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By Jason Simpkins
Associate Editor
The U.S. Senate last night (Wednesday) passed a $700 billion banking-sector bailout package, and will now watch as the House of Representatives reviews the inducement-laden pact. The House rejected an earlier version of this bill on Monday.
The legislation, approved by a 74-25 vote, authorizes the federal government to buy problem financial assets from banks and other financial institutions that have been squeezed by a credit crunch that stems from a burst housing bubble that's led to record home foreclosures. The new bill contains two political "sweeteners" that were included to get the House to reverse its earlier opposition to this plan: The first raises the limit on federal bank-deposit insurance; and the second underscores the authority of U.S. securities regulators to suspend asset-valuing rules that corporate executives blame for fueling the crisis.
Many analysts anticipate this bill will pass after the Dow Jones Industrial Average's 778-point drop Monday provided very tangible evidence of the precariousness of the U.S. economy. The Senate vote didn't start until after 7:30 p.m. EDT, last night. The hope is that the House of Representatives will then be ready to take action on this new bailout bill version on Friday, Bloomberg News reported.
"The big drop [in the Dow Index] really had a chilling effect on a lot of our members and a lot of their constituents," House Republican Leader John Boehner, R-Ohio, told Fox News. With changes made by the Senate, the legislation "has a much better chance" of passage this time, he said.
In addition to a dramatic increase in public support, the amendments added to the bill the House rejected in an attempt to capture the support of skeptical Republicans, Congressional spokesman Kevin Smith told MarketWatch.com.
"We think we'll have a better shot at passing this bill than we did on Monday," said Smith, who is a spokesman for Boehner. "The bill has continued to get better from our standpoint."
Officially called the Emergency Economic Stabilization Act of 2008, the revamped Senate bailout bill adheres to the core fix-it plan developed by U.S. Treasury Secretary Henry M. "Hank" Paulson Jr. and U.S. Reserve Chairman Ben Bernanke, a proposal that called for the federal government buy and hold so-called "toxic" mortgage assets, thereby freeing up funds for banks to begin lending again. It gives Paulson the $700 billion in phases, with $250 billion up front, another $100 billion pending presidential approval. The final outlay of $350 billion required Congressional approval.
However, the Senate package contains the following new measures that weren't part of the House bill that was slapped aside with the help of House Republicans on Monday:
- An increase in the Federal Deposit Insurance Corp. (FDIC) deposit-insurance cap, boosting the level of government-guaranteed deposits from the current $100,000 to the new level of $250,000.
- A one-year "patch," or relief, from the alternative minimum tax, or AMT, which is expected to save about 24 million households a combined $62 billion.
- Optional insurance for mortgage-backed securities, with financial institutions paying the premiums.
- A "Mental Health Parity" provision that provides insurance for mental illness.
- Roughly $17 billion in tax credits for the development of renewable energy such as wind and solar power.
- An extension of tax breaks that would save individuals and corporations roughly $150 billion over the next 10 years, as well as tax breaks for those impacted by natural disasters.
- The Senate bill also reiterates the U.S. Securities and Exchange Commission's authority to suspend the so-called "fair-value accounting standard," which requires companies to review assets and report losses if their values decline. Lawmakers, the American Bankers Association, and companies that include American International Group Inc. (AIG), have urged the SEC to suspend or ease the rule, saying it forces firms to report deeper losses than needed on assets such as subprime mortgages, Bloomberg said.
Some Dems Won't be Budged
Of course, while the chances for a House approval have increased with the new provisions, there's still no guarantee – and there are some hardliners who refuse to be swayed.
"The bill that they are going to send back is the same bill that I voted against two days ago," Rep. Joe Barton, R-Tex., said in an interview with Bloomberg Television. "Why would I turn around and vote for it?"
Also some analysts argue that the sweeteners meant to appease House Republicans could turn off House Democrats, as many of the tax breaks being offered – especially the suspension of the AMT – are not fully offset by other tax revenue, meaning they are almost certain to boost the federal deficit.
Fiscally conservative Democrats, often called Blue Dogs, could be scared off by generous tax breaks being tacked on to an already extravagant bill.
"We're going to have to be talking to them," House Majority Leader Steny Hoyer, D-Md., told NBC's The Today Show. "I'm not particularly pleased with that addition [to the bill] myself, very frankly."
While House Republicans made up the majority of opposition to the bailout on Monday – with two-thirds voting ‘Nay' – roughly 40% of the House Democrats also voted against the bill, helping ensure its defeat.
Monday Morning Quarterbacks
The original bailout plan was shot down in the House of Representatives by a vote of 228-205, after House Republicans slammed the legislation as a Wall Street bailout financed by the U.S. taxpayer.
Ahead of that vote, a great number of representatives had reportedly been overwhelmed with calls from their constituents, irate over the notion that the Wall Street firms that treated the economy with such a selfish disregard and a reckless abandon would be spared from failure by taxpayer dollars.
However, when the bill died on the floor of the House Monday, there was no legitimate alternative standing by to restore functionality to the credit markets and save the U.S. economy from potentially stalling and diving into a severe recession. That was reflected by U.S. stock indices, which spiraled uncontrollably downward.
The benchmark Dow suffered its biggest-ever one-day point loss, plunging 777.68 points on Monday, and shedding and losing 7% of its value. The broader Standard & Poor's 500 Index skidded 106.59 points, or 8.79%, and the tech-laden Nasdaq Composite Index plummeted 199.61 points, or 9.14%.
The collapse resonated throughout the country, and suddenly, a new wave of phone calls and letters came pouring into Washington – this time imploring policymakers to take action by approving legislation. E-mail traffic was so dense that it reportedly stalled Congressional computers.
"More than $1 trillion worth of market value was wiped off the books by the stock market drop," U.S. Sen. Robert Bennett, R-Utah, told Bloomberg News. "It is ordinary people looking at ordinary pensions, with their ordinary Main Street kind of 401(k) plans, who lost that $1 trillion. And they lost it in a matter of minutes."
Lobbyist also ramped up their efforts, petitioning Congress with an open letter from a coalition of 56 different trade groups. These groups ranged from the U.S. Chamber of Commerce and the American Bankers Association to the National Roofing Contractors Association and the American Meat Institute.
Failure is not an Option
The consequences for the U.S. economy, should the bill fail again, could be catastrophic.
When asked by Sen. Christopher Dodd, D-Conn., about the possible consequences of the bailout being rejected, U.S. Federal Reserve Chairman Ben S. Bernanke responded by saying that the financial markets are in a "fragile condition," underscoring that "absent a plan they will get worse."
Most of the time, it's a softening economy that causes the credit markets to go sour. Unfortunately, this time around, the economic downturn is unfolding in precisely the opposite manner: The credit crisis is creating a liquidity shortage, meaning banks can't (or won't) lend, businesses can't grow, and jobs can't be created. Ultimately, the economy will start to shrink, causing a recession that hammers corporate profits, torpedos consumer confidence, sends the stock market into a nosedive, and induces a major uptick in U.S. unemployment.
And because the credit problems are so deep, these problems could take years – not months – to unwind and resolve.
That's why it's best to fix these problems now, Bernanke contends.
"I believe," Bernanke said, "if the credit markets are not functioning, that jobs will be lost, that our credit rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover in a normal, healthy way."
U.S. economic growth slowed to just 2.8% in the second quarter, down from the 3.3% originally reported. And even that modest growth was bolstered by blistering exports – which will no doubt slow in coming months as the global economy cools – and one final push from the U.S. government stimulus checks stemming from the earlier Bush administration tax cut.
Consumer spending increased in May and June, thanks to the billions of dollars in payments sent to American taxpayers as part of the Economic Stimulus Act of 2008, but plateaued in August as the effects of those payments subsided.
Any hope that the holiday season would rejuvenate American consumers was dashed by the National Retail Federation, which last week forecast a scant 2.2% increase in end-of-year retail purchases – the slowest rate of growth in six years.
Unemployment is also on the rise, as an average of 466,000 Americans filed first-time jobless claims, up from 443,000 in August and 363,000 in the first six months of 2008.
"It looks like we are poised to see a real-term decline in personal consumption and that will likely result in a negative GDP number in the third quarter," James O'Sullivan, an economist at UBS Securities (UBS), told Reuters.
Exports, which contributed 2.9 percentage points to second-quarter growth, won't be much of a help going forward, either, as orders from overseas markets are beginning to falter. The Institute of Supply Management's export gauge fell from 57 in August to 52 in September, and worse, the group's factory index slumped to 43.5, its lowest level since October 2001, from 49.9 in August. All these figures are indicative of a severe drop in manufacturing.
News and Related Story Links:
- Bloomberg:
Senate Sets Bank-Rescue Vote, House May Act Friday. - Wikipedia:
Economic Stimulus Act of 2008. - Wikipedia:
alternative minimum tax.
- Reuters:
Fearful consumers stop spending in August
- Money Morning:
Dismal Holiday Shopping Season Holds Little Relief for the U.S. Economy. - Wikipedia:
Blue Dog Coalition. - Wikipedia:
Mortgage-Backed Securities. - MarketWatch.com:
Rescue plan appears headed for passage in Senate. - Bloomberg News:
Bailout Bill Sent Back to House After Senate Passage.
[…] Senate passed the bailout bill late Wednesday night (Oct. 1), followed by the House of Representatives Friday (Oct. 3). U.S. […]
[…] added to garner support (though plenty of “pork” and unrelated tax breaks appeared in the Senate’s passed version). While the plan may be far from perfect, “experts” believe it represents the […]
This thing is still a turkey! We won't start to dig out from under this until the real genesis of this problem (democrat party) is identified and made to answer for it.
[…] pay for the new $700 billion bailout bill, or even to cover the ever-growing federal debt, the U.S. government sells securities – lots of […]
Scot, it's pretty obvious that it isn't a political party at the root of this crisis, but fraudulent and irresponsible business practices, such as mortgage brokers selling mortgages based on capital gains to buyers of RE who otherwise couldn't carry the load.
It wasn't Democrats that dropped interest rates to levels low enough to drive this mechanism, although they certainly led cheers. Both parties remain irrelevant to the real solution to the credit crisis, which is to seize the insolvent banks, repeal the Federal Reserve Act, and for the US to issue greenback currency, and to repudiate the usurious and predatory Fed monetary debts that have overloaded American, and global, productive economies.
When that happens, after this bailout fails dramatically, and the banksters make a run for borders with hot cash stuffed in their pockets, it will be undertaken by a third party composed of Americans utterly disenfranchised by both parties who have participated in, and driven, the corrupt practices resulting in the present crisis.
As for the leadership of both the Republicrats and the Demoblicans, lynching is too good for them. The laws they have drafted regarding bankruptcy, rendition, surveillance, and 'aggressive interrogation' will hopefully be applied to them in full measure during the reformation of our economy, and the recompense for the crimes committed that led to this crisis.
Treasury Asset Recovery Program (TARP) "Implementation is complex", and the government MUST NOT OVERPAY — but there is a way likely to avoid this. I call it Minipriced Asset Sales with Buyback Options (MASBO). I suggested this in a letter to Sec. Paulson. I believe it circumvents most of the problems you cited above. Can it be implemented within the flexibility of the draft plan and would it work? If so, it could operate in the following manner:
1. Treasury (Treas) offers to buy illiquid assets that pass its validity vetting at a lowball miniprice, with a buyback option for seller. Offers to buy are valid for a limited period — say 3 months from date of start's announcement; buyback options are exercisable for 5 years.
2. If any fraudulent or purely junk assets are offered, all assets in the group being offered are rejected by Treas in an offer-vetting process. Groups of illiquid assets that pass vetting are purchased by Treas for a fixed miniprice of 10% (or 20% at most) of face value.
3. Seller receives cash from TARP fund together with a special TARP Buyback Option (TBO) for each group of assets sold. A TBO has an expiration date of 5 years from date of issue, and a unique certificate number is assigned, referencing it to the particular group of securities sold. Treas creates a market to enable trading of TBOs between financial institutions and other investors.
4. Exercise of a TBO provides repurchase by the TBO holder of the same group of securities that was originally sold at the same low miniprice as the original sale to Treas, plus any return of capital collected by Treas from the original date of sale to the TBO Exercise Date. Treas retains only the interest collected during the Treas holding period. Cash paid for exercise of TBOs is returned to TARP fund.
5. SEC provides a special ruling ONLY FOR TBOs, WHOSE UNDERLYING SECURITIES HAVE BEEN VETTED BY TREAS. This special ruling, to be valid only for three years following its announcement, would permit the holder of a TBO to estimate its fair or intrinsic value AND INCLUDE THIS VALUE ON ITS BALANCE SHEET during the three-year period prescribed by the ruling. In this way, a bank's capitalization is significantly improved to reflect both the cash initially received from Treas for a small portion of the value of the group of illiquid securities sold at a low price, and for the balance of the value as estimated by bank management for the corresponding TBO. This effectively would leverage the low price of the original sale to the full estimated value of the assets. Such a SEC ruling is key to gaining acceptance of the holders of illiquid securities for such a small (only 10% of face value) sale price, and its limited three-year operability is key to having most buyback options exercised sooner than the 5-year expiration so the TARP funds initially paid out by Treas can be returned to it sooner rather than later.
6. By limiting the special ruling from SEC (see 5. above) that restricts its application ONLY FOR TBOs, WHOSE UNDERLYING SECURITIES HAVE BEEN VETTED BY TREAS, opportunity for fraud and misrepresentation of spurious or totally worthless securities is minimized. (An alternative proposed cure that would allow any and all illiquid securities to be priced at the whim of any management holding them would insure future financial system afflictions far worse than the current disease. Except for the special case of illiquid TBOs, relaxation of "Mark to Market" rules would invite eventual corruption not only for banks but for other corporations that would demand the same relief.)
7. As the assets underlying a TBO approach maturity and as the financial crisis subsides, the holder of a TBO will recognize that its increasing value represents a real bargain. This can be procured only upon exercise of the TBO, and holders will do so surely prior to its expiration at the end of the 5 year period. This will return to the TARP fund most of the cash initially advanced by Treas during the initial purchases, thereby greatly limiting taxpayer risk. Even if no TBOs are exercised, a very unlikely possibility, at a lowball 10% purchase miniprice, $1.0 Trillion of assets can be covered with only $100 Billion of taxpayer funds at risk, far less than the $700 Billion fund being requested.
8. Upon expiration of the 5-year TBO exercise period, any residual securities remaining from unexercised TBOs can be auctioned by Treas, and the proceeds, if any, are returned to the TARP fund for the benefit of taxpayers.
9. Because such minor taxpayer funding is at risk, it should be possible to implement this "Minipriced Asset Sales with Buyback Options" (MASBO) approach while resisting demands for extracting taxpayer benefits such as options, preferred stock, and warrants, etc. that would socialize and partly nationalize the US Financial System.
M. Robert Paglee, Moorestown, NJ
[…] question becomes even more crucial now that, under the proposed banking-sector rescue legislation that was passed by the Senate Wednesday night, the individual cap on the level of government-guaranteed deposits would be raised from the current […]
[…] were added to garner support (though plenty of “pork” and unrelated tax breaks appeared in the Senate’s passed version). While the plan may be far from perfect, “experts” believe it represents the best hope for […]
[…] Senate passed the bailout bill late Wednesday night (Oct. 1), followed by the House of Representatives Friday (Oct. 3). U.S. […]
[…] question becomes even more crucial now that, under the proposed banking-sector rescue legislation that was passed by the Senate Wednesday night, the individual cap on the level of government-guaranteed deposits would be raised from the current […]
[…] cries about credit markets choking off lending arose. The 2008 Emergency Economic Stabilization Act package of $700 billion was enacted, and this morning before Congress members of the banking industry defended their […]