have argued that the programme is unlikely to cost anything close to $700 billion. Conceivably, it could turn a profit if the mortgages which it buys default at or below the rate implied by the prices it pays. The Congressional Budget Office has told Democrats that it will include only the expected loss on the programme, not the full $700 billion, in estimating the budget impact.
None of these concessions seriously cripples Mr Paulson’s flexibility or the programme’s appeal to the industry. He can structure the warrants to be painful or painless. The provisions on executive do not seriously hinder companies’ ability to hand over fat paycheques. The prospect of higher taxes five years from now should not affect a firm’s decision on whether to participate today. “The highest priority is restoring liquidity to the markets,” says Scott Talbott of the Financial Services Roundtable, representing financial companies. “Companies will participate in the programme even with the restrictions.”
Big questions remain about the programme’s implementation. One challenge is figuring out how to acquire the myriad of mortgage-related securities now clogging the financial system without being ripped off. An even bigger challenge is moving fast enough to create a firebreak against the raging crisis.