authorizing the United States Secretary of the Treasury
to spend up to US$
700 billion to purchase distressed assets, especially mortgage-backed securities
, and make capital injections into banks (however, the plan to purchase distressed assets has been abandoned). Both foreign and domestic banks are included in the program. The Federal Reserve also extended help to American Express
, whose bank-holding application it recently approved. The Act was proposed by Treasury Secretary
during the global financial crisis of 2008.
The original proposal was submitted to the United States House of Representatives
, with the purpose of purchasing bad assets, reducing uncertainty regarding the worth of the remaining assets, and restoring confidence in the credit markets. The bill was then expanded and put forth as an amendment to . The amendment was rejected via a vote of the House of Representatives on September 29, 2008, voting 205–228.
On October 1, 2008, the Senate
debated and voted on an amendment to H.R. 1424
, which substituted a newly revised version of the Emergency Economic Stabilization Act of 2008 for the language of H.R. 1424. See also the Senate Committee on Banking page: Emergency Economic Stabilization Act of 2008 The Senate accepted the amendment and passed the entire amended bill, voting 74–25. Additional unrelated provisions added an estimated $150 billion to the cost of the package and increased the length of the bill to 451 pages. (See Public Law 110-343
for details on the added provisions.) The amended version of H.R. 1424 was sent to the House for consideration, and on October 3, the House voted 263-171 to enact the bill into law. President George W. Bush
signed the bill into law within hours of its congressional enactment, creating the $700 billion Troubled Asset Relief Program (TARP) to purchase failing bank assets.
Supporters of the plan argued that the market intervention called for by the plan was vital to prevent further erosion of confidence in the U.S. credit markets and that failure to act could lead to an economic depression. Opponents objected to the plan's cost and rapidity, pointing to polls that showed little support among the public for "bailing out" Wall Street investment banks, claimed that better alternatives were not considered, and that the Senate forced passage of the unpopular version through the opposing house by "sweetening
" the bailout package.
Businessman and commentator Peter Schiff
argued that since the problems of the American economy were created by excess credit and debt, a massive infusion of credit and debt into the economy only exacerbates the problems. This argument has been opposed by both supporters and critics of the program.
Economic backgroundAfter the freeing up of world capital markets in the 1970s and the repeal of the Glass–Steagall Act in 1999, the banking practices (mostly Greenspan inspired "self-regulation") along with subprime mortgage crisis
sold as no risk investments, reached a critical stage during September 2008, characterized by severely contracted liquidity
in the global credit markets and insolvency threats to investment banks and other institutions. In response, the U.S. government announced a series of comprehensive steps to address the problems, following a series of "one-off" or "case-by-case" decisions to intervene or not, such as the $85 billion liquidity facility for American International Group
on September 16, the federal takeover of Fannie Mae and Freddie Mac
, and the bankruptcy of Lehman Brothers
On Monday, October 6, the Dow Jones Industrial Average
dropped more than 700 points and fell below 10,000 for the first time in four years. The same day, CNN reported these worldwide stock market events:
- Britain's FTSE 100 IndexFTSE 100 IndexThe FTSE 100 Index, also called FTSE 100, FTSE, or, informally, the footsie , is a share index of the 100 most highly capitalised UK companies listed on the London Stock Exchange....
was down 7.9%
- Germany's DAXDAXThe DAX is a blue chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange. Prices are taken from the electronic Xetra trading system...
- France's CAC 40CAC 40The CAC 40 is a benchmark French stock market index. The index represents a capitalization-weighted measure of the 40 most significant values among the 100 highest market caps on the Paris Bourse...
- In Russia, trading in shares was suspended after the RTSRussian Trading SystemThe Russian Trading System is a stock market established in 1995 in Moscow, consolidating various regional trading floors into one exchange. Originally RTS was modelled on NASDAQ's trading and settlement software; in 1998 the exchange went on line with its own in-house system...
stock index fell more than 20%.
- IcelandIcelandIceland , described as the Republic of Iceland, is a Nordic and European island country in the North Atlantic Ocean, on the Mid-Atlantic Ridge. Iceland also refers to the main island of the country, which contains almost all the population and almost all the land area. The country has a population...
halted trading in six bank stocks while the government drafted a crisis plan.
Paulson proposalU.S. Treasury Secretary
proposed a plan under which the U.S. Treasury would acquire up to $700 billion worth of mortgage-backed securities. The plan was immediately backed by President George W. Bush
and negotiations began with leaders in the U.S. Congress to draft appropriate legislation.
, U.S. Securities and Exchange Commission chairman Christopher Cox, congressional leaders, and President Bush, moved forward efforts to draft a proposal for a comprehensive solution to the problems created by illiquid assets. News of the coming plan resulted in some stock, bond, and currency markets stability on September 19, 2008.
The proposal called for the federal government to buy up to US$700 billion of illiquid mortgage-backed securities with the intent to increase the liquidity of the secondary mortgage market
s and reduce potential losses encountered by financial institutions owning the securities. The draft proposal was received favorably by investors in the stock market, but caused the U.S. dollar to fall against gold
, the Euro
, and petroleum
. The plan was not immediately approved by Congress; debate and amendments were seen as likely before the plan was to receive legislative enactment.
Throughout the week of September 20, 2008, there was contentious wrangling among members of Congress over the terms and scope of the bailout, amplified by continued failures of institutions like Washington Mutual
, and the upcoming November 4 national election.
- On September 21, Paulson announced that the original proposal, which would have excluded foreign banks, had been revised to include foreign financial institutions with a presence in the United States. The U.S. administration pressured other countries to set up similar bailout plans.
- On September 23, the plan was presented by Paulson and Bernanke to the Senate Banking CommitteeUnited States Senate Committee on Banking, Housing, and Urban AffairsThe United States Senate Committee on Banking, Housing, and Urban Affairs has jurisdiction over matters related to: banks and banking, price controls, deposit insurance, export promotion and controls, federal monetary policy, financial aid to commerce and industry, issuance of redemption of notes,...
, who rejected it as unacceptable.
- On September 24, President Bush addressed the nation on prime time television, describing how serious the financial crisis could become if action was not taken promptly by Congress.
- Also on September 24, 2008, Republican PartyRepublican Party (United States)The Republican Party is one of the two major contemporary political parties in the United States, along with the Democratic Party. Founded by anti-slavery expansion activists in 1854, it is often called the GOP . The party's platform generally reflects American conservatism in the U.S...
nominee for President, John McCainJohn McCainJohn Sidney McCain III is the senior United States Senator from Arizona. He was the Republican nominee for president in the 2008 United States election....
, and Democratic PartyDemocratic Party (United States)The Democratic Party is one of two major contemporary political parties in the United States, along with the Republican Party. The party's socially liberal and progressive platform is largely considered center-left in the U.S. political spectrum. The party has the lengthiest record of continuous...
nominee for President, Barack ObamaBarack ObamaBarack Hussein Obama II is the 44th and current President of the United States. He is the first African American to hold the office. Obama previously served as a United States Senator from Illinois, from January 2005 until he resigned following his victory in the 2008 presidential election.Born in...
, issued a joint statement describing their shared view that "The effort to protect the American economy must not fail."
The plan was introduced on September 20, by Paulson. Named the Troubled Asset Relief Program, but also known as the Paulson Proposal or Paulson Plan, it should not be confused with Paulson's earlier 212-page plan, the Blueprint for a Modernized Financial Regulatory Reform, that was released on March 31, 2008.
The proposal was only three pages long, intentionally short on details to facilitate quick passage by Congress.
Mortgage asset purchasesA key part of the proposal is the federal government's plan to buy up to $700 billion of illiquid mortgage backed securities (MBS) with the intent to increase the liquidity of the secondary mortgage market
s and reduce potential losses encountered by financial institutions owning the securities. The draft proposal of the plan was received favorably by investors in the stock market.
This plan can be described as a risky investment, as opposed to an expense. The MBS within the scope of the purchase program have rights to the cash flows from the underlying mortgages. As such, the initial outflow of government funds to purchase the MBS would be offset by ongoing cash inflows represented by the monthly mortgage payments. Further, the government eventually may be able to sell the assets, though whether at a gain or loss will remain to be seen. While incremental borrowing to obtain the funds necessary to purchase the MBS may add to the United States public debt
, the net effect will be considerably less as the incremental debt will be offset to a large extent by the MBS assets.
A key challenge would be valuing the purchase price of the MBS, which is a complex exercise subject to a multitude of variables related to the housing market and the credit quality of the underlying mortgages. The ability of the government to offset the purchase price (through mortgage collections over the long-run) depends on the valuation assigned to the MBS at the time of purchase. For example, Merrill Lynch wrote down the value of its MBS to approximately 22 cents on the dollar in Q2 2008. Whether the government is ultimately able to resell the assets above the purchase price or will continue to merely collect the mortgage payments is an open item.
On February 10, 2009, the newly confirmed Secretary of the Treasury Timothy Geithner outlined his plan to use the $300 billion or so dollars remaining in the TARP funds. He mentioned that the U.S. Treasury and Federal Reserve wanted to help fund private investors to buy toxic assets from banks, but few details have yet been released. Yet, there is still some skepticism if Taxpayers can buy troubled assets without having to overpay. Oppenheimer & Company analyst Meridith Whitney argues that banks will not sell bad assets at fair market values because they are reluctant to take asset write downs. Removing toxic assets would also reduce the volatility of banks' stock prices. Because stock is a call option
on a firm's assets, this lost volatility
will hurt the stock price of distressed banks. Therefore, such banks will only sell toxic assets at above market prices.
On April 6, 2008, the State Foreclosure Prevention Working Group reported that the pace of foreclosures exceeded the capacity of homeowner rescue programs, such as the Hope Now Alliance
, in the first quarter of 2008, in part because a myriad of investors and complex MBS contracts must be consulted as part of the refinancing process.
Sweeping powersThe original plan would have granted the Secretary of the Treasury unlimited power to spend, proofing his or her actions against congressional or judicial review. Section 8 of the Paulson proposal states: "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." This provision was not included in the final version.
Potential effectsThe maximum cost of a $700 billion bailout would be $2,295 estimated cost per American (based on an estimate of 305 million Americans), or $4,635 per working American (based on an estimate of 151 million in the work force).
The bulk of this money would be spent to purchase mortgage backed securities, ultimately backed by American homeowners, which possibly could be sold later at a profit, by the government.
Economist Michael Hudson
predicts that the bailout would cause hyperinflation
and dollar collapse.
However, there is no persuasive evidence of prices rising and the U.S. Dollar Index
has actually risen to higher levels than before the plan's announcement.
Indeed, during the week before and after the EESA was agreed, investment bank UBS
was continually flatly rejecting that bailouts such as these were inflationary, emphasizing instead that they were anti-deflationary, not inflationary.
The 2008 federal budget submitted by the president is $2.9 trillion, meaning a $700 billion bailout would constitute a 24% increase to $3.6 trillion, which would in fact far exceed the $3.1 trillion 2009 budget. The total government commitment and proposed commitments so far in its current and proposed bailouts is reportedly $
1 trillion compared to the $14 trillion United States economy
Government officialsIn his testimony before the U.S. Senate, Treasury Secretary Henry Paulson
summarized the rationale for the bailout:
- Stabilize the economy: "We must... avoid a continuing series of financial institution failures and frozen credit markets that threaten American families' financial well-being, the viability of businesses both small and large, and the very health of our economy."
- Improve liquidity: "These bad loans have created a chain reaction and last week our credit markets froze – even some Main Street non-financial companies had trouble financing their normal business operations. If that situation were to persist, it would threaten all parts of our economy."
- Comprehensive strategy: "We must now take further, decisive action to fundamentally and comprehensively address the root cause of this turmoil. And that root cause is the housing correction which has resulted in illiquid mortgage-related assets that are choking off the flow of credit which is so vitally important to our economy. We must address this underlying problem, and restore confidence in our financial markets and financial institutions so they can perform their mission of supporting future prosperity and growth."
- Immediate and significant: "This troubled asset relief program has to be properly designed for immediate implementation and be sufficiently large to have maximum impact and restore market confidence. It must also protect the taxpayer to the maximum extent possible, and include provisions that ensure transparency and oversight while also ensuring the program can be implemented quickly and run effectively."
- Broad impact: "This troubled asset purchase program on its own is the single most effective thing we can do to help homeowners, the American people and stimulate our economy."
In his testimony before the U.S. Senate on September 23, 2008, Fed Chairman Ben Bernanke
also summarized the rationale for the bailout:
- Investor confidence: "Among the firms under the greatest pressure were Fannie Mae and Freddie Mac, Lehman BrothersLehman BrothersLehman Brothers Holdings Inc. was a global financial services firm. Before declaring bankruptcy in 2008, Lehman was the fourth largest investment bank in the USA , doing business in investment banking, equity and fixed-income sales and trading Lehman Brothers Holdings Inc. (former NYSE ticker...
, and, more recently, American International GroupAmerican International GroupAmerican International Group, Inc. or AIG is an American multinational insurance corporation. Its corporate headquarters is located in the American International Building in New York City. The British headquarters office is on Fenchurch Street in London, continental Europe operations are based in...
(AIG). As investors lost confidence in them, these companies saw their access to liquidity and capital markets increasingly impaired and their stock prices drop sharply." He also stated: "Purchasing impaired assets will create liquidity and promote price discovery in the markets for these assets, while reducing investor uncertainty about the current value and prospects of financial institutions. More generally, removing these assets from institutions' balance sheets will help to restore confidence in our financial markets and enable banks and other institutions to raise capital and to expand credit to support economic growth."
- Impact on Economy and GDP: "Extraordinarily turbulent conditions in global financial markets... these conditions caused equity prices to fall sharply, the cost of short-term credit—where available—to spike upward, and liquidity to dry up in many markets. Losses at a large money market mutual fund sparked extensive withdrawals from a number of such funds. A marked increase in the demand for safe assets—a flight to quality—sent the yield on Treasury bills down to a few hundredths of a percent. By further reducing asset values and potentially restricting the flow of credit to households and businesses, these developments pose a direct threat to economic growth."
Regarding the $700 billion number, Forbes.com quoted a Treasury spokeswoman: "It's not based on any particular data point. We just wanted to choose a really large number."
JournalistsAccording to CNBC commentator Jim Cramer, large corporations and institutions are pulling their money out of bank money market funds, in favor of government-backed Treasury bills. This move is slowly taking away the capital reserves the banks have grown to depend on. Cramer called it "an invisible run on the banks," one that has no lines in the lobby but pushes banks to the breaking point nonetheless. Bank runs are taking place under the radar, he said. Chief financial officers, lawyers, the wealthy – they're all pulling their money from savings accounts and asking for T-bills. As a bank's deposits evaporate, so too does its ability to lend and correspondingly make money. This will continue until Congress agrees on a bailout deal. "The lack of confidence inspired by Lehman's demise, the general poor health of many banks, this is going to turn this into an intractable moment," Cramer said, "if someone in the government doesn't start pushing for more deposit insurance."
Reaction to the initial proposalSkepticism regarding the plan occurred early on in the House. Many members of Congress, including the House of Representatives, did not support the plan initially, mainly conservative free-market Republicans and liberal anti-corporate Democrats. Alabama Republican Spencer Bachus
has called the proposal "a gun to our head" fear-inflicting policy of the administration to stifle proper debate and affect decision. However, many sources have reported that for this crisis there are many alternatives and options, and other less risky and more profitable solutions to use the taxpayers' funds that aren't being debated, but ought to be debated, in the rush to the sudden deal.
Immediate market reactionsOn September 19, 2008, when news of the bailout proposal emerged, the U.S. stock market rose by 3%. Foreign stock markets also surged, and foreign currencies corrected slightly, after having dropped earlier in the month. The value of the U.S. dollar
dropped compared to other world currencies after the plan was announced. The front end oil futures contract spiked more than $25 a barrel during the day Monday September 22, ending the day up over $16. This was a record for the biggest one-day gain. However, there are other factors that caused the massive spike in oil prices. Traders who got "caught" at the end of the October contract session were forced to purchase oil in large batches to cover themselves, adding to the surge in prices. Further out, oil futures contracts rose by about $5 per barrel. Mortgage rates increased following the news of the bailout plan. The 30-year fixed-rate mortgage averaged 5.78% in the week before the plan was announced; for the week ending September 25, the average rate was 6.09%, still far below the average rate during the early 1990s recession, when it topped 9.0%.
Potential conflict of interestThere was concern that the current plan created a conflict of interest
for Paulson. Paulson was a former CEO of Goldman Sachs
, which stood to benefit from the bailout. Paulson has hired Goldman executives as advisors and Paulson's former advisors have joined banks that were also to benefit from the bailout. Furthermore, the original proposal exempted Paulson from judicial oversight
. Thus there was concern that former illegal activity by a financial institution or its executives might be hidden.
The treasury staff member responsible for administering the bailout funds is Neel Kashkari
, a former vice-president at Goldman Sachs
In the Senate, Senator Judd Gregg (R-NH) was the leading Republican author of the TARP program while he had a multi-million dollar investment in the Bank of America.
Views from the public, politicians, financiers, economists, and journalists
The publicProtests opposing the bailout occurred in over 100 cities across the United States on Thursday September 25. Grassroots group TrueMajority
said its members organized over 251 events in more than 41 states. The largest gathering has been in New York City
, where more than 1,000 protesters gathered near the New York Stock Exchange
along with labor union members organized by New York Central Labor Council. Other grassroots groups have planned rallies to protest against the bailout, while outraged citizens continue to express their opposition online through blogs and dedicated web sites.
- In a survey conducted September 19–22 by the Pew Research CenterPew Research CenterThe Pew Research Center is an American think tank organization based in Washington, D.C. that provides information on issues, attitudes and trends shaping the United States and the world. The Center and its projects receive funding from The Pew Charitable Trusts. In 1990, Donald S...
, by a margin of 57 percent to 30 percent, Americans supported the bailout when asked "As you may know, the government is potentially investing billions to try and keep financial institutions and markets secure. Do you think this is the right thing or the wrong thing for the government to be doing?"
- In a survey conducted September 19–22 by Bloomberg/Los Angeles TimesLos Angeles TimesThe Los Angeles Times is a daily newspaper published in Los Angeles, California, since 1881. It was the second-largest metropolitan newspaper in circulation in the United States in 2008 and the fourth most widely distributed newspaper in the country....
, by a margin of 55 percent to 31 percent, Americans opposed the bailout when asked whether "the government should use taxpayers' dollars to rescue ailing private financial firms whose collapse could have adverse effects on the economy and market, or is it not the government's responsibility to bail out private companies with taxpayers' dollars?".
- In a survey conducted September 24 by USA TodayUSA TodayUSA Today is a national American daily newspaper published by the Gannett Company. It was founded by Al Neuharth. The newspaper vies with The Wall Street Journal for the position of having the widest circulation of any newspaper in the United States, something it previously held since 2003...
/GallupThe Gallup OrganizationThe Gallup Organization, is primarily a research-based performance-management consulting company. Some of Gallup's key practice areas are - Employee Engagement, Customer Engagement and Well-Being. Gallup has over 40 offices in 27 countries. World headquarters are in Washington, D.C. Operational...
, when asked "As you may know, the Bush administration has proposed a plan that would allow the Treasury Department to buy and re-sell up to $700 billion of distressed assets from financial companies. What would you like to see Congress do?", 56 percent of respondents wanted Congress to pass a plan different from the original Paulson proposal, 22 percent supported the Paulson proposal in its initial form, and 11 percent wanted Congress to take no action.
- Senator Sherrod BrownSherrod BrownSherrod Campbell Brown is the senior United States Senator from Ohio and a member of the Democratic Party. Before his election to the U.S. Senate, he was a member of the United States House of Representatives, representing Ohio's 13th congressional district from 1993 to 2007...
said he had been getting 2,000 e-mail messages and telephone calls a day, roughly 95 percent opposed.
- As of Thursday September 25, Senator Dianne FeinsteinDianne FeinsteinDianne Goldman Berman Feinstein is the senior U.S. Senator from California. A member of the Democratic Party, she has served in the Senate since 1992. She also served as 38th Mayor of San Francisco from 1978 to 1988....
's (D-Calif.) offices had received a total of 39,180 e-mails, calls and letters on the bailout, with the overwhelming majority of constituents against it.
- Former British Prime MinisterPrime Minister of the United KingdomThe Prime Minister of the United Kingdom of Great Britain and Northern Ireland is the Head of Her Majesty's Government in the United Kingdom. The Prime Minister and Cabinet are collectively accountable for their policies and actions to the Sovereign, to Parliament, to their political party and...
Gordon BrownGordon BrownJames Gordon Brown is a British Labour Party politician who was the Prime Minister of the United Kingdom and Leader of the Labour Party from 2007 until 2010. He previously served as Chancellor of the Exchequer in the Labour Government from 1997 to 2007...
supported the plan, saying that it was essential to restore stability to the markets.
- The then presidential candidates from both major parties, Senators Barack Obama (D) and John McCain (R) voted in favor of the Senate version of the bill on October 1, 2008. Senator John McCain claimed he suspended his presidential campaign and negotiated on behalf of wavering House of Representatives members to urge them to support the legislation.
- Former Arkansas Governor and 2008 Presidential Candidate Mike HuckabeeMike HuckabeeMichael "Mike" Dale Huckabee is an American politician who served as the 44th Governor of Arkansas from 1996 to 2007. He was a candidate in the 2008 United States Republican presidential primaries, finishing second in delegate count and third in both popular vote and number of states won . He won...
has criticized the bailout saying it socializes the risks amongst top members.
- "This plan is stunning in its scope and lack of detail," said Connecticut Senator Christopher DoddChristopher DoddChristopher John "Chris" Dodd is an American lawyer, lobbyist, and Democratic Party politician who served as a United States Senator from Connecticut for a thirty-year period ending with the 111th United States Congress....
, chairman of the Senate Banking Committee. "It does nothing in my view to help a single family save a home."
- "I am concerned that Treasury's proposal is neither workable nor comprehensive, despite its enormous price tag," said Alabama Senator Richard ShelbyRichard ShelbyRichard Craig Shelby is the senior U.S. Senator from Alabama. First elected to the Senate in 1986, he is the ranking member of the United States Senate Committee on Banking, Housing, and Urban Affairs and was its chairman from 2003 to 2007....
, the ranking Republican on the committee.
- "The Paulson plan will not bring a stop to the slide in home prices. But the Paulson plan will spend 700 billion taxpayer dollars to prop up and clean up the balance sheets of Wall Street. This massive bailout is not a solution. It is financial socialism and it's un-American," said Sen. Jim BunningJim BunningJames Paul David "Jim" Bunning is an American former Major League Baseball pitcher and politician.During a 17-year baseball career, he pitched from 1955 to 1971, most notably with the Detroit Tigers and the Philadelphia Phillies. When he retired, he had the second-highest total of career...
- Then Democratic presidential candidate Barack ObamaBarack ObamaBarack Hussein Obama II is the 44th and current President of the United States. He is the first African American to hold the office. Obama previously served as a United States Senator from Illinois, from January 2005 until he resigned following his victory in the 2008 presidential election.Born in...
said any bailout must include plans to recover the money, and protect working families and big financial institutions and be crafted to prevent such a crisis from happening again.
- TexasTexasTexas is the second largest U.S. state by both area and population, and the largest state by area in the contiguous United States.The name, based on the Caddo word "Tejas" meaning "friends" or "allies", was applied by the Spanish to the Caddo themselves and to the region of their settlement in...
Republican U.S. Representative and former two-time presidential candidate Ron PaulRon PaulRonald Ernest "Ron" Paul is an American physician, author and United States Congressman who is seeking to be the Republican Party candidate in the 2012 presidential election. Paul represents Texas's 14th congressional district, which covers an area south and southwest of Houston that includes...
publicly opposed any bailout and called for other type of reforms to remedy the crisis.
- OhioOhioOhio is a Midwestern state in the United States. The 34th largest state by area in the U.S.,it is the 7th‑most populous with over 11.5 million residents, containing several major American cities and seven metropolitan areas with populations of 500,000 or more.The state's capital is Columbus...
Democratic U.S. Representative Dennis KucinichDennis KucinichDennis John Kucinich is the U.S. Representative for , serving since 1997. He was furthermore a candidate for the Democratic nomination for President of the United States in the 2004 and 2008 presidential elections....
, a former two-time presidential candidate, delivered a speech on the House floor denouncing the bailout as "too much money, in too short of a time, going to too few people, while too many questions remain unanswered," and asking, "Is this the U.S. Congress or the board of directorsBoard of directorsA board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors...
at Goldman SachsGoldman SachsThe Goldman Sachs Group, Inc. is an American multinational bulge bracket investment banking and securities firm that engages in global investment banking, securities, investment management, and other financial services primarily with institutional clients...
- Democratic opponents of the bailout include OregonOregonOregon is a state in the Pacific Northwest region of the United States. It is located on the Pacific coast, with Washington to the north, California to the south, Nevada on the southeast and Idaho to the east. The Columbia and Snake rivers delineate much of Oregon's northern and eastern...
U.S. Representative Peter DeFazioPeter DeFazioPeter Anthony DeFazio is the U.S. Representative for , serving since 1987. He is a member of the Democratic Party. The district includes Eugene, Springfield, Roseburg and part of Corvallis. As Oregon's most senior member of Congress, he is the dean of Oregon's House of Representatives delegation...
, who called for a modified Tobin taxTobin taxA Tobin tax, suggested by Nobel Laureate economist James Tobin, was originally defined as a tax on all spot conversions of one currency into another...
on stock transactions to pay for any bailout, and CaliforniaCaliforniaCalifornia is a state located on the West Coast of the United States. It is by far the most populous U.S. state, and the third-largest by land area...
Congressman Brad ShermanBrad ShermanBradley J. "Brad" Sherman is an American politician. He has been a Democratic member of the United States House of Representatives since 1997, representing ....
, who compared the bailout to a ransomRansomRansom is the practice of holding a prisoner or item to extort money or property to secure their release, or it can refer to the sum of money involved.In an early German law, a similar concept was called bad influence...
demand for "$700 billion in unmarked bills".
- Republican opponents of the bailout include Texas U.S. Representative Ted PoeTed PoeLloyd "Ted" Poe is a Republican politician currently representing Texas's 2nd congressional district in the United States House of Representatives. The district includes most of northern Houston, as well as most of the Beaumont-Port Arthur metropolitan area. He is the first Republican to ever...
, who gave a speech on the House floor comparing the dire economic warnings of the bailout's proponents to the Y2K scareYear 2000 problemThe Year 2000 problem was a problem for both digital and non-digital documentation and data storage situations which resulted from the practice of abbreviating a four-digit year to two digits.In computer programs, the practice of representing the year with two...
, and Michael C. BurgessMichael C. BurgessMichael Clifton Burgess, is the U.S. Representative for , serving since 2003, and a member of the Tea Party Caucus.-Early life, education, and early career:...
, who accused the House leadership of declaring "martial lawMartial lawMartial law is the imposition of military rule by military authorities over designated regions on an emergency basis— only temporary—when the civilian government or civilian authorities fail to function effectively , when there are extensive riots and protests, or when the disobedience of the law...
" to pass the legislation without debate.
- After negotiations, bipartisan groups of Congressional leaders were willing to support the highly revised plan. Despite the leaders' support, the rest of the House of Representatives did not follow their lead.
- In a Wall Street JournalThe Wall Street JournalThe Wall Street Journal is an American English-language international daily newspaper. It is published in New York City by Dow Jones & Company, a division of News Corporation, along with the Asian and European editions of the Journal....
opinion piece, Senator Hillary Clinton has advocated addressing the rate of mortgage defaults and foreclosures that ignited this crisis, not just bailing out Wall Street firms: "If we do not take action to address the crisis facing borrowers, we'll never solve the crisis facing lenders." She has proposed a new Home Owners' Loan CorporationHome Owners' Loan CorporationThe Home Owners' Loan Corporation was a New Deal agency established in 1933 by the Home Owners' Loan Corporation Act under President Franklin D. Roosevelt. Its purpose was to refinance home mortgages currently in default to prevent foreclosure. This was accomplished by selling bonds to lenders in...
(HOLC), similar to that used after the Depression, which was launched in 1933. The new HOLC would administer a national program to help homeowners refinance their mortgages. She is also calling for a moratorium on foreclosures and freezing of rate hikes in adjustable rate mortgages.
- LibertarianLibertarian Party (United States)The Libertarian Party is the third largest and fastest growing political party in the United States. The political platform of the Libertarian Party reflects its brand of libertarianism, favoring minimally regulated, laissez-faire markets, strong civil liberties, minimally regulated migration...
presidential candidate Bob BarrBob BarrRobert Laurence "Bob" Barr, Jr. is a former federal prosecutorand a former member of the United States House of Representatives. He represented Georgia's 7th congressional district as a Republican from 1995 to 2003. Barr attained national prominence as one of the leaders of the impeachment of...
has been one of the most outspoken opponents of the bailout. He spoke out against it while it was making its way through Congress. He took his message to the airwaves and explained the government should not toss around taxpayer dollars so easily and that government should decrease regulation and privatize Fannie Mae and Freddie Mac.
- Investor Warren BuffettWarren BuffettWarren Edward Buffett is an American business magnate, investor, and philanthropist. He is widely regarded as one of the most successful investors in the world. Often introduced as "legendary investor, Warren Buffett", he is the primary shareholder, chairman and CEO of Berkshire Hathaway. He is...
says he could put in $10B plus $90B nonrecourse debtNonrecourse debtNon-recourse debt or a non-recourse loan is a secured loan that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender's recovery is limited to the...
; that is, without having to repay beyond $10B if mortgages did not repay. (This is 10 to 1 leverage, 10 times upside with 1 times downside.) He also said that the government should pay market price, which may be below the carry value. Buffett says "I would think they might insist on the directors of the institutions that participate in this program waiving all director's fees for a couple of years. They should, maybe, eliminate bonuses." Buffett says "...if someone wants to sell a hundred billion of these instruments to the Treasury, let them sell two or three billion in the market and then have the Treasury match that, ... . You don't want the Treasury to be a patsyPatsyPatsy is a given name often used as a diminutive of the feminine given name Patricia or sometimes the masculine name Patrick, or occasionally other names containing the syllable "Pat" or "Pet" .-Historical usage:...
." Mr. Buffett's company owns financial companies which will benefit directly or indirectly, including his investment in Goldman Sachs.
- Alan GreenspanAlan GreenspanAlan Greenspan is an American economist who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. He currently works as a private advisor and provides consulting for firms through his company, Greenspan Associates LLC...
, former Chairman of the Federal Reserve, endorsed Paulson's plan on September 19.
- Investor George SorosGeorge SorosGeorge Soros is a Hungarian-American business magnate, investor, philosopher, and philanthropist. He is the chairman of Soros Fund Management. Soros supports progressive-liberal causes...
is opposed to the original Paulson plan – "Mr Paulson's proposal to purchase distressed mortgage-related securities poses a classic problem of asymmetric information. The securities are hard to value but the sellers know more about them than the buyer: in any auction process the Treasury would end up with the dregs. The proposal is also rife with latent conflict of interest issues. Unless the Treasury overpays for the securities, the scheme would not bring relief." – but calls Barack ObamaBarack ObamaBarack Hussein Obama II is the 44th and current President of the United States. He is the first African American to hold the office. Obama previously served as a United States Senator from Illinois, from January 2005 until he resigned following his victory in the 2008 presidential election.Born in...
's list of conditions for the plan "the right principles".
- Investor Carl IcahnCarl IcahnCarl Celian Icahn is an American business magnate and investor.-Biography:Icahn was raised in Far Rockaway, Queens, New York City, where he attended Far Rockaway High School. His father was a cantor, his mother was a schoolteacher...
described the bailout as "crazy and inflationary hell".
- Investor Jim RogersJim RogersJames Beeland Rogers, Jr. is an American investor, author, and occasional financial commentator. He is currently based in Singapore. Rogers is the Chairman of Rogers Holdings and Beeland Interests, Inc...
called the plan "astonishing, devastating, and very harmful for America".
- Tim McCormack (Chief Investment Officer, Alpha Titans, Santa Barbara, CA) has diagnosed the underlying problem as a failure of regulatory oversight, which allowed firms to overly leverage mortgage-backed assets. He criticizes the Paulson Plan as a giveaway. He has also written that fears of the domino effect, rather than illiquidity, are the cause of the credit freeze.
- William Seidman was critical of rescuing the banks' managements and their shareholders, comparing the bailout with action he and his team at the Resolution Trust CorporationResolution Trust CorporationThe Resolution Trust Corporation was a United States Government-owned asset management company run by Lewis William Seidman and charged with liquidating assets, primarily real estate-related assets such as mortgage loans, that had been assets of savings and loan associations declared insolvent by...
took during the S&L crisis of the 1980s: "What we did, we took over the bank, nationalized it, fired the management, took out the bad assets and put a good bank back in the system."
- In an open letter sent to Congress on September 24, over 100 university economistEconomistAn economist is a professional in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...
s expressed "great concern for the plan proposed by Treasury Secretary Paulson". The letter, endorsed within a few days by 231 economists at American universities, has been described as "the emerging consensus from academic economists". Its authors described three "fatal pitfalls" they perceived in the plan as it was initially proposed:
1) Its fairness. The plan is a subsidy to investors at taxpayers' expense. Investors who took risks to earn profits must also bear the losses. [...] The government can ensure a well-functioning financial industry [...] without bailing out particular investors and institutions whose choices proved unwise.
2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.
3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.
- Nobel Prize-winning economist Joseph Stiglitz strongly criticizes the bill in an article written for The NationThe NationThe Nation is the oldest continuously published weekly magazine in the United States. The periodical, devoted to politics and culture, is self-described as "the flagship of the left." Founded on July 6, 1865, It is published by The Nation Company, L.P., at 33 Irving Place, New York City.The Nation...
- Economist, The New York TimesThe New York TimesThe New York Times is an American daily newspaper founded and continuously published in New York City since 1851. The New York Times has won 106 Pulitzer Prizes, the most of any news organization...
columnist and Nobel laureate Paul KrugmanPaul KrugmanPaul Robin Krugman is an American economist, professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics, and an op-ed columnist for The New York Times...
recommended that, instead of purchasing the assets, equity capital could be provided to the banks directly in exchange for preferred stockPreferred stockPreferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument...
. This would strengthen the financial position of the banks, encouraging them to lend. Dividends would be paid to the government on the preferred shares. This would be similar to what happened during the S&L crisis and with the GSE bailoutFederal takeover of Fannie Mae and Freddie MacThe federal takeover of Fannie Mae and Freddie Mac refers to the placing into conservatorship of government sponsored enterprises Fannie Mae and Freddie Mac by the U.S. Treasury in September 2008. It was one financial event among many in the ongoing subprime mortgage crisis.On September 6, 2008,...
. This avoids the valuation questions involved in the direct purchase of MBS. This is an approach based on the 1990s Swedish banking rescueSwedish banking rescueDuring 1991 and 1992, a housing bubble in Sweden deflated, resulting in a severe credit crunch and widespread bank insolvency. The causes were similar to those of the subprime mortgage crisis of 2007-2008...
- The first half of the bailout money was primarily used to buy preferred stock in banks instead of troubled mortgage assets. This has led some economists to argue that buying preferred stock will be far less effective in getting banks to lend efficiently than buying common stock.
- A recent study shows that market's reaction to the announcement of a rescue plan is positive independently to the type of the intervention. It indicates that a timely bad plan could be better than an untimely good one.
- The EconomistThe EconomistThe Economist is an English-language weekly news and international affairs publication owned by The Economist Newspaper Ltd. and edited in offices in the City of Westminster, London, England. Continuous publication began under founder James Wilson in September 1843...
magazine said that although "Mr Paulson's plan is not perfect ... it is good enough" and that "Congress should pass it—and soon."
- "The deal proposed by Paulson is nothing short of outrageous. It includes no oversight of his own closed-door operations. It merely gives congressional blessing and funding to what he has already been doing, ad hoc." - Robert KuttnerRobert KuttnerRobert Kuttner is an American journalist and writer. Kuttner is the co-founder and current co-editor of The American Prospect, which was created in 1990 as "an authoritative magazine of liberal ideas," according to its mission statement...
- Journalist Rosalind Resnick favors a hypothetical scenario in which "consumers and businesses would be able to borrow at the fed funds rate at 2 percent, just like the big banks do. This means that every cash-strapped homeowner would be able to refinance his mortgage and cut his payments in half, saving thousands of homes from foreclosure. Consumers could also refinance their credit card balances, auto loans and other debt at interest rates they can afford" and that this plan "would cost U.S. taxpayers absolutely nothing."
- Journalist Michael Hudson says "It is bad enough for the government to buy $700 billion of bad bank investments at prices that no private-sector investor has been willing to approach. This itself is an undeserved giveaway to the financial institutions that caused the problem..."
Alternative proposalsSuggested alternative approaches to address the issues underlying the financial crisis include: mortgage assistance proposals try to increase the value of the asset base while limiting the disruption of foreclosure; bank recapitalization through equity investment by the government; asset liquidity approaches to engage market mechanisms for valuing troubled assets; and financial market reforms promoting transparency and conservatism to restore trust by market investors.
- Conservative Republican Representatives have offered a mortgage insurance plan as an alternative to the bailout. There has been speculation that U.S. Senator John McCainJohn McCainJohn Sidney McCain III is the senior United States Senator from Arizona. He was the Republican nominee for president in the 2008 United States election....
may support this plan but this has not been confirmed.
- Arnold Kling, a former senior economist at Freddie Mac, defines "home borrowers" as "people who are nominally owners but who put down so little money for their purchase that they are better described as living in borrowed homes." He thinks the plan should be to replace home borrowing with renting or home ownership.
- Senator Hillary Clinton has proposed a new Home Owners' Loan CorporationHome Owners' Loan CorporationThe Home Owners' Loan Corporation was a New Deal agency established in 1933 by the Home Owners' Loan Corporation Act under President Franklin D. Roosevelt. Its purpose was to refinance home mortgages currently in default to prevent foreclosure. This was accomplished by selling bonds to lenders in...
(HOLC), similar to that used after the Depression, which was launched in 1933. The new HOLC would administer a national program to help homeowners refinance their mortgages. She is also calling for a moratorium on foreclosures and freezing of rate hikes in adjustable rate mortgages.
- Jonathan Koppell, Associate Professor of Politics and Management at the Yale School of ManagementYale School of ManagementThe Yale School of Management is the graduate business school of Yale University and is located on Hillhouse Avenue in New Haven, Connecticut, United States. The School offers Master of Business Administration and Ph.D. degree programs. As of January 2011, 454 students were enrolled in its MBA...
, recommends assisting homeowners by lowering interest rates on loans in default. The money spent would be repaid from profits when the homes eventually sell after the housing market has recovered.
- A ten-point plan by New York UniversityNew York UniversityNew York University is a private, nonsectarian research university based in New York City. NYU's main campus is situated in the Greenwich Village section of Manhattan...
economist Nouriel RoubiniNouriel RoubiniNouriel Roubini is an American economist. He claims to have predicted both the collapse of the United States housing market and the worldwide recession which started in 2008. He teaches at New York University's Stern School of Business and is the chairman of Roubini Global Economics, an economic...
goes beyond a Home Owners' Loan CorporationHome Owners' Loan CorporationThe Home Owners' Loan Corporation was a New Deal agency established in 1933 by the Home Owners' Loan Corporation Act under President Franklin D. Roosevelt. Its purpose was to refinance home mortgages currently in default to prevent foreclosure. This was accomplished by selling bonds to lenders in...
to include recreating a combination of a Resolution Trust CorporationResolution Trust CorporationThe Resolution Trust Corporation was a United States Government-owned asset management company run by Lewis William Seidman and charged with liquidating assets, primarily real estate-related assets such as mortgage loans, that had been assets of savings and loan associations declared insolvent by...
, and a Reconstruction Finance CorporationReconstruction Finance CorporationThe Reconstruction Finance Corporation was an independent agency of the United States government, established and chartered by the US Congress in 1932, Act of January 22, 1932, c. 8, 47 Stat. 5, during the administration of President Herbert Hoover. It was modeled after the War Finance Corporation...
. Roubini has advocated bank recapitalization (by providing cash in exchange for preferred shares) and suspending all dividend payments.
- Economist Paul KrugmanPaul KrugmanPaul Robin Krugman is an American economist, professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics, and an op-ed columnist for The New York Times...
recommended equity investments in the banks, an approach similar to what happened during the S&L crisisSavings and Loan crisisThe savings and loan crisis of the 1980s and 1990s was the failure of about 747 out of the 3,234 savings and loan associations in the United States...
, the GSE bailoutFederal takeover of Fannie Mae and Freddie MacThe federal takeover of Fannie Mae and Freddie Mac refers to the placing into conservatorship of government sponsored enterprises Fannie Mae and Freddie Mac by the U.S. Treasury in September 2008. It was one financial event among many in the ongoing subprime mortgage crisis.On September 6, 2008,...
, and the 1990s Swedish banking rescueSwedish banking rescueDuring 1991 and 1992, a housing bubble in Sweden deflated, resulting in a severe credit crunch and widespread bank insolvency. The causes were similar to those of the subprime mortgage crisis of 2007-2008...
. This avoids the valuation questions involved in the direct purchase of MBS.
- The first half of the bailout money was primarily used to buy preferred stock in banks instead of troubled mortgage assets. This has led some economist to argue that buying preferred stock will be far less effective than buying common stock.
- Luigi Zingales, Professor of Entrepreneurship and Finance at the University of ChicagoUniversity of ChicagoThe University of Chicago is a private research university in Chicago, Illinois, USA. It was founded by the American Baptist Education Society with a donation from oil magnate and philanthropist John D. Rockefeller and incorporated in 1890...
, has proposed a special chapter of the bankruptcy code to convert banks' debt to equity which would improve capital adequacy ratios and enable a return to lending.
- Janet TavakoliJanet TavakoliJanet Tavakoli is an American author and structured finance expert based in Chicago. She has had three books published on credit derivatives, structured finance, and the 2008 global financial crisis.-Education and background:...
, a financial consultant and a former adjunct professor of derivatives at the University of Chicago's Graduate School of Business, criticizes the bailout because in her view it hides problems and continues price uncertainty. She also advocates forced restructuring, with a combination of debt forgiveness and debt for equity swaps, rather than a bailout.
- Christopher Ricciardi, former Merrill LynchMerrill LynchMerrill Lynch is the wealth management division of Bank of America. With over 15,000 financial advisors and $2.2 trillion in client assets it is the world's largest brokerage. Formerly known as Merrill Lynch & Co., Inc., prior to 2009 the firm was publicly owned and traded on the New York...
banker, wrote a letter to Treasury Secretary Henry M. Paulson Jr. proposing alternatively that the government should be backing some troubled assets to encourage private investors to purchase them — as opposed to the direct purchase of troubled assets from financial institutions.
- Investor Warren BuffettWarren BuffettWarren Edward Buffett is an American business magnate, investor, and philanthropist. He is widely regarded as one of the most successful investors in the world. Often introduced as "legendary investor, Warren Buffett", he is the primary shareholder, chairman and CEO of Berkshire Hathaway. He is...
believes the government should pay market price for the assets rather than an artificially high hold-to-maturity price. The market price would be determined by selling a portion of the assets to private investors. Some of the letters published in the September 27 Denver Post suggest taking similar steps to reduce the taxpayers' risk and commitment.
Financial market reform
- Dominique Strauss-KahnDominique Strauss-KahnDominique Gaston André Strauss-Kahn , often referred to in the media, and by himself, as DSK, is a French economist, lawyer, politician, and member of the French Socialist Party...
, Managing Director of the International Monetary FundInternational Monetary FundThe International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...
, has recommended three near-term actions to assist banks: provision of liquidity, purchase of distressed assets, and recapitalization. In addition, he argues for addressing the structural issues with more prudential regulation, better accounting rules, and more transparency.
Legislative historyOver the weekend (September 27–28), Congress continued to develop the proposal. That next Monday, the House put the resulting effort, the Emergency Economic Stabilization Act of 2008, to a vote. It did not pass. US stock markets dropped 8 percent, the largest percentage drop since Black Monday in 1987
Congressional leaders, including both presidential candidates, started working with the Bush Administration and the Treasury department on key negotiation points as they worked to finalize the plan. Key items under discussion included:
- Additional foreclosure avoidance and homeowner assistance
- Executive pay limits
- Government equity interests in firms participating in program, to provide additional taxpayer protection
- Judicial review, Congressional oversight and right to audit
- Structure and authority of the entities that will manage the program
Political negotiationsAfter the President's announcement of the bailout plan on Wednesday, September 24, there were negotiations on altering the proposal, and declarations of fundamental understanding between the White House and the congressional leaders having been reached were made already on Thursday morning. This apparent eagerness of the Democratic Party politicians to reach an early accommodation with the Bush administration created (in light of persistent reports of popular opposition to the bailout program) a propaganda vacuum and opportunity, into which the House Republicans quickly moved, raising objections, refusing to support the deal and presenting themselves as defenders of the ordinary taxpayer's interests. The negotiations then continued throughout Friday, when some politicians predicted a conclusion by the end of the weekend, while others indicated willingness to take their time and work on the package until it was ready.
First House vote, September 29Just after midnight Sunday, September 28, leaders of the Senate and House, along with Treasury Secretary Paulson, announced a tentative deal had been reached to permit the government purchase of up to $700 billion in mortgage backed securities to provide liquidity to the security holders, and to stabilize U.S. financial firms and markets. The bill was made final later that Monday morning. Amendment to the Senate Amendment to H.R. 3997 House Committee on Financial Services (retrieved September 30, 2008). See also the committee's press release links: Emergency Economic Stabilization Act of 2008.
A debate and vote was scheduled for the House for Monday, September 29, to be followed by a Senate debate on Wednesday.
In an early morning news conference, on Monday September 29, President George W. Bush expressed confidence that the bill would pass Congress, and that it would provide relief to the U.S. economy. A number of House Republicans remained opposed to the deal and intended to vote against it.
That same day, the legislation for the bailout was put before the United States House of Representatives
and failed 205–228, with one not voting. Democrats voted 140–95 in favor of the legislation, while Republicans voted 133–65 against it.
During the legislative session, at the conclusion of the vote, the presiding chair declared the measure, HR3997, to be unfinished business. The bill is subject to additional legislative action.
House Speaker Nancy Pelosi
said at a press conference after the vote: "The legislation has failed. The crisis has not gone away. We must continue to work in a bipartisan manner."
Senate Banking Committee Chairman Christopher Dodd
, a Connecticut
Democrat, appearing at a joint press conference with Senator Judd Gregg
, a New Hampshire
Republican, said a bailout plan could still pass Congress. Dodd said: "We don't intend to leave here without the job being done. While it may take another few days, we're confident that can happen."
Market reaction to September 29 voteFollowing the House vote, the Dow Jones Industrial Average
dropped over 777 points in a single day, its largest single-day point drop ever. The $1.2 trillion loss in market value received much media attention, although it still does not rank among the index's ten largest drops in percentage terms. The S & P lost 8.8%, its seventh worst day in percentage terms and its worst day since Black Monday
in 1987. The NASDAQ composite also had its worst day since Black Monday, losing 9.1% in its third worst day ever. The TED spread
, the difference between what banks charge each other for a three-month loan and what the Treasury charges, hit a 26-year high of 3.58%; a higher rate for inter bank loans than Treasury loans is a sign that banks fear that their fellow banks won't be able to pay off their debts. Meanwhile, the price of U.S. light crude oil
for November delivery fell $10.52 to $96.37 a barrel, its second largest one-day drop ever, on expectations of an economic slowdown reducing oil consumption and demand. The Dow Jones industrial average recovered 485 points or about 62% of the entire loss the very next day.
Markets which had expected the bill to pass and had moved on to debating whether it would be sufficient were already skittish after news that Wachovia Bank was being bought out by Citigroup
to avoid collapse. The events were compounded by news from Europe that Dutch-Belgian Fortis Bank was given a $16.4 billion lifeline to avoid collapse, failing British bank Bradford & Bingley
was nationalized, and Germany extended banking and real estate giant Hypo Real Estate
billions to ensure its survival.
Later in October, after the bill had been passed, the Dow Jones Industrial Average would drop by more in percentage terms, and market volatility remained at historically high levels, as measured by the VIX
Senate vote October 1
The amendment was approved by a 74–25 vote, and the entire bill was also passed by the same margin, 74–25.
Only cancer-stricken Senator Ted Kennedy
did not vote. Under the legislative rule for the bill, sixty votes were required to approve the amendment and the bill.
A House leader accused the Senate of legislating "by blunt force" without public-consent. Senate has also been accused of "sweetening" the bailout to force its passage by the opposing House.
Describing the Senate's reason for passing the bill, former Senator Evan Bayh
"described a scene from 2008 where Ben Bernanke warned senators that the sky would collapse if the banks weren't rescued. 'We looked at each other,' said Bayh, 'and said, okay, what do we need.'"
Second House vote, October 3
President Bush signed the bill into law within hours of its enactment, creating a $700 billion dollar Treasury fund to purchase failing bank assets.
The revised plan left the $700 billion bailout intact and appended a stalled tax bill. The law has three major divisions, Division A: the Emergency Economic Stabilization Act of 2008; Division B: Energy Improvement and Extension Act of 2008, and Division C: the Tax Extenders and Alternative Minimum Tax Relief Act of 2008.
The tax part of the law has provisions that will have a net expenditure of $100 billion over 10 years. It had been stalled due to a disagreement between Democrats that did not want to increase spending without a corresponding increase in taxes and Republicans, who were adamantly opposed to any tax increases.
Key items in the legislationOn October 3, 2008, the Emergency Economic Stabilization Act became law with the signing of Public Law 110-343
, which included the act. Below is a list of key items and how the legislation deals with them.
Interest on bank deposits held by the Federal Reserve
(the Fed) to begin paying banks a high interest rate
on their deposits held for reserve requirement
s. It reads:
- Section 203 of the Financial Services Regulatory Relief Act of 2006 (12 U.S.C. 461) is amended by striking `October 1, 2011' and inserting `October 1, 2008'.
balances on October 6, 2008. Banks immediately increased the amount of their money on deposit with the Fed, up from about $10 billion total at the end of August, 2008, to $880 billion by the end of the second week of January, 2009. In comparison, the increase in reserve balances reached only $65 billion after September 11, 2001 before falling back to normal levels within a month. The U.S. Treasury Department explained the changes, saying:
The Federal Reserve will continue to take a leadership role with respect to liquidity in our markets. It is committed to using all of the tools at its disposal to provide the increased liquidity that is now required for the effective functioning of financial markets. In this regard, the authority to pay interest on reserves that was provided by EESA is essential, because it allows the Federal Reserve to expand its balance sheet as necessary to support financial stability while conducting a monetary policy that promotes the Federal Reserve's macroeconomic objectives of maximum employment and stable prices. The Federal Reserve and the Treasury Department are consulting with market participants on ways to provide additional support for term unsecured funding markets.
Reactions to the change were mixed, with banks generally approving of their new ability to earn high interest without risk on funds that they would otherwise need to use to extend credit in order to make a profit for their shareholders, while those involved in the commercial paper
markets, the primary and secondary sectors of the goods and services economy, shipping
, and others depending on the liquidity of credit from banks were more skeptical of the further pressure against credit availability in the midst of the ongoing credit liquidity crisis
The day after the change was announced, on October 7, Fed Chairman Ben Bernanke
expressed some confusion about it, saying, "We're not quite sure what we have to pay in order to get the market rate, which includes some credit risk, up to the target. We're going to experiment with this and try to find what the right spread is." The Fed adjusted the rate on October 22, after the initial rate they set October 6 failed to keep the benchmark U.S. overnight interest rate close to their policy target, and again on November 5 for the same reason. Beginning December 18, the Fed directly established interest rates paid on required reserve balances and excess balances
instead of specifying them with a formula based on the target federal funds rate.
The government issued $400 billion of short-term debt intended to help replace the $1.8 trillion commercial paper market which was wiped out by the change, (exacerbated by money market
funds' sudden refusal to support commercial paper as well) but the world economy began to deflate as international shipping, dependent on commercial paper, slowed in some regions to a few percent of levels prior to the change. The FDIC announced a new program on October 14, under which newly issued senior unsecured debt issued on or before June 30, 2009, would be fully protected in the event the issuing institution subsequently fails, or its holding company files for bankruptcy. The FDIC program is expected to cover about $1.4 trillion of bank debt.
The Congressional Budget Office
estimated that payment of interest on reserve balances would cost the American taxpayers about one tenth of the present 0.25% interest rate on $800 billion in deposits:
|Millions of dollars||0||-192||-192||-202||-212||-221||-242||-253||-266||-293||-308|
|(Negative numbers represent expenditures; losses in revenue not included.)|
0.25% simple interest on $800 billion is $2 billion, not $202 million as shown for 2009. But those expenditures pale in comparison to the lost tax revenues worldwide resulting from decreasing economic activity due to damage to the short-term commercial paper
and associated credit markets.
On January 7, 2009, the Federal Open Market Committee
decided that, "the size of the balance sheet and level of excess reserves would need to be reduced." On January 13, Ben Bernanke
said, "In principle, the interest rate the Fed pays on bank reserves should set a floor on the overnight interest rate, as banks should be unwilling to lend reserves at a rate lower than they can receive from the Fed. In practice, the federal funds rate has fallen somewhat below the interest rate on reserves in recent months, reflecting the very high volume of excess reserves, the inexperience of banks with the new regime, and other factors. However, as excess reserves decline, financial conditions normalize, and banks adapt to the new regime, we expect the interest rate paid on reserves to become an effective instrument for controlling the federal funds rate." The same day, Financial Week said Mr. Bernanke admitted that a huge increase in banks' excess reserves is stifling the Fed's monetary policy moves and its efforts to revive private sector lending.
On January 15, Chicago Fed
president and Federal Open Market Committee member Charles Evans said, "once the economy recovers and financial conditions stabilize, the Fed will return to its traditional focus on the federal funds rate. It also will have to scale back the use of emergency lending programs and reduce the size of the balance sheet and level of excess reserves. 'Some of this scaling back will occur naturally as market conditions improve on account of how these programs have been designed. Still, financial market participants need to be prepared for the eventual dismantling of the facilities that have been put in place during the financial turmoil,' he said."
At the end of January, 2009, excess reserve balances at the Fed stood at $793 billion but less than two weeks later on February 11, total reserve balances had fallen to $603 billion. On April 1, reserve balances had again increased to $806 billion, and late November, 2009, they stood at $1.16 trillion.
Management of the Troubled Asset Relief ProgramThe bill authorizes the Secretary of the Treasury
to establish the Troubled Assets Relief Program
to purchase troubled assets from financial institutions. The Office of Financial Stability is created within the Treasury Department
as the agency through which the Secretary will run the program. The Secretary is required to consult with the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation
, the Comptroller of the Currency
, the Director of the Office of Thrift Supervision
, and the Secretary
of Housing and Urban Development
when running the program.
FundingThe bill authorizes $700 billion for the program. The Treasury Secretary has immediate access to the first $250 billion. Following that, an additional $100 billion can be authorized by the President
. For the last $350 billion, the President must notify Congress of the intention to grant the additional funding to the Treasury; Congress then has 15 days to pass a resolution disallowing the authority. If Congress fails to pass a resolution opposing the funding within 15 days, or if the resolution passes, but is veto
ed by the President, and Congress does not have enough votes to override
the veto, the Treasury will receive the final $350 billion.
Government equity interests in participating firmsThe Treasury Secretary is required to obtain a financial warrant
guaranteeing the right to purchase non-voting stock
or, if the company is unable to issue a warrant, senior debt from any firm participating in the program. The Secretary is allowed to make a de minimis
exception to the rule, but that exception may not exceed $100 million.
Executive pay limitsIf the Treasury purchases assets directly from a company, and also receives a meaningful equity or debt position in that company, the company is not allowed to offer incentives that encourage "unnecessary and excessive risks" to its senior executives (that is, the top five executives). Also, the company is prohibited from making golden parachute
payments to a senior executive. Both of these prohibitions expire when the Treasury no longer holds an equity or debt position in that company. The company also is given "clawback" permission; that is, the opportunity to recover senior executive bonus or incentive pay based on earnings, gains, or other data that proves to be inaccurate.
If the Treasury purchases assets via auction, and that purchase exceeds $300 million, any new employment contract for a senior officer may not include a golden parachute provision in the case of involuntary termination, bankruptcy filing, insolvency
, or receivership
. This prohibition only applies to future contracts; golden parachutes already in place will remain unaffected.
In either scenario, no limits are placed on executive salary, and existing golden parachutes will not be altered.
Foreclosure avoidance and homeowner assistanceFor mortgages
involved in assets purchased by the Treasury Department, the Treasury Secretary is required to (1) implement a plan that seeks to maximize assistance for homeowners, and (2) encourage the servicers of the underlying mortgages to take advantage of the HOPE for Homeowners Program of the National Housing Act or other available programs to minimize foreclosure
s. Furthermore, the Secretary is allowed to use loan guarantees and credit enhancement
s to encourage loan modifications to avert foreclosure. The bill does not provide a mechanism to change the terms of a mortgage without the consent of any company holding a stake in that mortgage.
This $24 billion asset detoxification
plan was requested by Federal Deposit Insurance Corporation
Chair Sheila Bair, but the Treasury did not use the provision. "The primary purpose of the bill was to protect our financial system from collapse," Secretary Henry Paulson
told the House Financial Services Committee, "The rescue package was not intended to be an economic stimulus or an economic recovery package."
Judicial reviewThe bill establishes that actions taken by the Treasury Secretary regarding this program are subject to judicial review
, reversing the request for immunity made in the original Paulson proposal.
OversightSeveral oversight mechanisms are established by the bill. Contractors were also used to help manage the TARP funds.
Financial Stability Oversight Board
The Financial Stability Oversight Board is created to review and make recommendations regarding the Treasury's actions. The members of the board are:
- Chairman of the BoardChairman of the Federal ReserveThe Chairman of the Board of Governors of the Federal Reserve System is the head of the central banking system of the United States. Known colloquially as "Chairman of the Fed," or in market circles "Fed Chairman" or "Fed Chief"...
of the Federal ReserveFederal Reserve SystemThe Federal Reserve System is the central banking system of the United States. It was created on December 23, 1913 with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907...
- SecretaryUnited States Secretary of the TreasuryThe Secretary of the Treasury of the United States is the head of the United States Department of the Treasury, which is concerned with financial and monetary matters, and, until 2003, also with some issues of national security and defense. This position in the Federal Government of the United...
of the TreasuryUnited States Department of the TreasuryThe Department of the Treasury is an executive department and the treasury of the United States federal government. It was established by an Act of Congress in 1789 to manage government revenue...
- Director of the Federal Housing Finance AgencyFederal Housing Finance AgencyThe Federal Housing Finance Agency is an independent federal agency created as the successor regulatory agency resulting from the statutory merger of the Federal Housing Finance Board , the Office of Federal Housing Enterprise Oversight , and the U.S...
- Chairman of the Securities and Exchange Commission
- SecretaryUnited States Secretary of Housing and Urban DevelopmentThe United States Secretary of Housing and Urban Development is the head of the United States Department of Housing and Urban Development, a member of the President's Cabinet, and thirteenth in the Presidential line of succession. The post was created with the formation of the Department of Housing...
of the Department of Housing and Urban DevelopmentUnited States Department of Housing and Urban DevelopmentThe United States Department of Housing and Urban Development, also known as HUD, is a Cabinet department in the Executive branch of the United States federal government...
Congressional Oversight Panel
A Congressional Oversight Panel is created by the bill to review the state of the markets, current regulatory system, and the Treasury Department's management of the Troubled Asset Relief Program. The panel is required to report their findings to Congress every 30 days, counting from the first asset purchase made under the program. The panel must also submit a special report to Congress about regulatory reform on or before January 20, 2009.
The panel consists of five outside experts appointed as follows:
- One member chosen by the Speaker of the HouseSpeaker of the United States House of RepresentativesThe Speaker of the United States House of Representatives, or Speaker of the House, is the presiding officer of the United States House of Representatives...
- One member chosen by the minority leaderParty leaders of the United States House of RepresentativesParty leaders of the United States House of Representatives are elected by their respective parties in a closed-door caucus by secret ballot and are also known as floor leaders. The U.S. House of Representatives does not officially use the term "Minority Leader", although the media frequently does...
of the House
- One member chosen by the majority leaderParty leaders of the United States SenateThe Senate Majority and Minority Leaders are two United States Senators who are elected by the party conferences that hold the majority and the minority respectively. These leaders serve as the chief Senate spokespeople for their parties and manage and schedule the legislative and executive...
of the Senate
- One member chosen by the minority leaderParty leaders of the United States SenateThe Senate Majority and Minority Leaders are two United States Senators who are elected by the party conferences that hold the majority and the minority respectively. These leaders serve as the chief Senate spokespeople for their parties and manage and schedule the legislative and executive...
of the Senate
- One member chosen by the Speaker of the House and the majority leader of the Senate, following consultation with the minority leaders of Congress
Comptroller General oversight requirement
The Comptroller General
(director of the Government Accountability Office
) is required to monitor the performance of the program, and report findings to Congress every 60 days. The Comptroller General is also required to audit the program annually. The bill grants the Comptroller General access to all information, records, reports, data, etc. belonging to or in use by the program.
Office of the Special Inspector General
The bill creates the Office of the Special Inspector General for the Troubled Asset Relief Program, appointed by the President
and confirmed by the Senate. The Special Inspector General's purpose is to monitor, audit and investigate the activities of the Treasury in the administration of the program, and report findings to Congress every quarter.
FDIC insuranceFrom the date of enactment of the bill (October 3, 2008) until December 31, 2009, the amount of deposit insurance
provided by the FDIC
is increased from $100,000 to $250,000.
Budget-related provisionsTitle II sets out guidelines for consultation and reporting between the Treasury Secretary, the Office of Management and Budget, and the Congressional Budget Office.
Tax provisionsThe bill makes the following changes to tax law.
- Qualified financial institutions may count losses on FNMA and FHLMC preferred stock against ordinary income, rather than capital gain income.
- New limitations are added on deductibility of executive compensation by corporations participating in the bailout.
- The mortgage debt forgiveness provision of the Mortgage Forgiveness Debt Relief Act of 2007Mortgage Forgiveness Debt Relief Act of 2007The Mortgage Forgiveness Debt Relief Act was introduced in Congress on September 25, 2007, and became law on December 20, 2007. This act offered relief to homeowners who would formerly owe taxes on forgiven mortgage debt after facing foreclosure. The act extends such relief for three years,...
is extended by three years, so that it applies to debts forgiven through the year 2012.
- Extend the expiration date of the section 41 Research & Development Tax Credit from December 31, 2007, to December 31, 2009; also, increase the Alternative Simplified Credit percentage from 12% to 14%.
Administration of the lawCAMELS ratings
are being used by the United States
government to help it decide which banks to provide special help for and which to not as part of its capitalization program authorized by the Emergency Economic Stabilization Act of 2008.
The New York Times
states: "The criteria being used to choose who gets money appears to be setting the stage for consolidation in the industry by favoring those most likely to survive" because the criteria appears to favor the financially best off banks and banks too big to let fail. Some lawmakers are upset that the capitalization program will end up culling banks in their districts.
Known aspects of the capitalization program "suggest that the government may be loosely defining what constitutes healthy institutions. [... Banks] that have been profitable over the last year are the most likely to receive capital. Banks that have lost money over the last year, however, must pass additional tests. [...] They are also asking if a bank has enough capital and reserves to withstand severe losses to its construction loan portfolio, nonperforming loans and other troubled assets." Some banks received capital with the understanding the banks would try to find a merger partner. To receive capital under the program banks are also "required to provide a specific business plan for the next two or three years and explain how they plan to deploy the capital."
Effects on national debtThe United States annual budget deficit for fiscal year 2009 surpassed $1 trillion. The original Paulson proposal would lift the United States federal debt ceiling by $700 billion, to $11.3 trillion from the current $10.6 trillion.
Other informationA review of investor presentations and conference calls by executives of some two dozen US-based banks by The New York Times found that "few [banks] cited lending as a priority. An overwhelming majority saw the bailout program as a no-strings-attached windfall that could be used to pay down debt, acquire other businesses or invest for the future."
- 2008 United Kingdom bank rescue package2008 United Kingdom bank rescue packageA bank rescue package totalling some £500 billion was announced by the British government on 8 October 2008, as a response to the ongoing global financial crisis. After two unsteady weeks at the end of September, the first week of October had seen major falls in the stock market and severe worries...
- Financial crisis of 2007–2010
- Economic crisis of 2008
- January 2008 stock market downturn
- List of entities involved in 2007-2008 financial crises
- Bear Stearns subprime mortgage hedge fund crisis
- Federal takeover of Fannie Mae and Freddie MacFederal takeover of Fannie Mae and Freddie MacThe federal takeover of Fannie Mae and Freddie Mac refers to the placing into conservatorship of government sponsored enterprises Fannie Mae and Freddie Mac by the U.S. Treasury in September 2008. It was one financial event among many in the ongoing subprime mortgage crisis.On September 6, 2008,...
- Investment tax credit
- Bankruptcy of Lehman BrothersBankruptcy of Lehman BrothersLehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008. The bankruptcy of Lehman Brothers remains the largest bankruptcy filing in U.S...
- Federal Reserve bailout of AIG
- Global financial crisis of September–October 2008
- Bankruptcy of Washington Mutual
- Savings and Loan crisisSavings and Loan crisisThe savings and loan crisis of the 1980s and 1990s was the failure of about 747 out of the 3,234 savings and loan associations in the United States...
- Subprime mortgage crisisSubprime mortgage crisisThe U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
- Subprime crisis impact timelineSubprime crisis impact timelineThe subprime crisis impact timeline lists dates relevant to the creation of a United States housing bubble and the 2005 housing bubble burst and the subprime mortgage crisis which developed during 2007 and 2008...
- Subprime lendingSubprime lendingIn finance, subprime lending means making loans to people who may have difficulty maintaining the repayment schedule...
- Mortgage backed securitiesMortgage-backed securityA mortgage-backed security is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.-Securitization:...
- United States housing market correctionUnited States housing market correctionA United States housing market correction is a market correction or "bubble bursting" of a United States housing bubble; the most recent began following a national home price peak first identified in July 2006. Because realty trades in illiquid markets relative to financial assets such as common...
- Lemon socialismLemon socialism"Lemon socialism" is a pejorative term for government support of private-sector companies whose imminent collapse is perceived to threaten broader economic stability. Some assert it is not a subcategory of socialism per se; rather, it points to a corruption of free-market capitalist systems, which...
- Socialism for the rich and capitalism for the poorSocialism for the rich and capitalism for the poorSocialism for the rich and capitalism for the poor is a classical political-economic argument, stating that in the advanced capitalist societies state policies assure that more resources flow to the rich than to the poor, for example in form of transfer payments...
- Corporate welfareCorporate welfareCorporate welfare is a pejorative term describing a government's bestowal of money grants, tax breaks, or other special favorable treatment on corporations or selected corporations. The term compares corporate subsidies and welfare payments to the poor, and implies that corporations are much less...
- CronyismCronyismCronyism is partiality to long-standing friends, especially by appointing them to positions of authority, regardless of their qualifications. Hence, cronyism is contrary in practice and principle to meritocracy....
- The world housing bubbleReal estate bubbleA real estate bubble or property bubble is a type of economic bubble that occurs periodically in local or global real estate markets...
- Indian property bubbleIndian property bubbleThe origins of Indian Property Market Bubble can be traced to the interest rate reductions made by the NDA coalition government in the years following 2001. Home Loan Rates fell to a historical lows of 7.5% in early 2004. This prepared the basis for the increase in real estate property prices...
- Irish property bubbleIrish property bubbleThe property bubble in the Republic of Ireland began in 2000 and peaked in 2006, as with many other western European countries, with a combination of increased speculative construction and rapidly rising prices....
- Japanese asset price bubbleJapanese asset price bubbleThe was an economic bubble in Japan from 1986 to 1991, in which real estate and stock prices were greatly inflated. The bubble's collapse lasted for more than a decade with stock prices initially bottoming in 2003, although they would descend even further amidst the global crisis in 2008. The...
- Spanish property bubbleSpanish property bubbleThe Spanish property bubble refers to the massive growth of real state prices observed, in various stages, from 1985 up to 2008 in Spain. The housing burst can be clearly divided in three periods: 1985-1991, in which the price nearly tripled, 1992-1996, in which the price remained somewhat stable,...
- United States housing bubbleUnited States housing bubbleThe United States housing bubble is an economic bubble affecting many parts of the United States housing market in over half of American states. Housing prices peaked in early 2006, started to decline in 2006 and 2007, and may not yet have hit bottom as of 2011. On December 30, 2008 the...
- United Kingdom housing bubble
- Swedish banking rescueSwedish banking rescueDuring 1991 and 1992, a housing bubble in Sweden deflated, resulting in a severe credit crunch and widespread bank insolvency. The causes were similar to those of the subprime mortgage crisis of 2007-2008...
- Automotive industry crisis of 2008
- Library of Congress drafts:
- Text of original Paulson proposal
- Stimulus Watch, a complete guides to all economic recovery efforts.
- Jobs and Economic Growth - a discussion of the proposal from the George W. Bush White House Archive.
- Agreed-upon draft of House Resolution for the bailout (110 pages)
- Text version of House Res 1517 Bailout Bill
- Text of the revised bill (List and U.S. map with districts of members of Congress voting "no". (Background on development of the Treasury proposal to Congress)
- A Directory of Related U.S. Government Agency Statements, Actions, Documents, Videos, and News Concerning the Emergency Economic Stabilization Act of 2008 / TARP (Troubled Assets Relief Program)
- Feb 2009 Updates: Bank Lending Report $275B Foreclosure Plan
- Nomi Prins: "Obama Banking Too Much on Banks" - video report by Democracy Now!Democracy Now!Democracy Now! and its staff have received several journalism awards, including the Gracie Award from American Women in Radio & Television; the George Polk Award for its 1998 radio documentary Drilling and Killing: Chevron and Nigeria's Oil Dictatorship, on the Chevron Corporation and the deaths of...