| Emergency Act, Needed or Not, Is Likely to Have Long-Lasting Impact |
| Written by Jonathan Smoke | |
| 09.29.2008 | |
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Discuss this article on the forums. (0 posts) No matter what your political persuasion or philosophy regarding the appropriateness of the “Bail Out Bill,” it appears that those in power are convinced we are in dire straits and hence we deserve an “Emergency Economic Stabilization Act,” or so the legislation is formally titled. I read through the bill that was finalized yesterday that was debated and voted down in the House today. The down vote was a bit surprising considering how much of a compromise plan it was supposed to be. At my writing of this, the House Democratic leadership is planning a second vote while they try to strong-arm both Democrats and Republicans who voted against it. If it passes, it is not likely to change, so it is worth noting several important pieces of the legislation to determine what impact in may have on those involved in the housing industry. First and foremost, this bill considers a troubled asset to go well beyond mortgage securities and CDOs. According to Section 3, subsection 9 of the bill, troubled assets include: “…(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and (B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress.”
That’s quite a lot of discretion left to the Treasury to define, but it’s clearly inclusive of all types of mortgages, securitized or not, residential or not. That means it can clearly cover construction and development loans. Before 45 days after enactment, the Secretary has to publish guidelines for how troubled assets will be purchased, methods for pricing and valuing troubled assets, procedures for selecting asset managers, and criteria for identifying troubled assets for purchase. So we should know a lot more by mid-November. One key policy already set by the Congress is that sellers of troubled assets cannot get a higher price from the Treasury than what they paid for an asset. I’m not sure that everyone will be clamoring to sell assets to the fund anyway unless they are truly desperate since doing so puts the selling entity under more regulation. For example, executive compensation is limited for any institution that the government lends money to or takes an equity position. Likewise, any institution that sells troubled assets worth more than $300 million in aggregate in an auction process will also be subject to executive compensation limits. Beyond the fund for purchasing troubled assets, there is the provision fought for by the House Republicans that establishes insurance on troubled assets to protect financial institutions against default. The insurance program entails establishing guarantees on any troubled assets originated before March 14, 2008, and establishing the associated premiums. Guarantees can be established up to 100% of the payments of interest and principal. Premiums can be based on credit risk. Premiums must cover reserves necessary for anticipated claims. Assuming the actuarial analysis works out, this may be more palatable to financial institutions not directly in harm’s way. But since those risks are not well known yet, it is hard to determine what the price of the premiums will be. If it is successful, it is important to note that the Troubled Asset Relief Program fund is limited by the size of the insurance fund. They both total to a maximum $700 billion. The bill is filled with all types of new authorizes and bureaucracies. For example, it establishes the Troubled Asset Relief Program (TARP) under a new Office of Financial Stability headed by an assistant secretary of Treasury to be appointed by the President and approved by the Senate. There is also a new Special Inspector General to be appointed by the President and approved by the Senate. The Financial Stability Oversight Board will oversee all policy decisions and performance in keeping with the objectives of the act. The Board’s members will be the Fed chairman, the Secretary of the Treasury, the Director of the Federal Home Finance Agency, the Chairman of the SEC, and the Secretary of Housing and Urban Development. The Board will cease to exist when the last asset is sold or the last insurance contract expires. The act also establishes a new Congressional Oversight Panel, which is charged with reviewing the state of the financial markets and the regulatory system. The Panel has 5 members, each appointed by the following Washington honchos: the Speaker of the House, the minority leader of the House, the Senate majority leader, the Senate minority leader, and one appointed by the Speaker of the House and the majority leader of the Senate with input from the minority leaders. Does that sound politically charged or what? The Democrats fought for help for homeowners and that result is that all federally owned or managed loans will be reviewed for potential actions such as workouts, loan repricing and principal write-offs to prevent foreclosures. If the fund sees any action, the whole market should benefit from some improved information caused by Section 114 on Market Transparency: "(a) PRICING—To facilitate market transparency, the Secretary shall make available to the public, in electronic form, a description, amounts, and pricing of assets acquired under this Act, within 2 business days of purchase, trade, or other disposition.
(b) DISCLOSURE—For each type of financial institutions that sells troubled assets to the Secretary under this Act, the Secretary shall determine whether the public disclosure required for such financial institutions with respect to off-balance sheet transactions, derivatives instruments, contingent liabilities, and similar sources of potential exposure is adequate to provide to the public sufficient information as to the true financial position of the institutions. If such disclosure is not adequate for that purpose, the Secretary shall make recommendations for additional disclosure requirements to the relevant regulators." The total fund’s authority is gradually extended, starting with $250 billion. The President can authorize $100 billion more, while Congress can extend upon request of the President to $700 billion. It is important to note that the total is set by purchase prices paid—was this a nod to how stupid mark-to-market policies are for illiquid assets? On that point, Section 132 provides the SEC the authority to suspend mark-to-market accounting if the SEC determines that suspension of the practice is “necessary or appropriate in the public interest and is consistent with the protection of investors.” Even if the SEC doesn’t take this authority immediately, the SEC must provide a comprehensive report on mark-to-market accounting standards including their role in this year’s bank failures and alternatives to these standards. This ought to be fun—a new year’s present. If mark-to-market isn’t abandoned immediately, my bet is that this study will confirm that the standards were a very bad idea. Section 134 is the comical resort of the debate on making sure that “taxpayers” aren’t left footing the bill of the bailout. It sets forth that the President has to submit a legislative proposal to Congress to recoup any shortfalls caused by TARP. The financial industry will be on the hook. I’m not sure just how dire our straits are, but this legislation is complex and has left much of the details to be worked out over the coming weeks. From first review, I’d say the only fat cats who will get their “money for nothin’ and their chicks for free” will be the newly commissioned bureaucrats put in charge of the various new committees and boards. 
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