> House Conservatives Blast Socialist DemocRAT Bailout!

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House Conservatives Blast Bailout

Monday, September 29, 2008

Emergency Economic Stabilization Act of 2008

Summary: The Emergency Economic Stabilization Act provides the
Treasury Department with the authority to purchase illiquid, troubled
assets on the books of private financial institutions, in an effort to
resolve the current financial crisis. The highlights include the
following:

Purchase Authority: Provides $700 billion in purchase authority at any
one time to Treasury to purchase ?troubled assets from any financial
institutions,? of which $250 billion would be made immediately
available and another $100 billion once the President certifies that
Treasury needs the authority. The final $350 billion is authorized,
but Congress could halt the authority by passing a joint resolution
disapproving the action (under fast-track procedures). However, such
joint resolutions require the signature of the President to take
effect. While provided in installments or ?tranches,? the bill
provides the full $700 billion, as initially requested by the
Administration to calm the financial markets.

Troubled Assets: Broadens the Treasury Department?s original request
for mortgage-related assets to a larger class of ?troubled? assets.?
Such assets are defined as ?any residential or commercial mortgages
any securities, obligations, or other instruments that are based on or
related to such mortgages? and ?any other financial instrument that
the Secretary?determines the purchase of which is necessary to promote
financial market stability? (emphasis added). This definition
significantly expands the scope of the purchasing program to
potentially many more classes of securities (e.g.., those backed by
car loans, credit-card debt, etc.).

Insurance Component: Requires the Treasury Department to establish a
federally-backed insurance program, similar to the Federal Deposit
Insurance Corporation (FDIC), for holders of troubled assets, if it
utilizes its purchase authority (which it is expected to do). Treasury
would guarantee up to 100% of the timely payment of principal and
interest on certain classes of troubled assets, presumably those worth
more than the ones which will be immediately purchased. A
risk-adjusted premium would be assessed to holders of these assets to
self-finance the program through the participants. The total amount of
assets insured by the program, minus the premiums, would offset the
purchase authority available to Treasury. However, it is unclear
whether the insurance program would be set up quickly or effectively
(with a large enough class of assets) to ensure that it can be used to
substantially offset Treasury?s purchase authority.

Private Firms as Financial Agents: Authorizes Treasury to designate
private financial institutions as its agents to carry out such duties
as may be required in exercising its new authority. The bill directs
Treasury to solicit bids from a broad range of qualified firms and to
?take appropriate steps to manage conflicts of interest, including
requiring potential firms to indentify and disclose? potential
conflicts.? The FDIC would be among the candidates chosen to manage
the purchased assets.

Priorities: Requires the Treasury Secretary to exercise its authority
in a manner that will protect the taxpayer, provide stability and
prevent disruption to the financial market system, the need to help
families keep their homes and to stabilize their communities, etc. (in
that order).

Executive Compensation: Sets executive compensation limits on two
classes of firms, 1) those which the federal government directly takes
over ?AIG-style? and 2) those who sell $300 million or more in assets
to the federal government, so-called ?high-volume sellers.? For those
firms directly taken over, the Secretary would establish limits on
compensation for taking unnecessary and excessive risk, a prohibition
on ?golden parachute? payments, and a process for recouping any
incentive payments made to ?senior executives? (top 5 executives of a
public company) based on earning statements later proven to be
materially inaccurate. For high-volume sellers, the legislation would
also ban golden parachute payments and lower the current deduction for
executive compensation from $1 million to $500,000. Many conservatives
may be concerned that, while aimed only at participating firms, this
change to tax law sets a dangerous precedent since liberals have
pushed for years to lower this deduction. It should be noted that the
limit on the deduction itself is one of the main reasons for
corporations to structure incentives-based compensation that may cause
corporate actors to take excessive risks to boost share prices.

Reverse Auctions: Requires the Secretary to use methods, such as
auctions or ?reverse? auctions, in purchasing firms? troubled assets,
in order to minimize the cost to taxpayers. Treasury intends to use a
process whereby it indicates its intent to buy a certain class of
troubled assets and competing firms provide the terms for which they
would sell. If the process works, Treasury would choose the seller
with the lowest sticker price. When these assets are later sold, the
proceeds would flow into general revenues. However, some conservatives
may be concerned that this process may not work in practice because:
1) all sellers have an incentive to hold onto to their assets until
the government offers an inflated price over what the market would
currently bear (since firms are undercapitalized and there is a limit
to the losses that they can sustain by selling their assets at market
or below-market rates), and 2) the classes of assets are not
particularly large or homogenized, since many of these securities are
so complex and unique, perhaps making it difficult to attract a large
pool of willing sellers to drive down prices.

Warrants: Requires the Treasury to receive warrants for non-voting,
common or preferred stock in firms that sell more than $100 million in
troubled assets to the government. A warrant is a certificate that
entitles the holder to purchase securities at a certain price. Giving
the federal government a warrant to shares of participating firms
provides a mechanism for taxpayers to recoup a portion of the initial
price if share prices increase and the shares can later be bought and
sold for a profit. However, it also sets a dangerous precedent in that
it allows the federal government to own shares in private companies,
if the warrant is exercised instead of being sold. While the warrants
could only purchase non-voting shares, minimizing any authority that
comes with such ownership, some conservatives had recommended that the
federal government only be able to sell these warrants and never
exercise them. This would have allowed for similar levels of taxpayer
recoupment without setting a dangerous precedent of the federal
government inevitably owning large swaths of the U.S. financial
sector.

5-Year Recoupment Plan: Requires the President after five years to
determine whether taxpayers have suffered a net loss as a consequence
of the purchase program, and if so, to submit a legislative proposal
to recoup that amount from participating firms. There is nothing in
the bill to ensure that the President?s proposal is considered or
passed by Congress, casting doubt on the efficacy of this provision?a
variation of the Blue Dogs? initial proposal to place an
indiscriminate tax on the entire financial sector, regardless of
whether a firm?s assets where purchased by the Treasury. But to the
extent that this provision does lead to legislation, some
conservatives may be concerned that it could result in a tax increase.
Market and Program Transparency: Requires the Secretary to make
information regarding each purchase available to the public in an
electronic form, including a description, amounts, and pricing of such
assets. The language also requires the Secretary to make public the
mechanisms for purchasing troubled assets, the methods of valuing
assets, the process for hiring asset managers, and the criteria for
identifying troubled assets for purchase.

Debt Limit: Increases the limit statutory debt limit from $10.615
trillion to $11.315 trillion, an increase of 6.6%. If enacted, the
110th Congress will have presided over three debt limit increases?a
total of $2.33 trillion or 26.2%.

Foreign Banks and Financial Authorities: Defines a participating
financial institution to include foreign banks if ?established and
regulated under the laws of the U.S. or any State?and having
significant operations in the U.S.? A central bank or institution
owned by foreign government would generally be excluded. However, the
Treasury would also be required to coordinate with foreign financial
authorities and central banks to establish similar programs in other
countries, and to the extent that such foreign institutions lend money
to firms with troubled assets that have failed or defaulted, they
would be made eligible.

Oversight Board: Establishes a five-person Financial Stability
Oversight Board, including the Chairman of the Federal Reserve, the
Treasury Secretary, the Director of the Federal Home Finance Agency,
the Chairman of the SEC, and the Secretary of Housing and Urban
Development, to review the exercise of authority under this
legislation and make recommendations to the Treasury.

Bank Losses on GSE Stock: Allows banks to treat losses on shares of
preferred stock in Fannie Mae and Freddie Mac as ordinary losses to
offset ordinary income, not as capital losses (which is capped). This
provision is targeted at many community banks who hold GSE preferred
stock and sustained heavy loss after Treasury placed Fannie and
Freddie in conservatorship.

Discharge of Mortgage Debt: Extends for two years the exclusion (set
to expire on January 1, 2010) from a taxpayer?s gross income any
discharge of indebtedness income, as long as the debt is for the
acquisition, construction, or substantial improvement of the
taxpayer?s principal home (in addition to certain refinancing).

Affordable Housing Earmark: Does not include the provision proposed by
Democrat negotiators to earmark 20% of any funds recouped from the
disposition of the purchased assets for the Affordable Housing Fund,
whose funds flow to many non-profit entities such as ACORN or La Raza.
It should be noted that this provision was not part of the original
Treasury plan.

Mortgage ?Cram-Down?: Does not authorize bankruptcy judges, as part of
creating plans for debtors facing foreclosure to repay their subprime
or nontraditional (e.g. interest-only) mortgage debts to reduce or
delay adjustments to adjustable-rate subprime or nontraditional
mortgages, set a new, fixed interest rate, extend repayment periods,
etc.

Foreclosure Mitigation: Directs the Secretary of the Treasury, as an
owner of mortgages underlying troubled assets, to implement a plan to
maximize assistance to homeowners and to encourage servicers of the
underlying mortgages to take advantage of foreclosure prevention
programs. In addition, the language requires the Secretary to consent
to ?reasonable requests? (undefined) from loan servicers for mortgage
term extensions, rate reductions, principal write-downs, increases in
the proportion of loans within a trust, or the removal of other
modification limits.

Expiration of Authority: Terminates the Secretary?s authority to
purchase and insure troubled assets on December 31, 2009, but allows
for extensions until two years after the date of enactment. These
sunset dates do not apply to the Secretary?s ability to hold purchased
assets, since many of these assets may still not be able to be sold by
that point.

Mark to Market Accounting: Restates current law that authorizes the
SEC to suspend mark-to-market accounting with respect to any class or
category of transactions. The bill also requires the SEC to study the
impact of mark-to-market regulations on the balance sheets of
financial firms and the advisability and feasibility of potential
modifications. Some conservatives may be concerned with the lack of
stronger language, requiring the SEC to promulgate new rules that
allow firms to better reflect the true economic value of the
mortgage-related assets on their books.

Exchange Stabilization Fund: Requires the Secretary to replenish the
Exchange Stabilization Fund for any funds used to provide a temporary
guarantee program for the money market fund industry and bars it from
ever being used that way again.

Conservative Concerns: No one would argue that the question before
Congress of whether to give Treasury the authority to nationalize
mortgage-related and other troubled assets is an easy one. Financial
markets are clearly in turmoil, and many large?previously thought to
be impregnable?financial firms have and may fail in the weeks to come.
Many experts and news reports also warn that without some federal
action to bolster market confidence there will continue to be either
stagnation in the capital markets or worse, a run on all depository
institutions. No one wants those fears to be realized.

However, many conservatives may be concerned that authorizing the
Secretary of Treasury to purchase up to $700 billion amounts to an
indirect tax of $6,034 per American household, and it will likely
forever change the landscape of the nation?s free-market system.
Institutions, policies, and precedents?right or wrong? enacted in
crisis tend to become permanent fixtures.

As Luigi Zingales, a professor at the University of Chicago, writes:

The decisions that will be made this weekend matter not just to the
prospects of the U.S. economy in the year to come; they will shape the
type of capitalism we will live in for the next fifty year. Do we want
to live in a system where profits are private, but losses are
socialized? Where taxpayer money is used to prop up failed firms? Or
do we want to live in a system where people are held responsible for
their decisions, where imprudent behavior is penalized and prudent
behavior rewarded? For somebody like me who believes strongly in the
free market system, the most serious risk of the current situation is
that the interest of few financiers will undermine the fundamental
workings of the capitalist system. The time has come to save
capitalism from the capitalists.

Some conservatives may believe that Treasury is right, and given the
present circumstances, the risk of inaction is so grave as to warrant
such new authority. Others may indeed wonder whether in this moment of
crisis, America is on the brink of something far worse?forfeiting its
free-market system by placing an implicit guarantee on all economic
failure. The message to rational actors with a bail-out of this
magnitude is that your profits will be private but your losses
socialized. But the system often does not work that way, at least not
for long. If losses are socialized, it is likely that profits will
soon be on the way, meaning Americans will no longer be free, not just
to fail, but to succeed.

Specifically, many conservatives may have the following concerns with
the legislation, because the plan:

Fails to adequately penalize the debtholders and shareholders
(including many of the executives themselves), who should bear the
risk of any losses, and indirectly infuses capital directly onto the
books of these financial institutions.

Alters fundamentally the nation?s free-market system in that it
broadly socializes firm?s money-losing mortgage assets and places the
U.S. on a slippery slope whereby profits may also be nationalized.

Cedes massive authority to Treasury. Given the fact that the
Presidential election is a mere six weeks away and a new Secretary
will take office in January 2009, lawmakers have absolutely no idea
what individual will ultimately be exercising this vast new authority
over the long-term.

Sets up Treasury to pay inflated prices for assets. Since there is
nothing in the proposal that forces the financial institutions to sell
their assets at a discount rate or event at all, many of these owners
may simply wait on the government to increase their bid, leading to
more inflated prices than the market would currently bear.

Creates the potential for an enormous bureaucracy that will be needed
to administer the purchase and insurance programs.

Increases the federal deficit and national debt. The new mandatory
spending, will cause a massive increase in the national debt and an
immediate (although smaller) increase in the federal deficit. These
annual deficits are funded by selling government bonds purchased by a
host of large investors, including foreign countries. However, there
is a limit to the amount of bonds that a government can float without
adverse financial effects.

Aids financial institutions that may not pose a systemic risk. Some
companies, such as AIG, may truly pose a systemic risk to the entire
market. However, there is no requirement under the proposal that a
company truly be ?too big to fail.? Instead, any financial
institutions with mortgage-related assets would be eligible.

Additional Background: On Friday, September 19, 2008, the Treasury
Department requested broad new authority to calm U.S. financial
markets and purchase illiquid mortgage-related assets from various
financial institutions. According to extensive press reporting, the
Administration took this action after a series of repeated federal
interventions were unsuccessful and a panic began to spread throughout
financial markets.

The market for commercial paper, or short-term corporate bonds,
tightened as institutional investors increasingly valued ready cash.
These investors, namely money-market funds, continued to hoard cash in
preparation of an expected run on their funds, which began as
investors withdrew roughly $144.5 billion (compared to $7.1 billion
the week before). In many cases, these investors fled to short-term
government bonds, accepting little-to-no rate of return in exchange
for the knowledge that their cash was secured. One money-market fund,
Putnam Prime Money Market Fund, shut down because too many investors
sought to take their money out at one time, and another, Reserve
Primary Fund, announced that it would suspend redemptions temporarily.
Administration officials feared that such a lack of confidence would
spread.

The case of Reserve Primary Fund is instructive, because it was this
money-market fund which seems to have set off the run due to the
amount of corporate debt it held in Lehman Brothers. Lehman Brothers
had filed for Chapter 11 bankruptcy protection the day before with
more than $613 billion in debt. Between 2004 and 2007, this debt had
been used in part to purchase almost $300 billion in securities backed
by residential and commercial mortgages, otherwise known as
mortgage-backed securities or MBS, which have been significantly
devalued since the downturn in the housing market.

These ?toxic? mortgage-related assets have been virtually unmovable
from the portfolios of many financial institutions, such as Lehman
Brothers, in part because the market has no idea what they are worth.
This underlying predicament led to the Treasury Department?s request
for blanket authority for the federal government to purchase
them?taking them off portfolios, instilling confidence and capital in
those firms who had previously held them, in order that lending and
borrowing can resume.

Committee Action: The legislation has not been considered by any
congressional committee.

Cost to Taxpayers: A CBO score is not yet available. However, the
funding authorized is not subject to appropriations and constitutes
mandatory spending. The bill treats the cost of purchasing the assets
under the provisions Federal Credit Reform Act of 1990, ensuring that
the net-present value of the purchased securities will be scored
instead of the initial outlays. This treatment recognizes that the
securities have some value (even if less than the purchase price), but
value which may not realized until they are sold. Under credit-reform
scoring, the cost of the initial outlays is offset by an estimation of
what the eventual sale of the assets will return in receipts, and it
is this figure which will impact the federal deficit. Given the
uncertain value of many of these securities, it is unclear whether CBO
will have the necessary information to accurately score the
legislation?s long-term fiscal impact.

Furthermore, Sec. 204 deems all costs arising under the legislation an
emergency for purposes of the Congressional budget process.

Does the Bill Expand the Size and Scope of the Federal Government?
Yes, substantially as the federal government would now be purchasing
billions of dollars worth of troubled securities.

Does the Bill Contain Any New State-Government, Local-Government, or
Private-Sector Mandates? A CBO score is not yet available.

Does the Bill Comply with House Rules Regarding Earmarks/Limited Tax
Benefits/Limited Tariff Benefits? A Committee report designating
compliance with clause 9 of rule XXI is unavailable.

Constitutional Authority: A Committee report citing Constitutional
authority is unavailable. House Rule XIII, Section 3(d)(1), requires
that all committee reports contain a statement citing the specific
powers granted to Congress in the Constitution to enact the law
proposed by the bill or joint resolution.
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