Treasury Bailout Power Grab?

Here is the Treasury Bailout plan, with our comments interspersed:

Section 1. Short Title.

This Act may be cited as ____________________.

Sec. 2. Purchases of Mortgage-Related Assets.

(a) Authority to Purchase.--The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.

Comment: This has since been expanded to "any institution doing substantial business in the U.S." In other words, we could be bailing out just about every major financial institution in the world.

(b) Necessary Actions.--The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:

Comment: Can we say "raw power grab"?  We developed a Constitution with checks and balances.

(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;

Comment: These people will be extraordinarily powerful, yet will not be subject to Senate confirmation.

(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;

Comments: "No-bid" contracts will be OK and the Secretary can favor whomever he wants.

(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;

Comment: Sounds like we will be giving lots of power to any institution so designated.

(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and

(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.

Sec. 3. Considerations.

In exercising the authorities granted in this Act, the Secretary shall take into consideration means for--

(1) providing stability or preventing disruption to the financial markets or banking system; and

(2) protecting the taxpayer.

Comment: The provisions down below give me very little hope that objective number (2) here is anything more than window dressing.

Sec. 4. Reports to Congress.

Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.

Sec. 5. Rights; Management; Sale of Mortgage-Related Assets.

(a) Exercise of Rights.--The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this
Act.

(b) Management of Mortgage-Related Assets.--The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.

(c) Sale of Mortgage-Related Assets.--The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.

(d) Application of Sunset to Mortgage-Related Assets.--The authority of the Secretary to hold any mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.

Comment: The government can be buying this stuff for up to two years, but we could be holding onto it forever.

Sec. 6. Maximum Amount of Authorized Purchases.

The Secretary's authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time.

Comment: Note that it says $700 billion "outstanding at any one time," thus if the Government sells off some of the assets acquired, it can plow the proceeds back into the fund to buy up more of this crap paper.

Thus, while if we bought up $700 billion we would not suffer a $700 billion loss, sonce we would get something from each sale of the paper. However, if we (a.k.a. taxpayers), say, lose 30% on the first batch, and then plough the proceeds back into more paper, and lose 30% on that, we very well could see the total tab hit the $700 billion mark.

Sec. 7. Funding.

For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.

Comment: I'm not enough of an expert on the U.S. Code to say what Chapter 31 is all about; might have to look into it and post about it in a later blog.

Sec. 8. Review.

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.

Comment: This one is a doozy -- all decisions are final, and if you don't like what the Treasury Secretary does, then go jump in a lake. This seems to be questionable on constitutional grounds since it is asking to pass a law that is not reviewable by the courts.

Sec. 9. Termination of Authority.

The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act.

Sec. 10. Increase in Statutory Limit on the Public Debt.

Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000.

Comment: We are raising the debt ceiling to $11.3 trillion. In comparison, the debt ceiling was about $5 trillion when Bush came into office. 

Just who are we going to borrow all this money from?  Is there any limit to the amount of treasuries that foreign central banks will buy?  Yes, right now in a flight to safety move, everyone is buying up T-Bills, but this is a sudden and massive increase in the supply of government debt, and I have my doubts about where the demand will come from.  There is a chance that much of this will end up being monetized, leading to very high rates of inflation down the road.

Sec. 11. Credit Reform.

The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable.

Sec. 12. Definitions.

For purposes of this section, the following definitions shall apply:

(1) Mortgage-Related Assets.--The term "mortgage-related assets" means 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 September 17, 2008.

Comment: Created up until last week. In other words, if they were creating bad paper even after all the warnings of disaster we have had all year long, the paper can still be part of the program.

(2) Secretary.--The term "Secretary" means the Secretary of the Treasury.

(3) United States.--The term "United States" means the States, territories, and possessions of the United States and the District of Columbia.

Final thoughts: Note that there is no mention of how the price of these assets will be determined, other than at the discretion of the Treasury Secretary.  There are investors who are willing to buy these assets, they just don't want to pay the price that the banks and investment banking firms want (and need). 

I am personally willing to buy $1 billion face value of these troubled Mortgage Backed Securities for the princely sum of $10. There, proof that there are willing buyers out there. 

If the paper is currently trading for say $0.25 on the dollar -- which is probably generous given that Merrill Lynch (MER) sold a big slug of this paper for $0.22 on the dollar and had to engage in seller financing to do it -- and the Government pays $0.25 on the dollar, then the taxpayer is generally well protected, but it does not solve the problem. 

The banks would have to recognize the loss when they sold the paper, and their capital would take the hit. 

Yes, it would provide more transparency as to what is on the books of the bank, but that is about it. Now, to the extent that the government is going to pay more than the $0.25 then the difference between that price and the $0.25 is a pure giveaway to the banks. It is the same as if you bought a stock at $100 a share and it plunged to $25 a share.  If the government comes along and says it will pay you $75 a share, it is giving you $50. 

The plan attacks the problem of excessive leverage (assets/equity) from the asset side.  We buy up all the bad assets so leverage comes down. It would be far better to attack this from the equity side.  This could be done by the Government buying a large amount of preferred stock in each firm at current market prices. Yes, current shareholders would be severely diluted, but the banks would then be in a strong enough position financially to continue to make more loans. We need banks to continue lending; if they stop, that's where the very real threat of financial Armageddon comes from.

This is VERY different than the original RTC.  In the original case, the Government already had the assets.  It acquired them by virtue of paying off the depositors of failed savings and loans. The RTC was simply a consolidated way to dispose of those assets (and provide more funds to the FDIC).  The shareholders of the savings and loans, both common and preferred were wiped out in the process, and most of the time the creditors of the bank also took a haircut.

Here we are talking about buying up the junk paper of existing institutions, most likely at inflated prices.  If we were talking about this being limited to handling the assets and liabilities of already failed firms like Lehman Brothers (LEH), then the analogy to the RTC would hold, and the plan would make sense. 

Do the taxpayers get any upside?   None that I see in this proposal. 

At least in the FNM/FRE and AIG situations, the taxpayers wind up with 80% of the equity on the institution and the existing shareholders took a huge hit, and the managements of those institutions were replaced.

I was giving Paulson and Bernanke very high marks for their creativity in navigating very treacherous waters with thise plans. They will cost the taxpayer a bundle, at least in the short term, but with those there is a very real possibility of the taxpayer making money in the long run.

Anyone claiming that this plan will make the taxpayer money in the long run is euphoric. I see no reason to share in their optimism.

Read the full analyst report on MER

Read the full analyst report on LEH

Read the full analyst report on FNM

Read the full analyst report on FRE

Read the full analyst report on AIG