While many of the more widely discussed features of last night’s House Discussion Draft still need to be addressed, there are many more obvious flaws distributed throughout the plan. Here are a few to think hard about before to government commits billions of dollars of assistance that skewers private sector incentives for generations to come. All references are to the House Discussion Draft.
§102 Guarantees – The proposal to allow Treasury to guarantee returns to investors in structured finance deals makes them into a financial guarantor, like MBIA, Ambac, and AIG and exposes Treasury to the same risks as those institutions. Indeed, we can fully expect losses under §102 because…
§109 … retains language seeking to “maximize” assistance and “minimize” foreclosures. Such terms are part of the root of the housing initiative program, which sought to “increase” homeownership similarly without constraint. Furthermore, the legislation may by this provision – upon fiat of the Treasury Secretary – become an instrument by which a (potentially future) Treasury Secretary seeks to use up to $700 billion to restructure mortgages. §102 and §109 should be struck or substantially modified: if we want this to be a homeowner bailout, say so, but leaving that decision to a Cabinet appointee for implementation by fiat is irresponsible.
§113 on warrants does not follow private sector practice of taking voting rights (or, better yet, super voting rights) that can be used to restore institutions to solvency. Indeed, the section allows for debt to be purchased in lieu of warrants or stock. These terms are especially egregious because the equity program we are introducing here is specifically FOR insolvent institutions (which – itself – is not a sound proposition). More debt only contributes to deeper insolvency. Furthermore, dividends are not restricted and the Treasury, itself, decides when to exit. None of these provisions are either private sector nor IMF best practices and should be substantially modified. You want controlling voting rights and private dividend suspension, as those are both your measure of ensuring investments that restore the firm to solvency and allowing private shareholder votes to retire government shares once profitability is restored.
Little noticed §114 is supposed to provide for transparency by having Treasury essentially issue an audit certification on all §101 seller institutions. There is no mention of what standards apply nor what time period the institution is judged to have delivered “public disclosure” revealing the “true financial position of the institutions.” I think the market has judged in this regard that financial institutions reporting has been woefully inadequate. Coming to any other conclusion with regard to a participating institution will seem disingenuous and substantially deter from the goals of the program.
Last, §115 on the Graduated Authorization creates some rather strange incentives. In actuality, the President can authorize the Treasury to go beyond the $350 billion “limit.” Congress then has fifteen days for both houses to rush through a joint resolution with limited debate. If Congress objects, the President that just authorized the increase can (and probably will) veto Congress’ decision. This is just a convoluted mechanism to once again – probably soon – strongarm Congress into additional authorizations beyond the original intent, formalizing the apparent need to react to coming crises with hast rather than judgment.
Treasury’s strong arming the rank and file on weekends just prior to recess is what is leaving a bad taste in Congress’ and the public’s months, as it should. Treasury and the Fed have had since last year, and if they didn’t believe then since the Bear Stearns bailout, and if they didn’t believe then since the Fannie and Freddie bailout, to craft better-reasoned reforms that can meaningfully stop this crisis. Roughly two years into the crisis there is no excuse for not having a thoughtful well-reasoned plan for restructuring markets without such heavy reliance on Federal bailouts. While perhaps “one more” bailout may be necessary in light of events of two weeks ago, we owe it to markets and taxpayers to do our best to make sure this is the last.
In summary, §101, the purchase plan is bad enough in that it only restricts the Treasury to guard against “unjust enrichment” by purchasing securities at a value lower than the price the institution originally bought at, i.e., book value. Unjust enrichment, properly defined, would have Treasury purchasing at anything higher than market price. While market price may not be currently observable, provisions could be devised that allow Treasury to recover overpricing in future periods, once transparency is apparent. Such language is highly doubtful and only dubiously implementable, as is much of the entire bill, itself.
I therefore remain true to my convictions that, while some degree of assistance may be necessary to stabilize markets in the short term the more important consideration is medium term measures that directly address investors’ key questions:
1) who has the duff assets and 2) how do I avoid them, as well as remaining conditions of over-leverage among consumers and businesses alike. Today, however, I doubt that short-term assistance is as desirable or necessary as two weeks ago, given that markets have found equilibrium stability– albeit not at levels investors prefer.
It would be best if all in Congress could keep their heads about them while the President and Treasury Secretary cry “fire,” so as to devise meaningful strategy for truly emerging from crisis. Such composure will alleviate the need to throw yet more money at the problem a few months down the road – a while still needing to devise meaningful strategy for truly emerging from crisis.