Proposed bailout of U.S. financial system (2008)
If approved, the plan would grant the Secretary of the Treasury unprecedented powers ...Paulson financial rescue plan states: "Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion... effectively rendering the Treasury Secretary above the law and explicitly making him or her unanswerable to any body.
Proposed bailout of U.S. financial system (2008)
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United States Department of the TreasuryFollowing the bankruptcy of Lehman Brothers and the sale of Merrill Lynch to Bank of America on September 14, and the sudden bailout of American International Group by the Federal Reserve on September 16—events considered part of the on-going financial crisis of 2007-2008—the U.S. Treasury Secretary Henry Paulson proposed his Troubled Asset Relief Program on September 20 As originally proposed, the plan would give absolute and un-reviewable authority to purchase up to US$700 billion of mortgage backed securities from financial institutions for the purpose of stabilizing the market.
The plan was just three pages long and included notable provisions such as the authority to enter into contracts for services, including employing consultants, "without regard to any other provision of law regarding public contracts"; and an assertion that "decisions by the Secretary... may not be reviewed by any court of law or any administrative agency."
The plan was presented by Henry Paulson and Ben Bernanke on September 23 to the Senate Banking Committee who rejected it as not acceptable. As of September 26, 2008, consultations over amendments to the plan are on-going.
2 Components of the plan
2.1 Mortgage asset purchases
2.2 Support money market funds
2.2.1 Loans to banks for Asset-Backed Commercial Paper
2.2.2 Insurance scheme for money market mutual funds
2.3 Temporary exception to bank regulations
2.4 Sweeping powers
3 Rationale for the bailout
4 Congressional proposals
5.2 Conflict of interest
5.4 Balancing Taxpayer and Wall Street Interests
5.5 Valuation of securities purchased
6.2 Views from Officials/Lawmakers/Politicians
6.3 Views from financiers
6.4 Views from economists
6.5 Views from journalists
8 Expectations and forecasts
10 External links
Main articles: Subprime mortgage crisis, Financial crisis of 2007-2008, and Economic crisis of 2008
A serious turmoil in the banking system and financial markets due to the subprime mortgage crisis reached a critical stage during September 2008, characterized by severely contracted liquidity in the global credit markets and going-concern threats to investment banks and other institutions. In response, the U.S. government announced a series of comprehensive steps to address the problems, following a series of "one-off" or "case-by-case" interventions such as the $85 billion AIG bailout on September 16.
President Bush meets with Congressional members, including John McCain and Barack Obama, at the White House to discuss the bailout, September 25, 2008Consultations by the Secretary of the Treasury Henry Paulson, the Chairman of the Federal Reserve Ben Bernanke, and the Chairman of the U.S. Securities and Exchange Commission Christopher Cox with Congressional leaders and President George W. Bush, moved forward efforts to draft a proposal for a comprehensive solution to the problems created by illiquid assets, and other measures, resulted in some stock, bond, and currency markets stability on September 19, 2008.
At the close of the week the Secretary of the Treasury Paulson and President Bush announced a proposal for the federal government to buy up to US$ 700 billion of illiquid mortgage backed securities with the intent to increase the liquidity of the secondary mortgage markets and reduce potential losses encountered by financial institutions owning the securities. The draft proposal was received favorably by investors in the stock market, but caused the US dollar to fall against gold, the Euro, and oil. The plan was not immediately approved by Congress; debate and amendments were seen as likely before the plan was to receive legislative enactment.
Throughout the week of 20-26 September there was in fact very contentious wrangling among Senators and congressmen over the terms and scope of the bailout, amplified by continued failures of institutions like Washington Mutual the fact that there would be a national election coming up on 4 November.
On September 21, 2008, Treasury Secretary Henry Paulson announced that the original proposal, which would have excluded foreign banks, had been revised to include foreign financial institutions with a presence in the US. The US administration pressured other countries to set up similar bailout plans.
On September 24, 2008, President George W. Bush addressed the nation on primetime television, describing how serious the financial crisis could become if action was not taken promptly by Congress.
This plan, sometimes dubbed "The Paulson Proposal" in the media is not to be confused with Henry Paulson's earlier 212 page plan known as the Blueprint for a Modernized Financial Regulatory Reform, which was released on March 31, 2008 and condemned as "a wild pitch. ... not even close to the strike zone" by Senator Chris Dodd, the same head of the Senate Banking Committee.
*Components of the plan
Mortgage asset purchases
A key part of the proposal is the federal government's plan to buy up to US$ 700 billion of illiquid mortgage backed securities with the intent to increase the liquidity of the secondary mortgage markets and reduce potential losses encountered by financial institutions owning the securities. The draft proposal of the plan was received favorably by investors in the stock market. Details of the bailout remain to be approved by Congress.
This plan can be described as a risky investment, as opposed to an expense. The mortgage-backed securities (MBS) within the scope of the purchase program have rights to the cash flows from the underlying mortgages. As such, the initial outflow of government funds to purchase the MBS would be offset by ongoing cash inflows represented by the monthly mortgage payments. Further, the government eventually may be able to sell the assets, whether at a gain or loss remains to be seen. While incremental borrowing to obtain the funds necessary to purchase the MBS may add to the U.S. public debt, the net effect will be considerably less as the incremental debt will be offset to a large extent by the MBS assets.
A key challenge would be valuing the purchase price of the MBS, which is a complex exercise subject to a multitude of variables related to the housing market and the credit quality of the underlying mortgages. The ability of the government to offset the purchase price (through mortgage collections over the long-run) depends on the valuation assigned to the MBS at the time of purchase. For example, Merrill Lynch wrote down the value of its MBS to approximately 22 cents on the dollar in Q2 2008. Whether the government is ultimately able to resell the assets above the purchase price or will continue to merely collect the mortgage payments is an open item.
As the primary investor owning the securities, the government would be in a better position to systematically modify mortgage terms quickly, helping homeowners keep their homes. At present, the pace of foreclosures is exceeding the capacity of programs such as the Hope Now Alliance to assist homeowners, in part because a myriad of investors and complex MBS contracts must be consulted as part of the refinancing process.
Support money market funds
Loans to banks for Asset-Backed Commercial Paper
How Money Markets Fund CorporationsEarlier in the week, money market mutual funds had begun to experience significant withdrawals of funds by investors. This created a significant risk because money market funds are integral to the ongoing financing of corporations of all types. Individual investors lend money to money market funds, which then provide the funds to corporations in exchange for corporate short-term securities called asset-backed commercial paper (ABCP). However, a potential bank run had begun on certain money market funds. If this situation had worsened, the ability of major corporations to secure needed short-term financing through ABCP issuance would have been significantly affected. To assist with liquidity throughout the system, the Treasury and Federal Reserve Bank announced that banks could obtain funds via the Federal Reserve's Discount Window using ABCP as collateral.
Insurance scheme for money market mutual funds
To stop the potential run on money market mutual funds, the Treasury also announced on September 19 a new $50 billion program to insure the investments, similar to the Federal Deposit Insurance Corporation (FDIC) program.
Temporary exception to bank regulations
Part of the announcements included temporary exceptions to section 23A and 23B (Regulation W), allowing financial groups to more easily share funds within their group. The exceptions expire on January 30, 2009, unless extended by the Federal Reserve Board.
If approved, the plan would grant the Secretary of the Treasury unprecedented powers, proofing his or her actions against congressional or judicial review. Section 8 of the Paulson financial rescue plan states: "Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency." This would mark a colossal investment of power in an unelected public official, effectively rendering the Treasury Secretary above the law and explicitly making him or her unanswerable to any body.
Rationale for the bailout
In his testimony before the U.S. Senate, Treasury Secretary Henry Paulson summarized the rationale for the bailout:
Stabilize the economy: "We must...avoid a continuing series of financial institution failures and frozen credit markets that threaten American families' financial well-being, the viability of businesses both small and large, and the very health of our economy."
Improve liquidity: "These bad loans have created a chain reaction and last week our credit markets froze - even some Main Street non-financial companies had trouble financing their normal business operations. If that situation were to persist, it would threaten all parts of our economy."
Comprehensive strategy: "We must now take further, decisive action to fundamentally and comprehensively address the root cause of this turmoil. And that root cause is the housing correction which has resulted in illiquid mortgage-related assets that are choking off the flow of credit which is so vitally important to our economy. We must address this underlying problem, and restore confidence in our financial markets and financial institutions so they can perform their mission of supporting future prosperity and growth."
Immediate and significant: "This troubled asset relief program has to be properly designed for immediate implementation and be sufficiently large to have maximum impact and restore market confidence. It must also protect the taxpayer to the maximum extent possible, and include provisions that ensure transparency and oversight while also ensuring the program can be implemented quickly and run effectively."
Broad impact: "This troubled asset purchase program on its own is the single most effective thing we can do to help homeowners, the American people and stimulate our economy."
In his testimony before the U.S. Senate on September 23, 2008, Fed Chairman Ben Bernanke also summarized the rationale for the bailout:
Investor confidence: "Among the firms under the greatest pressure were Fannie Mae and Freddie Mac, Lehman Brothers, and, more recently, American International Group (AIG). As investors lost confidence in them, these companies saw their access to liquidity and capital markets increasingly impaired and their stock prices drop sharply." He also stated: "Purchasing impaired assets will create liquidity and promote price discovery in the markets for these assets, while reducing investor uncertainty about the current value and prospects of financial institutions. More generally, removing these assets from institutions' balance sheets will help to restore confidence in our financial markets and enable banks and other institutions to raise capital and to expand credit to support economic growth."
Impact on Economy and GDP: "Extraordinarily turbulent conditions in global financial markets...these conditions caused equity prices to fall sharply, the cost of short-term credit--where available--to spike upward, and liquidity to dry up in many markets. Losses at a large money market mutual fund sparked extensive withdrawals from a number of such funds. A marked increase in the demand for safe assets--a flight to quality--sent the yield on Treasury bills down to a few hundredths of a percent. By further reducing asset values and potentially restricting the flow of credit to households and businesses, these developments pose a direct threat to economic growth."
Regarding the $700 billion number, Forbes.com quoted a Treasury spokeswoman: "It's not based on any particular data point. We just wanted to choose a really large number."
Congressional leaders, including both presidential candidates, are working with the Bush Administration and the Treasury department on key negotiation points as they work to finalize the plan. Key open items under discussion include: 
Additional foreclosure avoidance and homeowner assistance
Executive pay limits
Government equity interests in firms participating in program, to provide additional taxpayer protection
Judicial review, Congressional oversight and right to audit
Structure and authority of the entities that will manage the program
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Please improve this article if you can. (September 2008)
*****Authorized amount: Is the $700 billion proposed excessive? Of the $1.26 trillion in non-prime mortgages — that is, "sub-prime" and "Alt-A" mortgages — $743 billion is already either owned or guaranteed by Fannie Mae and Freddie Mac, companies that were shored up by a government rescue earlier in September 2008. That leaves $521 billion, which means the Treasury's $700 billion proposal would be more than necessary. However, Secretary Paulson has indicated that the plan may include other types of assets, not just MBS.
***Conflict of interest
There has been some criticism of Paulson, with suggestions that his plan may have some conflicts of interest, as until May 2006 he was CEO of Goldman Sachs, potentially one of the largest beneficiaries of the bailout.
Joshua Rosner, managing director of Graham Fisher & Co, questioned the constitutionality of Paulson's plan. Rod Smolla pointed out that the Paulson plan would establish policy decisions made by the Secretary of the Treasury as "non-reviewable...by any court of law."
Balancing Taxpayer and Wall Street Interests
In an Opinion piece in the Wall Street Journal, Senator Hillary Clinton has advocated addressing the rate of mortgage defaults and foreclosures that ignited this crisis, not just bailing out Wall Street firms: "If we do not take action to address the crisis facing borrowers, we'll never solve the crisis facing lenders." She has proposed a new Home Owners' Loan Corporation (HOLC), similar to that used after the Depression, which was launched in 1933. The new HOLC would administer a national program to help homeowners refinance their mortgages. She is also calling for a moratorium on foreclosures and freezing of rate hikes in adjustable rate mortgages.
Valuation of securities purchased
The valuation of the purchase price paid for mortgage-backed securities (MBS) is a key open question. Market value is affected by the ability to sell the MBS, not just the present value of future cash collections related to the MBS. The government must balance the assistance it intends to provide to the financial institution with its fiduciary responsibility to taxpayers. If the government pays the (lower) market value as opposed to the (higher) present value, it may not be enough to assist the banks. For the plan to work, Treasury may have to pay closer to the present value, offering a subsidy to financial institutions at the expense of taxpayers.
In a survey conducted September 19-22 by the Pew Research Center, by a margin of 57 percent to 30 percent, Americans supported the bailout when asked "As you may know, the government is potentially investing billions to try and keep financial institutions and markets secure. Do you think this is the right thing or the wrong thing for the government to be doing?"
In a survey conducted September 19-22 by Bloomberg/Los Angeles Times, by a margin of 55 percent to 31 percent, Americans opposed the bailout when asked whether "the government should use taxpayers' dollars to rescue ailing private financial firms whose collapse could have adverse effects on the economy and market, or is it not the government's responsibility to bail out private companies with taxpayers' dollars?".
Senator Sherrod Brown said he had been getting 2,000 e-mail messages and telephone calls a day, roughly 95 percent opposed.
Through late Thursday, Sen. Dianne Feinstein's (D-Calif.) offices had received a total of 39,180 e-mails, calls and letters on the bailout, with the overwhelming majority of constituents against it. "Public isn't buying Wall Street bailout"
Views from Officials/Lawmakers/Politicians
Henry M. Paulson, Jr., Secretary of the Treasury proposed the plan.
British prime minister Gordon Brown supported the plan, saying that it was essential to restore stability to the markets.
"This plan is stunning in its scope and lack of detail," said Connecticut Sen. Christopher Dodd, chairman of the Senate Banking Committee. "It does nothing in my view to help a single family save a home."
"I am concerned that Treasury's proposal is neither workable nor comprehensive, despite its enormous price tag," said Alabama Senator Richard Shelby, the ranking Republican on the committee.
"This massive bailout is not a solution. It is financial socialism and it's un-American," said Sen. Jim Bunning, R-Ky.
Democratic presidential candidate Barack Obama said any bailout must include plans to recover the money, and protect working families and big financial institutions and be crafted to prevent such a crisis from happening again. 
Dr. Ron Paul, U.S. Congressman, Texas District 14 publicly opposes any bailout and calls for further reforms to remedy the crisis 
Views from financiers
Investor Warren Buffett said he wholehearedly supported the plan. However, Mr. Buffet is not a disinterested third party in that his company owns financial companies which might benefit directly or indirectly.
Alan Greenspan, former Chairman of the Federal Reserve, endorsed Paulson's plan on September 19.
Investor George Soros is opposed to the original Paulson plan - "Mr Paulson's proposal to purchase distressed mortgage-related securities poses a classic problem of asymmetric information. The securities are hard to value but the sellers know more about them than the buyer: in any auction process the Treasury would end up with the dregs. The proposal is also rife with latent conflict of interest issues. Unless the Treasury overpays for the securities, the scheme would not bring relief." - but calls Barack Obama's list of conditions for the plan "the right principles".
Investor Carl Icahn described the bailout as "crazy and inflationary hell".
Joshua Rosner, managing director of Graham Fisher & Co., says there is plenty of liquidity out in the open market to purchase these securities when the price becomes cheap enough and the people shorting the securities will buy them at that point. "Joshua Rosner says bailout will create another bubble."
Investor Jim Rogers called the plan "astonishing, devastating, and very harmful for America".
Views from economists
In an open letter sent to Congress on September 23, over 100 university economists expressed great concern for the plan proposed by Treasury Secretary Paulson. The letter has been described as the emerging consensus from academic economists. Its authors described three fatal pitfalls they perceived in the plan as it was initially proposed:
1) Its fairness. The plan is a subsidy to investors at taxpayers' expense. Investors who took risks to earn profits must also bear the losses. [...] The government can ensure a well-functioning financial industry [...] without bailing out particular investors and institutions whose choices proved unwise.
2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.
3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.
As of September 25, the open letter had been signed by 192 economists from American universities.
Views from journalists
The Economist magazine said that although "Mr Paulson's plan is not perfect ... it is good enough" and that "Congress should pass it—and soon." 
"The deal proposed by Paulson is nothing short of outrageous. It includes no oversight of his own closed-door operations. It merely gives congressional blessing and funding to what he has already been doing, ad hoc." - Robert Kuttner
Paul Krugman (NY Times): Instead of purchasing the assets, equity capital could be provided to the banks directly in exchange for preferred stock. This would strengthen the financial position of the banks, encouraging them to lend. Dividends would be paid to the government on the preferred shares. This would be similar to what happened during the S&L crisis and with the GSE bailout. This avoids the valuation questions involved in the direct purchase of MBS.
On September 25, 2008, several hundred labor union members organized by New York Central Labor Council protested outside of the New York Stock Exchange against the bailout. Other grassroots groups such as TrueMajority have planned rallies to protest against the bailout.
Expectations and forecasts
Despite the unresolved issues, President Bush predicted the Democratic-controlled Congress would soon pass a "a robust plan to deal with serious problems."
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