Action plans (1)

This weekend's G20 meeting has produced a surprisingly long statement which departs somewhat from the usual anodyne assurances. Whether its bullet points and action plan will actually lead to any real coordinated efforts is anyone's guess, but it's hard to see much progress on any of these fronts being made before Obama is sworn in and the EU Presidency rotates.


Root causes?

Quasi-illiterate and question-begging, the statement's language on the root causes of the present crisis leaves much to be desired.

During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system. Policy-makers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions.

Major underlying factors to the current situation were, among others, inconsistent and insufficiently coordinated macroeconomic policies, inadequate structural reforms, which led to unsustainable global macroeconomic outcomes. These developments, together, contributed to excesses and ultimately resulted in severe market disruption.

From thirty thousand feet, the crisis is an "excess" created by a few market participants out of conditions of "prolonged stability" -- an anomaly, an outlier. Regulators failed to "keep pace" (it wasn't that they were incapable of doing so). Market participants sought higher yields (it wasn't that they were compelled to do so). The Pyrrhonism that has come to be associated with Nicholas Taleb -- the idea that the crisis was a "black swan" which no one could have anticipated, a reminder perhaps of eternal human frailty and the limits of cognition, but one without any more determinate consequences -- and the pensée unique reveal a hidden filiation: absent from either is any sense of structure.

In this world of mere phenomena, nothing concrete can be named. So "unsustainable global macroeconomic outcomes" -- but not the great actually existing polarities structuring the international economic system, the US as debtor of last resort and currency hegemon, the Chinese willingness to lend -- and inability to do otherwise. Nor the national policies in the advanced industrial countries which, whether nominally driven by the state (Britain, France) or the private sector (US), or transparently a result of rent-extraction (Norway), prop the standard of living of white people far above the global average in a futile attempt to postpone the equilibration of the most important economic disparity of our century, the vast concentration of capital in a few countries and labor in the rest.


Throw more money at it

On the way up, financialization is a necessary, virtuous symptom of industrial growth -- indeed, our great thinkers held not so very long ago, finance and other tertiary or even "quaternary" sector activities can replace manufacturing and agriculture as the roots of national wealth (thus the disastrous specialization of cities like London and New York in catering to the whims of transnational elites). On the way down, monetary disintermediation and debt deflation are perverse, unintended, unnecessary, and to be halted at all costs. Money and finance as essential social functions when they yield rents for politicians; as inessential mere appearances when they inconveniently refuse to extend more credit to the bankrupt.

Which is when government steps in.

* Recognize the importance of monetary policy support, as deemed appropriate to domestic conditions.
* Use fiscal measures to stimulate domestic demand to rapid effect, as appropriate, while maintaining a policy framework conducive to fiscal sustainability.
* Help emerging and developing economies gain access to finance in current difficult financial conditions, including through liquidity facilities and program support. We stress the International Monetary Fund's (IMF) important role in crisis response, welcome its new short-term liquidity facility, and urge the ongoing review of its instruments and facilities to ensure flexibility.

The ongoing coordinated bailout is likely the largest single government intervention in economic affairs in history. No surprise that it's likely to continue until either markets yield before it (certainly possible) or a genuine catastrophe ensues (sterling crisis, a sustained run on the dollar, sovereign debt crisis of an EMU member, revolution in China).

In the mean time, the temptations of beggar-thy-neighbor policies will only grow. Here that will mean fiscal stimulus that supports national champions -- like automakers -- in a deadly race to the bottom to subsidize global overcapacity, legacy costs, and inefficient production methods. So too the risk of unintended consequences from uncoordinated policy interventions -- as market participants learn the structure of bank recapitalization programs and new lending facilities and their quirks, and start to arbitrage one monetary authority against another. The spectre of the IMF as a global monetary authority is a hopeful one -- but relies on commitments to fund its operations which may well be withdrawn in the face of bigger problems at home.


Globalization tested

We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports. Further, we shall strive to reach agreement this year on modalities that leads to a successful conclusion to the WTO's Doha Development Agenda with an ambitious and balanced outcome. We instruct our Trade Ministers to achieve this objective and stand ready to assist directly, as necessary. We also agree that our countries have the largest stake in the global trading system and therefore each must make the positive contributions necessary to achieve such an outcome.

Leave aside the unhappy word "modalities" (it's a technical term of WTO negotiation). This is the strongest statement yet from a global or quasi-global body on governments' commitments to free trade and a globally interconnected economy -- even recognizing that those commitments will entail near-term costs for at least some of their domestic economies. And it is the strongest and most important single pledge in the G20 document. Unfortunately it is strong just because it is testable -- and whether new trade barriers are erected in the next year will be the biggest test of whether governments understand the importance of their interconnections. A Detroit bailout would be an inauspicious start to meeting this commitment.

Regulation is first and foremost the responsibility of national regulators who constitute the first line of defense against market instability. However, our financial markets are global in scope, therefore, intensified international cooperation among regulators and strengthening of international standards, where necessary, and their consistent implementation is necessary to protect against adverse cross-border, regional and global developments affecting international financial stability. Regulators must ensure that their actions support market discipline, avoid potentially adverse impacts on other countries, including regulatory arbitrage, and support competition, dynamism and innovation in the marketplace.

All true -- and nothing is weaker than truisms. Informed observers agree that this language is thanks to the US's unwillingness to tie its regulatory hands in any way -- a repetition in another key of our Queen of the May behavior towards other international institutions (the International Criminal Court, the Kyoto Protocol, and, oh, just fill in your favorite example). Whether the SEC, which has trouble implementing the XML standards it writes itself, is even capable of doing much in the way of "international cooperation," is another question.

The reality is that the current state of international financial regulation is the result of an ugly race to the bottom, the pigheadedness of individual regulatory bodies, and the galvanic reflex-arc of politicians stuck with scandals they don't understand. So Sarbanes-Oxley in the United States (because of "Enron"), even as the key provisions of Glass-Steagall are repealed; landgrabs for new regulatory territory (the NY State insurance regulators announcing unilaterally that they would regulate CDS) when old rules aren't being enforced. Or individual nations with strong traditions of securities regulation that refused to bow to trends -- and find themselves back in fashion (Canada). The blatant example of Britain, whose Labour governments rode on the back of a booming financial services business attracted by deliberately low taxes and lax regulation, designed to suck financial business away from other countries: the Gulf States hoping to follow the example of London. Within the EU, no one is clear on jurisdiction or on the Byzantine (and seemingly unwarranted) complexities of individual countries' securities law: witness the Volkswagen debacle, which caught investors from all over the world who didn't realize that in Germany it was possible to take vast stakes in a company through cash-settled swaps without ever announcing it.

Is there any regulator willing to take the lead? Which means not only to set out a clear, efficient, professional system of market regulation -- and then to enforce it, with all the costs (including the recruitment of talent) that entails -- but also to show the markets a path forward where financial "competition, dynamism and innovation" means something aside from tax evasion (sorry, "optimization"), regulatory and legal arbitrage, and structured obfuscation?

The innovation required is on the scale of the original invention of 1933 and 1934 -- the creation of the SEC. We may be excused for failing to see where the personal authority and the political will of a Franklin Roosevelt or a Joseph Kennedy (or even, in a much more muted key, a Carter Glass or a Henry Steagall) is to be found.

Secretary Paulson's enabling act (8)

The Senate will vote on a revised bailout bill at 7:30pm. The draft is now 451 pages and contains tacked-on provisions, including the "Paul Wellstone and Pete Domenici Mental Health Parity and Addiction Equity Act of 2008," which would require insurers to treat mental illness equivalently to physical sicknesses for certain purposes. (And, to be fair, the tax credits for alternative energy.)

The relevant portions of the bill are 113 pages long. The bill would require Treasury to publish guidelines related to the execution of the TARP, including:

(1) Mechanisms for purchasing troubled assets.
(2) Methods for pricing and valuing troubled assets.
(3) Procedures for selecting asset managers.
(4) Criteria for identifying troubled assets for purchase.

The talking heads all seem to think that mechanism design should be left up to Treasury -- but of course it is just in that mechanism design that all the key decisions about moral hazard and the proper expenditure of tax dollars will be taken. (The Secretary is to buy assets "at the lowest price that the Secretary determines to be consistent with the purposes of this Act.") As long as this is a black box, the bill is completely indeterminate as between a simple transfer of cash to banks -- an underhanded and expensive recapitalization -- and a legitimate (although perhaps more fundamentally wrongheaded) attempt to relieve liquidity pressures. The bill's provision against unjust enrichment is a lame duck, forbidding the purchase of assets above their original purchase price, but not above their current fair value.

Sec. 102 of the bill is the House Republicans' Mad Hatter insurance plan, which grants Treasury authority to insure assets up to par (!) and again in no way specifies how they are to do so:

In establishing any program under this subsection, the Secretary may develop guarantees of troubled assets and the associated premiums for such guarantees. Such guarantees and premiums may be determined by category or class of the troubled assets to be guaranteed.

Leave aside the ludicrous reality that the people who wrote this section claim to be protecting us from state socialism. They ask Treasury to set premiums in the insurance program

at a level necessary to create reserves sufficient to meet anticipated claims, based on an actuarial analysis, and to ensure that taxpayers are fully protected.

It is harder to insure assets than it is to price them -- you need more data -- even when those assets are straightforward. Many of the structured assets under consideration are singular and do not belong to an obvious class of similar assets -- how, for instance, to measure the risk of default of some particular equity tranche of some particular pool of mortgages from Wisconsin in the first half of 2006? Even if we accept the imperfection of the needed comparisons, the market in these assets that could provide price data for an insurance estimate is shut down -- and the same agency that will be insuring the assets is the one that will be granted $700bn to distort or substitute that market. It's hard to see how Treasury could even begin to make good-faith efforts to implement the insurance program.

The mandate of the program has expanded ungraspably, with Treasury instructed to take 9 factors (not obviously reconcilable, e.g. numbers 4 and 5, etc.) into consideration in its implementation:

(1) protecting the interests of taxpayers by maximizing overall returns and minimizing the impact on the national debt;

(2) providing stability and preventing disruption to financial markets in order to limit the impact on the economy and protect American jobs, savings, and retirement security;

(3) the need to help families keep their homes and to stabilize communities;

(4) in determining whether to engage in a direct purchase from an individual financial institution, the long-term viability of the financial institution in determining whether the purchase represents the most efficient use of funds under this Act;

(5) ensuring that all financial institutions are eligible to participate in the program, without discrimination based on size, geography, form of organization, or the size, type, and number of assets eligible for purchase under this Act;

(6) providing financial assistance to financial institutions, including those serving low- and moderate-income populations and other underserved communities, and that have assets less than $1,000,000,000, that were well or adequately capitalized as of June 30, 2008, and that as a result of the devaluation of the preferred government-sponsored enterprises stock will drop one or more capital levels, in a manner sufficient to restore the financial institutions to at least an adequately capitalized level;

(7) the need to ensure stability for United States public instrumentalities, such as counties and cities, that may have suffered significant increased costs or losses in the current market turmoil;

(8) protecting the retirement security of Americans by purchasing troubled assets held by or on behalf of an eligible retirement plan described in clause (iii), (iv), (v), or (vi) of section 402(c)(8)(B) of the Internal Revenue Code of 1986, except that such authority shall not extend to any compensation arrangements subject to section 409A of such Code; and

(9) the utility of purchasing other real estate owned and instruments backed by mortgages on multifamily properties.

Again, a good faith effort to follow these instructions would result in the failure of the bill to accomplish any of its objectives.

Toothless provisions on corporate governance apply only in the case when assets are purchased directly from institutions in exchange for debt and equity; they

exclude incentives for senior executive officers of a financial institution to take unnecessary and excessive risks that threaten the value of the financial institution

as well as providing for clawback of bonuses in cases of material inaccuracy in the statement of relevant criteria, and the elimination of golden parachutes -- but only for the five highest-paid executives, and only at public companies.

On the plus side, in exchange for asset purchases, Treasury will receive non-dilutable senior debt or equity warrants convertible to senior debt -- but "the exercise price for any warrant issued pursuant to this subsection shall be set by the Secretary, in the interest of the taxpayer."

And then there's the FDIC insurance limit -- raised to $250k from $100k. By any prudent ("actuarial," not to put words into our representatives' mouths) standard, the FDIC insurance fund is now underfunded by two and a half times. And the corporation is forbidden to fund itself adequately!

The temporary increase in the standard maximum deposit insurance amount made under paragraph (1) shall not be taken into account by the Board of Directors of the Corporation for purposes of setting assessments under section 7(b)(2) of the Federal Deposit Insurance Act (12 U.S.C. 1817(b)(2)).

But never fear -- to pay for this largesse, the FDIC's borrowing limits at the Fed will be lifted.

This would be a terrible bill even in the relatively competent hands of Hank Paulson -- what about Phil Gramm or John Corzine? It will stall the failure of insolvent banks and cast a veil of uncertainty over all those markets into which it intervenes. Cowardice, ignorance, and political expediency will ensure its passage into law.

Secretary Paulson's enabling act (7)

Nancy Pelosi's news release on the draft bailout bill:

REINVEST, REIMBURSE, REFORM
IMPROVING THE FINANCIAL RESCUE LEGISLATION

Significant bipartisan work has built consensus around dramatic improvements to the original Bush-Paulson plan to stabilize American financial markets -- including cutting in half the Administration's initial request for $700 billion and requiring Congressional review for any future commitment of taxpayers' funds. If the government loses money, the financial industry will pay back the taxpayers.

3 Phases of a Financial Rescue with Strong Taxpayer Protections

Reinvest in the troubled financial markets … to stabilize our economy and insulate Main Street from Wall Street

Reimburse the taxpayer … through ownership of shares and appreciation in the value of purchased assets

Reform business-as-usual on Wall Street … strong Congressional oversight and no golden parachutes

CRITICAL IMPROVEMENTS TO THE RESCUE PLAN

Democrats have insisted from day one on substantial changes to make the Bush-Paulson plan acceptable -- protecting American taxpayers and Main Street -- and these elements will be included in the legislation

Protection for taxpayers, ensuring THEY share IN ANY profits

Cuts the payment of $700 billion in half and conditions future payments on Congressional review

Gives taxpayers an ownership stake and profit-making opportunities with participating companies

Puts taxpayers first in line to recover assets if participating company fails

Guarantees taxpayers are repaid in full -- if other protections have not actually produced a profit

Allows the government to purchase troubled assets from pension plans, local governments, and small banks that serve low- and middle-income families

Limits on excessive compensation for CEOs and executives

New restrictions on CEO and executive compensation for participating companies:

No multi-million dollar golden parachutes

Limits CEO compensation that encourages unnecessary risk-taking

Recovers bonuses paid based on promised gains that later turn out to be false or inaccurate

Strong independent oversight and transparency

Four separate independent oversight entities or processes to protect the taxpayer

A strong oversight board appointed by bipartisan leaders of Congress

A GAO presence at Treasury to oversee the program and conduct audits to ensure strong internal controls, and to prevent waste, fraud, and abuse

An independent Inspector General to monitor the Treasury Secretary's decisions
Transparency -- requiring posting of transactions online -- to help jumpstart private sector demand

Meaningful judicial review of the Treasury Secretary's actions

Help to prevent home foreclosures crippling the American economy

The government can use its power as the owner of mortgages and mortgage backed securities to facilitate loan modifications (such as, reduced principal or interest rate, lengthened time to pay back the mortgage) to help reduce the 2 million projected foreclosures in the next year

Extends provision (passed earlier in this Congress) to stop tax liability on mortgage foreclosures

Helps save small businesses that need credit by aiding small community banks hurt by the mortgage crisis—allowing these banks to deduct losses from investments in Fannie Mae and Freddie Mac stocks

Secretary Paulson's enabling act (6)

There are reports this morning that John McCain was the sticking point in yesterday's bailout talks. Below is the text of a draft agreement on principles published by the WSJ's economics blog. Everything rests on the specific provisions of 1.b., of course; and yet it's 1.a. that is likely to get the drums beating.

1. Taxpayer Protection
a. Requires Treasury Secretary to set standards to prevent excessive or inappropriate executive compensation for participating companies
b. To minimize risk to the American taxpayer, requires that any transaction include equity sharing
c. Requires most profits to be used to reduce the national debt

2. Oversight and Transparency
a. Treasury Secretary is prohibited from acting in an arbitrary or capricious manner or in any way that is inconsistent with existing law
b. Establishes strong oversight board with cease and desist authority
c. Requires program transparency and public accountability through regular, detailed reports to Congress disclosing exercise of the Treasury Secretary’s authority
d. Establishes an independent Inspector General to monitor the use of the Treasury Secretary’s authority
e. Requires GAO audits to ensure proper use of funds, appropriate internal controls, and to prevent waste, fraud, and abuse

3. Homeownership Preservation
a. Maximize and coordinate efforts to modify mortgages for homeowners at risk of foreclosure
b. Requires loan modifications for mortgages owned or controlled by the Federal Government
c. Directs a percentage of future profits to the Affordable Housing Fund and the Capital Magnet Fund to meet America’s housing needs

4. Funding Authority
a. Treasury Secretary’s request for $700 billion is authorized, with $250 billion available immediately and an additional $100 billion released upon his or her certification that funds are needed
b. final $350 billion is subject to a Congressional joint resolution of disapproval

Secretary Paulson's enabling act (5)

With his characteristic lucidity, Lucian Bebchuk has written a very short paper (13pp) which says (almost) everything that needs to be said about the Paulson bailout proposal from a policy perspective. If you read only one thing this week about the bailout, make it this.

Edit: Bebchuk makes his case in Friday's WSJ.

Bebchuk limits himself to the premises and scope of the action proposed this week by Treasury: given, in other words, that the plan is proposed in good faith (i.e., it is not an attempt to distribute largesse to selected firms or actors, it is not a power-grab by Treasury or Paulson personally, it is not an attempt to buy the election for McCain, etc.), how ought it to be designed?

The pricing problem
Bebchuk states plainly the fundamental hypothesis about the state of the financial markets that underlies the policy proposal:

Because of the substantial presence of these illiquid troubled assets on the balance sheets of financial firms, the Treasury believes, financial firms have difficulty raising capital, are subject to risks of creditor runs, and are reluctant to carry out fully their role in financing the real economy....

The Treasury believes… that financial firms cannot currently sell these assets even at their reduced fundamental value… money managers that would otherwise be willing to purchase financial assets at any price below their fundamental value do not have sufficient liquidity to keep prices at fundamental values.

Given this premise, the problem is then, straightforwardly, a) whether government should introduce the needed liquidity into the markets (as opposed to private actors), and, b) how the assets to be purchased are to be priced.
The current plan gives Treasury the “freedom to confer massive gifts on private parties,” and so Bebchuk suggests at a minimum that the statute be altered to require Treasury to pay no more than fair value for troubled assets.

That begs the practical question, though, how fair value is to be assessed. “A situation in which a Treasury in-house official bargained one-on-one with a financial firm over the value of an asset would raise serious concerns.” It is nearly impossible to imagine how Treasury could assess the hold-to-maturity value of $700bn in complex securities under the time constraints supposed to be operative — Paulson has in his testimony to Congress suggested that Treasury might need to exercise the full $700bn of authority during the Congressional recess — even were the distribution of the performance of the underlying assets known. In this case, to value the underlying requires an additional prospective judgment about the macroeconomy (and in the case of individual mortgage pools, of particular market segments or regions) at a time of profound uncertainty: that is, at a time when Bush is going before the American people to warn, essentially, of the Great Depression. And exercising any effective oversight over those judgments would be difficult or impossible.

Nor do the sellers of these assets need to misrepresent their value in order to game an auction process. Even if Treasury bids as often overestimate as underestimate the value of assets for sale, sellers need only accept the high bids and reject the low.
And, realistically, the feasibility of and incentives for collusion are high: these assets are concentrated in the hands of relatively few actors, who are capable of coordinating their auction behavior.

Bebchuk therefore proposes dividing the pool of liquidity to be injected into the market among perhaps twenty managers: that is, rather than Treasury acting as a single buyer, funding an artificial market for the assets to be purchased. Competition amongst the managers could serve as a check on the price of the assets; and each manager could be incentivized based on the final profits of their fund. Bebchuk even suggests that qualified managers be asked to bid the profit cut they would be willing to accept for the privilege. Since Bill Gross has said in public he would manage Treasury’s fund for free, it shouldn’t be hard to find qualified people.
The point, of course, is that it’s possible to write stronger — much stronger — protections of taxpayers into legislation that accomplishes Paulson’s stated aims.

The capital problem
Bebchuk asks us to separate the asset-pricing question — a question, if Treasury is correct, of liquidity — from the question whether, independent of the illiquidity of asset markets, financial firms are undercapitalized. Providing capital to those that are is a legitimate aim of policy, but should be done “directly, aboveboard, and for consideration.” Capital infusions, in other words, should be and can be priced separately from asset purchases.

Bebchuk therefore proposes allowing Treasury to purchase newly issued securities from financial firms. This is superior to providing capital by overpaying for assets because it would compensate taxpayers for their transfers to banks; but also because the capital firms require may not be in proportion to their holdings of illiquid assets.

Bebchuk appears not to have read the Dodd proposal — since the equity participation granted to government under that plan would vest after the final asset sales, in a proportion of 125% of the shortfall, it is not subject to his criticism that under plans which give government equity, “government would still need to assess how much it is overpaying for the purchased troubled assets and what new equity tickets would provide adequate consideration for the amount overpaid.” But other problems (like the consequences of outstanding, hard-to-value, undilutable Dodd obligations on the books of financial corporations that might wish to undertake corporate actions) make his plan to untie equity from asset purchases preferable.

The problem is, of course, that while it is true that “some financial firms would need a capital infusion but would not wish to make significant use of the government’s willingness to purchase troubled assets,” this is precisely what Paulson’s plan is designed to obfuscate. Which is why Bebchuk does a third, greater service in setting things out so plainly.

Persecution and the art of writing
Hobbes writes:

Feare, without the apprehension of why, or what, PANIQUE TERROR; called so from the fables that make Pan the author of them; whereas in truth there is always in him that so feareth, first, some apprehension of the cause, though the rest run away by example; every one supposing his fellow to know why. And therefore this Passion happens to none but in a throng, or multitude of people.

Bebchuk’s criticism is constructive, in that his plan is designed to Treasury’s stated objectives better than Paulson’s. But it is also illustrative: of the hasty and unclear thinking which is dominating a hasty and unclear legislative effort; of the disparity between the rhetoric of crisis employed by the administration and the actual shape of their plan.

That is, in times of panic it can be useful to write as if panic were not a factor in human affairs: because it is only then that one can begin to ask how, and to what ends, that panic has been fostered and turned. Make no mistake that President Bush’s address to the nation was on the order of shouting fire in a crowded theater; as the old Leninists used to say, it was an attempt to “sharpen the contradictions:” and railroad Paulson’s plan through Congress.

Qui bono?

Secretary Paulson's enabling act (4)

We continue our review of Sen. Dodd's competing bailout proposal.

Dodd would establish a Special Inspector General for the TARP

It shall be the duty of the Special Inspector General for the Troubled Asset Program to conduct, supervise, and coordinate audits and investigations of the purchase, management, and sale of assets by the Secretary of the Treasury

He would require the Fed to report on any use of its discounting authority under 12 USC 343

(1) the justification for exercising the authority; and
(2) the specific terms of the actions of the Board, including the size and duration of the lending, the value of any collateral held with respect to such a loan, the recipient of warrants or any other potential equity in exchange for the loan, and any expected cost to the taxpayer for such exercise.

Provides for a study of financial leverage

(A) an analysis of the roles and responsibilities of the Board, the Securities and Exchange Commission, the Secretary of the Treasury, and banking regulators with respect to monitoring leverage and acting to curtail excessive leveraging;
(B) an analysis of the authority of the Board to regulate leverage, including by setting margin requirements, and what process the Board used to decide whether or not use its authority; and
(C) recommendations for the Board and Congress with respect to the existing authority of the Board.

And an impact assessment of the TARP

The Comptroller General shall conduct a study to assess the impact of the program authorized by this Act, including—
(A) whether it has—
(i) provided stability or prevented disruption to the financial markets or the banking system; and
(ii) protected taxpayers;

Dodd sets (gentle) executive compensation limits

(1) limits on compensation to exclude incentives for executives to take risks that the Secretary deems to be inappropriate or excessive;
(2) a claw-back provision for incentive compensation paid to a senior executive based on earnings, gains, or other criteria that are later proven to be inaccurate; and
(3) such limitations on the entity paying severance compensation to its senior executives as are determined to be appropriate in the public interest in light of the assistance being given to the entity.

Funds money-market fund insurance out of the TARP (and forbids the use of the Exchange Stabilization Fund)

And makes slight changes to the mortgage modification code

Secretary Paulson's enabling act (3)

Sen. Dodd's competing proposal is now available. We review the terms of his proposal in two posts.

Dodd retains the wide grant of authority

The Secretary is authorized to establish a program to purchase, and to make and fund commitments to purchase troubled assets from any financial institution, on such terms and conditions as are determined by the Secretary, and in accordance with policies and procedures developed by the Secretary

And even extends it

designating appropriate entities as financial agents of the Federal Government, authorized to perform in such capacity all such reasonable duties related to this Act as may be required;

But sets up an office to administer the program

The Secretary shall implement any program under paragraph (1) through an Office of Financial Stability... which office shall be headed by an Assistant Secretary of the Treasury.

Subject to the oversight of an Emergency Oversight Board to include the Fed, FDIC, and SEC chairmen

(A) reviewing the exercise of authority under a program developed in accordance with this Act, including—
(i) all actions taken by the Secretary and the office created under section 2, including the appointment of financial agents, the designation of asset classes to be purchased, and plans for the structure of vehicles used to purchase troubled assets; and
(ii) the effect of such actions in assisting American families in preserving home ownership, stabilizing financial markets, and protecting taxpayers; and
(B) making recommendations, as appropriate, to the Secretary regarding use of the authority under this Act.

Treasury will receive a contingent equity (or senior debt) stake when it makes a loss

In the event that the equity of the financial institution from which such troubled assets were purchased is not publicly traded on a national securities exchange, the Secretary shall acquire a senior contingent debt instrument in lieu of contingent shares, which shall automatically vest to the Secretary on behalf of the United States Treasury in an amount equal to 125 per cent of the dollar amount of the difference between the amount the Secretary paid for the troubled assets and the disposition price of such assets. The Secretary may demand payment of such contingent debt instrument under such terms and conditions as determined appropriate by the Secretary....
In the event that the equity of the financial institution from which such troubled assets were purchased is not publicly traded on a national securities exchange, the Secretary shall acquire a senior contingent debt instrument in lieu of contingent shares.

And will be immune to dilution

The instrument representing the contingent shares shall contain anti-dilution provisions of the type employed in capital market transactions, as determined by the Secretary, to protect the Secretary from transactions such as stock splits, stock distributions, dividends, and other distributions, mergers, and other reorganizations and recapitalizations.

The FDIC will manage mortgages and RMBS to limit foreclosures and will modify the underlying mortgages

the Corporation shall utilize a systematic approach for preventing foreclosures and ensuring long-term, sustainable homeownership through loan modifications and use of the HOPE for Homeowners Program established under section 257 of the National Housing Act and any other programs that may be available for such purposes.

And acquisitions of pooled MBS will be geared to acquire control over the underlying

The Secretary shall, to the
extent practicable, acquire—
(A) sufficient ownership or control of pooled residential mortgage loans, or a securitization vehicle for such loans so that the Corporation has authority to modify the underlying residential mortgage loans, either directly or through a designee; and
(B) whole residential mortgage loans, so that the Corporation may use its authority to modify the underlying residential mortgage loans, either directly or through a designee.

With foreclosed houses being made available to local government

Each Federal property manager shall make available to any State or local government that is receiving emergency assistance under section 2301 of the Foreclosure Prevention Act of 2008 (Public Law 110-289) for purchase at a discount, any properties that it owns through foreclosure in that State or locality, in order to facilitate the sale of such properties and to stabilize neighborhoods affected by foreclosures.

And 20% of the profits from asset sales going to fund the GSEs

(A) 65 percent shall be deposited into the Housing Trust Fund established under section 1338 of the Federal Housing Enterprises Regulatory Reform Act of 1992 (12 U.S.C. 4568); and
(B) 35 percent shall be deposited into the Capital Magnet Fund established under section 1339 of that Act (12 U.S.C. 4569).

Horseman, pass by

The Federal Reserve Board has waived the five-day statutory antitrust waiting period for Goldman and Morgan's applications to become bank holding companies.

In light of the unusual and exigent circumstances affecting the financial markets, and all other facts and circumstances, the Board has determined that emergency conditions exist that justify expeditious action on this proposal.

The banks are well capitalized:

The Board consistently has considered capital adequacy to be an especially important aspect in analyzing financial factors. Morgan is adequately capitalized and all the Morgan entities that are subject to regulatory capital requirements currently exceed the relevant requirements. In addition, MS Bank and MST are currently well capitalized under applicable federal guidelines. MS Bank and MST also would be well capitalized on a pro forma basis on consummation of the proposal.

The Board consistently has considered capital adequacy to be an especially important aspect in analyzing financial factors. Goldman is adequately capitalized, and all the Goldman entities that are subject to regulatory capital requirements currently exceed the relevant requirements. In addition, Goldman Bank currently is well capitalized under applicable federal guidelines. Goldman Bank also would be well capitalized on a pro forma basis on consummation of the proposal.

Anyone's guess what the rush is?

The Federal Reserve has issued a press release. Also see the Goldman order and the Morgan order.

Secretary Paulson's enabling act (1)

Treasury to buy up to $700bn of distressed assets at discretion

"The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, Troubled Assets from any Financial Institution, as those terms are defined in section 12 of the Act."

"The term “Troubled 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; and, upon the determination of the Secretary in consultation with the Chairman of the Board of Governors of the Federal Reserve, any other financial instrument, as he determines necessary to promote financial market stability.

From a wide variety of institutions

The term “Financial Institutions” means any institution including, but not limited to, banks, thrifts, credit unions, broker-dealers, and insurance companies, having significant operations in the United States; and, upon the Secretary’s determination in consultation with the Chairman of the Board of Governors of the Federal Reserve, any other institution he determines necessary to promote financial market stability.

Treasury may appoint agents

(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:
(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;
(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;
(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;
(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations

And will control and may hold to maturity the assets it purchases

(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.

With minimal oversight

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.

The draft text of the bill as published in Saturday's New York Times. Alea has the updated text.