Saturday, September 27, 2008

Financial Markets in Crisis: Silence on the Rescue Deal Is Golden

(Gibson, Dunn & Crutcher Financial Markets Crisis Group) In contrast to yesterday's public display of political and policy wrangling, today's activity was largely behind the scenes as designated negotiators worked to hash out the details of a rescue plan. Though congressional leaders reported yesterday that they had reached a compromise agreement, Republicans announced that they had developed a competing proposal late Thursday night. House Minority Leader John Boehner wrote Speaker Pelosi today to express concern that the Democrats had not addressed many of the issues Republicans had raised about the proposal before declaring that the two parties had reached a consensus. He said that he and many other Republican members could not support Secretary Paulson's plan until more taxpayer protections and free market principles had been incorporated into the legislation. Members from both sides of the aisle, however, have announced that they are working together to reach an agreement quickly.

The Republicans’ alternative proposal purports to place less risk on taxpayers than the Treasury and Democrats’ proposals and to incentivize private companies to finance much of the recovery. The plan would entail the government insuring mortgage-backed securities, as opposed to purchasing them outright. Holders of the MBS would be required to pay for the insurance premiums rather than placing that burden on taxpayers, and holders of the troubled assets would pay a higher risk-based premium. Through tax incentives and regulatory measures, the proposal is designed encourage private companies, instead of taxpayers, to inject capital into the markets.

Like the Democrats’ plan, the Republicans’ proposal calls for more transparency and oversight than did the initial Treasury request. Participating firms would have to disclose the value of their mortgage assets to Treasury, as well as the value of bids within the last year for those assets and their most recent audit report. Under the plan, the SEC would audit failed companies and would review the performance of the Credit Rating Agencies. The Republicans also seek to impose greater restrictions on government sponsored enterprises, forbidding them to securitize any unsound mortgages. Finally, the Republican plan would create a blue ribbon panel to assess the country’s financial situation and to suggest reforms for the market by January 1, 2009.

Republicans also have suggested including a "pay to play" provision, which would require participating firms to pay a set amount of money based on the amount of assets Treasury purchases, as well as creating an independent government corporation to purchase the troubled assets instead of Treasury, which would have congressional accountability and would minimize taxpayer exposure.

Key Points in the Latest Draft

A new draft of the rescue bill, dated September 25, 2008, includes new provisions and adds texture and detail to provisions of earlier drafts. Key provisions in this draft include the following:

  • limit participating financial institutions to United States institutions, meaning that they must be organized under United States law and must have significant operations in the States;
  • defines the “troubled assets” eligible for Treasury purchase as those assets based on or related to residential or commercial mortgages which were originated or issued on or before March 14, 2008;
  • creates an Office of Financial Stability within the Office of Domestic Finance of the Department of Treasury, through which the Secretary will implement these programs;
  • requires that the Secretary publish program guidelines either within two days of exercising this authority or within thirty days of enactment of the legislation. These guidelines will define how the assets will be priced and purchased and how asset managers will be selected;
  • establishes the Financial Stability Oversight Board, which will review the Secretary’s exercise of authority and will be composed of the Federal Reserve chairman, the Federal Deposit Insurance Corporation chairman, and the SEC chairman, as well as two other members who are not governmental employees, one of whom will be appointed by the majority leader of the Senate and Speaker of the House, and one of whom will be appointed by the Senate and House minority leaders;
  • requires the Secretary to report to Congress 60 days after the programs are initiated and every 30 days thereafter, as well as to make public the total amount of assets purchased and sold each week;
  • mandates that the Secretary review the financial markets and submit an improvement plan to Congress by April 30, 2009;
  • requires that at least 20 percent of any profit realized from the program be deposited into federal programs: 65 percent of that amount will be deposited into the Housing Trust Fund, and 35 percent into the Capital Magnet Fund;
  • authorizes the Secretary to contract for services through a streamlined process not subject to the Federal Acquisition Regulation. Sets out principles for awarding contracts, including contracts to asset managers. The principles require the Secretary:

    • to solicit proposals from a broad range of vendors;
    • to ensure the inclusion of minority- and women-owned businesses in the contracting process;
    • to consider the FDIC in the selection of asset managers.
  • requires the Secretary to develop conflict of interest standards;
  • charges the Secretary with a duty to assist homeowners and reduce foreclosures and requires the Secretary to alter mortgage terms when such requests are “reasonable”;
  • implements corporate governance and executive compensation standards that would be effective for two years after a corporation enters the program. These standards leave much to the Secretary’s discretion, placing limits on compensation which will exclude incentives for officers to take risks that the Secretary deems “inappropriate” or “excessive. The standards also prohibit golden parachute;
  • implements additional corporate governance standards for those institutions from which the Secretary makes a direct purchase, including proxy access for any shareholder or shareholder group representing 3 percent or more of the institution’s equity securities and a mandatory opportunity for shareholders to cast a non-binding vote on the institution’s executive compensation during any annual proxy solicitation and shareholder vote;
  • requires the Secretary to maximize the taxpayer investment by using market mechanisms, such as auctions or reverse auctions, but allows the Secretary to make direct purchases where appropriate;
  • requires the Secretary to obtain a warrant giving the Secretary the right to receive non-voting common stock from any institution from which the Secretary purchases troubled assets, which the Secretary may transfer freely, and which are protected from dilution by stock splits, distributions, dividends, or corporate reorganizations;
  • limits the Secretary’s purchasing authority to $700 billion, which will be granted to the Secretary in tranches. The initial authority will be limited to $250 billion; after a request to Congress, the authority will be limited to $350 billion; and after a final request and written report to Congress, the authority will be limited to $700 billio;
  • grants the Comptroller General of the United States oversight of the TARP program;
  • establishes the Office of the Special Inspector General for the Troubled Asset Relief Program;
  • raises the public debt limit to $11.315 trillion;
  • authorizes the Secretary to establish a temporary guaranty program for money market mutual funds; and
  • limits tax deductions for participating institutions for executive compensation to no more than $400,000 a year per executive.

We note that, it's not clear who supports this draft as it now stands. What is clear is that this draft will change – indeed, likely has changed – before it is voted on by the House and Senate.

Timing and Procedure

There is a desire among bill negotiators and others to reach agreement by the end of the weekend. One scenario would have the House and Senate voting on a rescue plan – either as a standalone measure or as an amendment to the Continuing Resolution (CR) – this weekend or possibly Monday morning. Another, perhaps more likely at this point, would have Congress coming back after Rosh Hashanah to finish up on Wednesday.

Various sources have reported that Treasury hopes to have the program functioning within 3-4 weeks.

On a procedural note, Senator Majority Leader Harry Reid filed cloture on the motion to proceed to the Continuing Resolution (CR) yesterday. Cloture will ripen tomorrow. This is significant in terms of timing because that means the CR may well serve as the vehicle to move (or at least vote on) the rescue bill (as will a second "stimulus" package).

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