US Law Briefing

U.S. Law Briefing
Government Response to Global Credit Crisis: Mortgage Bailout Legislation
The global financial markets have undergone sweeping changes in recent weeks, unrivaled in magnitude
and significance since the financial crises occurring 80 years ago surrounding the Great Depression. These
changes have affected many of the largest and most well-established U.S. financial institutions: Lehman
Brothers filed for bankruptcy, Bank of America acquired Merrill Lynch in the face of questions surrounding the
latter’s viability, AIG was rescued by the federal government through a loan and guarantee program that in
effect provides that the federal government will own and operate AIG and most recently, Wachovia and Wells
Fargo unveiled plans to merge, sparking a potential takeover battle to acquire Wachovia between Wells
Fargo and Citigroup.
Amid lingering concerns over the global effects of the spreading credit crisis, and its possible impact on
remaining market participants, and following rancorous political debate, Congress enacted financial bailout
legislation on October 3, 2008. The legislation includes the “Emergency Economic Stabilization Act of 2008”
(the “Act”) which establishes the “Troubled Assets Relief Program” (the “Plan”). The Plan represents the end
result of draft legislation (the “Proposal”) initially submitted by Secretary of the U.S. Department of the
Treasury (the “Treasury”) Henry Paulson (the “Secretary”) to Congress. The Proposal was heavily revised
by Congress, which believed the Proposal was severely flawed. The Act closely resembles the bill drafted by
the U.S. House of Representatives (the “House”) that failed in a close vote on the House floor on September
29, 2008. The House’s bill was revised by the U.S. Senate (the “Senate”) to increase its appeal across
Congressional party lines, and was attached to other packages that extend many individual and business tax
breaks, including production and use tax credits for renewable energy sources and a one-year alleviation of
the effects of the Alternative Minimum Tax.
The Plan is intended to rescue the crippled U.S. financial markets by permitting the Treasury to purchase up
to U.S.$700 billion worth of distressed assets, primarily mortgage-backed securities, to be bought from
financial institutions, and eventually either to hold such assets to maturity or to re-sell such assets to the
private sector. Under the Plan, the U.S.$700 billion will be available in installments, as further described
below. The Act also places restrictions on compensation received by executives at firms that participate in
the Plan, including bans on incentives that encourage excessively risky behavior, the claw-back of bonuses
paid out for earnings that fail to materialize, and limits on so-called “golden parachutes”, or generous
severance packages. Furthermore, it raises the Federal Deposit Insurance Corporation (“FDIC”) deposit
insurance cap from U.S.$100,000 to U.S.$250,000 through the end of 2009. If all goes as the U.S.
government envisions, this large-scale governmental intervention into the market will mitigate the financial
institutions’ struggles to raise and maintain capital and return some normalcy to the economy, including the
real estate market.
This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on
other areas of law, please contact one of your regular contacts, or contact the editors.
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⏐September 2008
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This Briefing is intended to summarize the Act, the initial reaction to it including uncertainties surrounding it,
and certain market-related issues.
Summary of the Plan
•
Fundamentals of the Plan:
•
Purchase of Troubled Assets: The Act authorizes the Secretary to establish the Plan
to purchase, on terms generally left up to his discretion (subject to the limits
summarized below), “Troubled Assets”, which are defined as residential or
commercial mortgages and any securities, obligations, or other instruments that are
based on or related to mortgages, that were originated or issued on or before March
14, 2008, plus any other financial instrument that the Secretary determines the
purchase of which is needed to promote financial market stability (the “Troubled
Assets”). Under the Act, the Secretary will establish an Office of Financial Stability
within the Treasury Department to implement the Plan. The Secretary is authorized to
take certain actions including designating financial institutions as financial agents of
the federal government to carry out the purposes of the Act.
•
Pricing of Troubled Assets and Purchase Procedures: The Secretary is authorized to
establish guidelines (within two business days of the first purchase or, at the latest, 45
days after enactment) of the Act setting forth the mechanisms for purchasing Troubled
Assets, pricing and valuing methods for Troubled Assets, procedures for selecting
asset managers, and criteria for identifying Troubled Assets for purchase. Generally,
the Secretary may not purchase a Troubled Asset at a price higher than what the
Seller paid to purchase the asset. The Secretary is required to use market
mechanisms for purchases whenever possible to maximize the efficiency of taxpayers
resources, including by holding auctions and reverse auctions, and shall pay “the
lowest price that the Secretary determines to be consistent with the purposes” of the
Plan. The Treasury may purchase Troubled Assets directly from individual financial
institutions where such market mechanisms are not feasible or appropriate, provided
the prices paid for such assets are reasonable and reflect the underlying value of the
Troubled Assets.
•
Eligible Sellers: The Troubled Assets can be purchased from any eligible financial
institution. The term “financial institutions” is defined to include any institution,
including, but not limited to, any bank, savings association, credit union, security
broker or dealer, or insurance company established and regulated under the laws of
the United States or any state and having significant operations in the U.S. As
defined, eligible financial institutions appear to include many U.S. subsidiaries,
branches and agencies of foreign banks if they are "established and regulated" in the
United States, but excludes any central bank of, or institution owned by, a foreign
government. Although the definition does not on its face cover affiliates of covered
institutions, the phrase “including but not limited to” will give the Secretary the power
to define covered institutions in rules and guidelines. The Secretary is prohibited from
discriminating against sellers with respect to their size, geography, form or
organization, or the size, type, and number of assets eligible for purchase.
2
•
Insurance of Troubled Assets: Alongside the purchase program under the Plan, the
Secretary must establish an insurance program (the “Insurance Program”) to
guarantee financial institutions' Troubled Assets. Any financial institution that decides
to participate in the Insurance Program is required to pay the government a premium
(that varies according to risk) at least at a level necessary to create reserves sufficient
to meet anticipated claims (as determined by the Secretary). The Insurance Program
can only guarantee Troubled Assets in amounts not greater than 100% of the amount
of the payment of principal and interest on the Troubled Assets. The amount the
Treasury spends to cover losses, minus the premiums collected under the Insurance
Program, will be deducted from the U.S.$700 billion the Treasury is authorized to
spend under the Plan. Many of the details of the Insurance Program are left to the
Secretary’s discretion.
•
Considerations: In exercising authority under the Act, the Secretary is required to take
into account a number of considerations, including protecting the taxpayers’ interests,
preventing disruption to financial markets, minimizing the impact on the national debt,
preserving homeownership, protecting the retirement security of Americans, ensuring
the needs of all financial institutions regardless of size or other characteristics, and
the needs of local communities. The Act also requires the Secretary to examine the
long-term viability of an institution in determining whether to directly purchase assets
from an individual financial institution.
•
Resale of Troubled Assets: The Secretary may exercise any rights received in
connection with Troubled Assets purchased under the Act at any time. The Secretary
has authority to manage Troubled Assets, and sell or enter into any financial
transactions in regard to any Troubled Assets. The profits from the sale of Troubled
Assets shall be paid into the Treasury for reduction of the national debt.
•
Conflicts of Interest: The Secretary is required to issue regulations or guidelines to
manage or prohibit conflicts of interest in the administration of the program including
conflicts arising in the selection or hiring of asset managers and the purchase or the
management of the Troubled Assets.
•
Coordination with Foreign Authorities and Central Banks: The Secretary shall
coordinate with foreign authorities and central banks to establish programs similar to
the Plan. To the extent that such foreign financial authorities or banks hold Troubled
Assets as a result of extending financing to financial institutions that have failed or
defaulted on such financing, such Troubled Assets qualify for purchase by the
Secretary under the Act.
•
Graduated Funding Authorization: The Act authorizes the full U.S.$700 billion as
requested by the Treasury Secretary for implementation of the Plan, but this total is
available only in installments. It allows the Secretary to immediately spend up to
U.S.$250 billion. Upon a Presidential certification of need, the Secretary may access
an additional U.S.$100 billion. The remaining U.S.$350 billion may be made available
after the President transmits a written report to Congress detailing the Secretary’s
plan to exercise the remaining authority. The Secretary may use this additional
3
authority unless within 15 days Congress passes a joint resolution of disapproval
which may be considered on an expedited basis.
•
•
Recoupment: Five years after the date of enactment, if the Plan is running a shortfall,
the President will be required to submit a legislative proposal to Congress that
recoups for taxpayers the amount of the shortfall from the financial industry.
•
Term: The Act provides that the Treasury's authority to purchase or guarantee
Troubled Assets under the Plan terminates on December 31, 2009, but may be
extended to expire not later than two years from the date of enactment of the Act
upon the submission of a certification of need by the Secretary to Congress
•
Source of Funding: Funding for the asset purchases will be provided by U.S. taxpayer
dollars, and the Act increases the U.S. federal debt limit from U.S.$10 trillion to
U.S.$11.3 trillion.
•
Mark-to-Market Accounting: The Act restates the authority of the U.S. Securities and
Exchange Commission (the “SEC”) to suspend the application of so-called “mark-tomarket” accounting rules under FASB Statement No. 157 and requires the SEC, in
cooperation with the Treasury and the Federal Reserve, to conduct a study on the
effects of mark-to market accounting on balance sheets and the quality of financial
information.
•
Exchange Stabilization Fund Reimbursement: The Act provides that the Secretary
shall reimburse the Exchange Stabilization Fund 1 for any losses incurred due to the
temporary money market mutual fund guarantee. The Act also prohibits any future
use of the Fund for any guarantee program for the money market mutual fund
industry.
Taxpayer Protections:
•
Minimization of Long-Term Costs and Maximization of Benefits for Taxpayers: The
Secretary is required to use his authority under the Act in a manner that will minimize
any potential long-term negative impact on the U.S. taxpayer, taking into account
various factors including the direct outlays, potential long-term returns on assets
purchased and overall economic benefits of the program.
•
Market Mechanisms: In making purchases of the Troubled Assets, the
Secretary shall use market mechanisms to the extent possible, as described
above.
•
Warrants: The Act requires sellers under the Plan to provide non-voting
warrants to the Secretary so that U.S. taxpayers gain an ownership stake and
benefit from any future growth of any financial institution selling assets to the
1
The Exchange Stabilization Fund (the “ESF”), which now amounts to U.S.$50 billion, authorizes the Secretary to
conduct interventions in foreign exchange markets. On September 19, 2008, President Bush approved use of the ESF by
the Secretary to establish a temporary guaranty program for the U.S. money market mutual fund industry. For the next
year, the Treasury will insure the holdings of any publicly offered eligible money market mutual fund (both retail and
institutional) that pays a fee to participate in the program.
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government. Specifically, the Secretary may not purchase any Troubled Assets
unless the Secretary receives from the seller a warrant to receive nonvoting
common stock or preferred stock in a seller that is a financial institution that is
traded on a national securities exchange, or a warrant for common or preferred
stock, or a senior debt instrument, from a seller that is not traded on a national
securities exchange. Warrants must provide the government with “reasonable
participation” in “equity appreciation” and provide additional protection against
loss in the sale of the assets. They must also contain anti-dilution provisions of
the type employed in capital market transactions, as determined by the
Secretary. No warrants are required for purchases of less than U.S.$100M from
any one financial institution for the duration of the Plan.
•
•
2
FDIC Insurance Cap Increase: The Act temporarily raises the FDIC limit on insured
bank deposits to U.S.$250,000 per account from U.S.$100,000, a level that had been
in place since 1980. This increase will expire on December 31, 2009. The Act
temporarily allows the FDIC to borrow unlimited amounts of money from the Treasury
in connection with such extension, in order to ensure depositors can be repaid if their
banks fail.
Executive Compensation Limits:
•
The Act places restrictions on compensation received by executives at firms that
participate in the Plan. 2
•
The executive compensation provisions of the Act apply to two different types of
financial institutions: (1) those firms in which the federal government engages in a
direct purchase of Troubled Assets, and in connection with the transaction takes a
meaningful equity or debt position (“Direct Purchases”) and (2) firms that sell at least
U.S.$300 million in Troubled Assets to the Treasury through an auction process
(“Auction Purchases”).
•
For each firm in which the federal government takes a meaningful equity or debt
position through a Direct Purchase, the Secretary will require that, with respect to with
any of its top five most highly-paid executives, the firm (1) not provide incentives to
take unnecessary and excessive risk during the period in which assets are held by the
Treasury, (2) “claw back” bonus or incentive compensation based on criteria that are
later proven to be materially inaccurate, and (3) not make any golden parachute
payments during the period in which the Treasury holds such position.
•
Firms that sell at least U.S.$300 million in Troubled Assets to the Treasury (including
both Auction Purchases and Direct Purchases) are subject to a prohibition on any
new employment contract with any of its top five most highly-paid executives that
provides for a “golden parachute” severance payment in the event of an involuntary
termination, bankruptcy filing, insolvency or receivership.
While a detailed discussion is beyond the scope of this Briefing, the Act also includes (separately from the Plan), new Section 457A
of the Code, which restricts the ability to defer compensation under a non-qualified deferred compensation plan of a foreign entity
that is essentially not subject to taxation (e.g., fee deferrals by U.S. managers of a Cayman Islands based fund).
5
•
•
Firms that sell at least U.S.$300 million in Troubled Assets to the Treasury (not
including Direct Purchases, if no Auction Purchases have been made from that
employer) are subject to new deduction limits added by an amendment to subsection
162(m) of the U.S. Internal Revenue Code (which prohibits publicly held corporations
from taking a deduction for amounts paid to “covered employees” in excess of
U.S.$1,000,000) to include a tax deduction cap for “covered executives” (the CEO,
CFO, and any of the top 3 highest-paid officers) of such firms of U.S.$500,000 in
compensation for any year (including any deferred compensation for that year). The
exceptions under 162(m) for performance-based compensation, commissions, and
certain “grandfathered” contracts do not apply. In addition, such firms are subject to
amendments to Section 280G of the U.S. Internal Revenue Code, which operate to
deny a deduction to such companies for “golden parachute” severance payments to
covered executives in the event of an involuntary termination, bankruptcy filing,
insolvency or receivership. These amendments will result in covered executives being
subject to a 20% excise tax on these payments under Section 4999 of the U.S.
Internal Revenue Code.
Oversight and Transparency:
•
Financial Stability Oversight Board: The Act establishes the Financial Stability
Oversight Board (the “Board”) to review and make recommendations regarding the
exercise of authority under the Act, such as establishing the Plan and the Insurance
Program. In addition, the Board will ensure that the policies implemented by the
Secretary are in the economic interests of the United States and consistent with
protecting taxpayers. The Board is comprised of the Chairman of the Board of
Governors of the Federal Reserve System, the Secretary, the Director of the Federal
Home Finance Agency, the Chairman of the SEC and the Secretary of the
Department of Housing and Urban Development.
•
Reports: (1) Monthly Reports: within 60 days of the first exercise of authority under
this Act and every month thereafter, the Secretary is required to report to Congress
his activities under the Plan, including detailed financial statements reflecting all
agreements and insurance contracts made, all transactions occurred, the nature of
purchased assets and the valuation or pricing model used. (2) Tranche Reports: for
every U.S.$50 billion in assets purchased, the Secretary is required to report to
Congress a detailed description of all transactions, a description of the pricing
mechanisms used, and justifications for the financial terms of such transactions. (3)
Regulatory Modernization Report: prior to April 30, 2009, the Secretary is required to
submit a report to Congress on the current state of the financial markets, the
effectiveness of the financial regulatory system, and to provide any recommendations
regarding (a) whether any other participants of the financial markets should become
subject to the regulatory system and (b) enhancement of the clearing and settlement
of over-the-counter swaps.
•
Transparency: The Act requires the online posting of a description, amounts, and
pricing of assets acquired under the Act within two business days of purchase, trade,
or other disposition of the Troubled Assets. The Secretary must determine whether
the public disclosure required for financial institutions with respect to off-balance
6
sheet transactions, derivatives instruments, contingent liabilities, and similar sources
of potential exposure is adequate. If such disclosure is not adequate for in that
context, the Secretary shall make recommendations for additional disclosure
requirements to the relevant regulators.
•
•
Oversight and Audits: The Act requires the Comptroller General of the United States
to conduct ongoing oversight of the activities and performance of the Plan, and to
report every 60 days to Congress. The Comptroller General is required to conduct an
annual audit of the Plan. In addition, the Act mandates a Government Accountability
Office (GAO) presence at Treasury to oversee the program and conduct audits to
ensure strong internal controls and prevent fraud, waste and abuse.
•
Study and Report on Margin Authority: The Comptroller General is obligated to
undertake a study to determine the extent to which leverage and sudden deleveraging
of financial institutions was a factor behind the current financial crisis and deliver a
report by June 2009.
•
Judicial Review: The Secretary’s actions will be set aside only if they are found to be
arbitrary, capricious, an abuse of discretion or a violation of law. No injunctions are
permitted that relate to the purchase of assets, the Insurance Program, management
and sale of assets, of foreclosure mitigation efforts. No suits by any financial
institution seller are permitted unless such right is expressly provided in a contract
with the Secretary.
•
The Plan establishes an independent Inspector General, appointed by the President,
to monitor the Secretary’s activities and to coordinate audits and investigations of
these actions. The Inspector General is required to submit a quarterly report to
Congress summarizing its activities and a detailed statement of all purchases,
obligations, expenditures and revenues associated with the purchase and guarantee
of the Troubled Assets by the Secretary under the Act.
•
Congressional Oversight Panel: A Congressional Oversight Panel is established, and
will review the state of the financial markets, the regulatory system and the use of
authority under the Plan. The panel will report to Congress every 30 days, and is
required to submit a report on regulatory reform no later than January 20, 2009, the
date the next U.S. President takes office. Membership will be composed of five
outside experts appointed in bipartisan fashion.
Homeownership Preservation:
•
3
Foreclosure Mitigation Efforts: For Troubled Assets acquired through the Plan, the
Secretary must implement a plan to maximize assistance for homeowners and to
minimize foreclosures by way of encouraging servicers of mortgages to modify loans
through Hope for Homeowners 3 and other programs. In addition, the Secretary is
authorized to use loan guarantees and credit enhancement to avoid foreclosures and
must coordinate with other federal entities that hold Troubled Assets in order to
Hope for Homeowners is a program created by the Congress under the “HOPE for Homeowners Act of 2008" within Federal Housing
Administration (FHA) to back FHA-insured mortgages to distressed borrowers. The new mortgages offered by FHA-approved lenders
will refinance abusive loans at a significant discount for homeowners facing difficulty meeting their mortgage payments.
7
identify opportunities to modify loans, and to permit bona fide tenants to remain in
their lease homes.
•
Assistance to Homeowners: The Act requires federal entities that hold mortgages and
mortgage-backed securities, including the Federal Housing Finance Agency, the
FDIC, and the Federal Reserve to develop a plan to maximize assistance for
homeowners and to minimize foreclosures. Those federal entities are required to work
with servicers to encourage loan modifications and encourage greater use of existing
governmental rent subsidies, taking into account net present value to the taxpayer.
•
The Plan extends a provision contained in previous legislation that blocks tax liability
on mortgage foreclosures.
Issues Surrounding the Proposal
The Plan’s language leaves many questions unanswered, the outcome of which may have significant effects
on the market. These uncertainties include:
•
•
Which “financial institutions” will the bailout be available to?
•
As mentioned in the Summary, the Plan broadly defines the types of “financial
institutions” that are allowed to participate in the bailout program. This definition
appears to capture U.S. bank subsidiaries, branches, and agencies of foreign banks,
as these entities are “established and regulated” in the United States. However, it is
unclear what activities will satisfy the requirement that a financial institution must have
significant U.S. operations. It is noteworthy that under special circumstances, the
Secretary can purchase Troubled Assets from foreign financial institutions and central
banks (if such an entity holds Troubled Assets as a result of financing a “financial
institution” that has failed or defaulted on such loans).
•
When considering whether to engage in a direct purchase from an individual financial
institution, the Secretary must gauge the “long-term viability” of such entity when
determining whether the purchase is the “most efficient use of funds” under the Plan.
Is it possible that this provision will prevent the most deeply troubled banks from
participating in the Plan, resulting in a kind of “triage”?
What class of assets will the Treasury be able to purchase?
•
The Plan permits “Troubled Assets” to be purchased or insured under the Plan. This
term includes not only mortgage-related assets, “the purchase of which the Secretary
determines promotes financial market stability”, but also “financial instruments” that
are not mortgage-related, provided that the Secretary (1) determines that their
purchase promotes financial stability and (2) consults with the Chairman of the
Federal Reserve. However, approval for such purchases of non-mortgage assets is
not required by the Chairman or the Financial Stability Oversight Board. Therefore,
the range of assets that can be purchased is seemingly limitless and is another
example of the wide discretion granted to the Secretary under the Plan.
8
•
•
How will the Troubled Assets be valued and what prices will be offered, especially given the
breakdown of the market?
•
The Plan permits the Secretary to establish guidelines (after the enactment of the
Plan) on mechanisms for purchasing the Troubled Assets, pricing methods, and
procedures for selecting Troubled Assets. Although the Secretary is explicitly granted
the authority to use market mechanisms to purchase Troubled Assets, such as
reverse auctions (whereby the sellers would bid against each other to sell their
securities to the Treasury at the lowest price), the Secretary can engage in direct
purchases. The Plan contains only limited constraints related to the pricing and
purchase of Troubled Assets, thereby granting the Secretary broad discretion: for
example, the Secretary must make purchases “at the lowest price that [he]
determines to be consistent with the purposes of the [Plan].” Because such purposes
explicitly include restoring liquidity and stability to the U.S. financial system and
protecting economic growth, there is no requirement to purchase Troubled Assets for
the lowest possible price. Similarly, although the Act prohibits the Secretary from
purchasing a Troubled Asset at a price higher than what the seller paid to purchase
the asset, the Act permits the Secretary to purchase assets at prices above current
market value.
•
Because the bailout plan likely will only succeed if financial institutions can remove
distressed assets from their balance sheets at prices that are high enough to prevent
additional losses, the Secretary may be able to pay prices that are well above the
lowest available price, if he determines it is necessary to achieve the Act’s goals.
Such actions, however, may help financial institutions at the expense of taxpayers
and may conflict with the Plan’s vague requirement that the Secretary must take
actions that maximize profit or minimize the eventual losses to the federal
government.
Sellers under the Plan must issue equity or debt to the government, but how will this play
out?
•
•
Financial institutions that sell Troubled Assets to the government must issue (1)
equity, in the form of warrants (in the case of entities whose stock is traded on a
national securities exchange) or (2) equity, in the form of warrants, or debt
instruments (for all other entities) to the Secretary. This provision is designed to give
the government and taxpayers a chance to capture profits if sellers under the Plan
experience financial success. However, the Secretary has broad discretion in deciding
the quantity and value of the equity or debt he receives; the requirement is merely
that the Secretary receives a “reasonable participation” in equity appreciation (or a
“reasonable interest rate premium” in the case of debt instruments). It is possible that
some companies may be discouraged from participating under the Plan due to these
conditions.
What will be the effect of permitting the SEC to suspend the application of FASB Statement
No. 157?
•
This accounting rule requires banks to report on the market value of their assets. The
Plan permits the SEC to suspend application of such mark-to-market accounting rules
9
with respect to any issuer or class or category of transaction, if the SEC determines it
is “necessary or appropriate in the public interest”. This provision may therefore be
expected to elicit strong lobbying efforts in favor of suspension.
•
What will the Plan’s effect be on prices in the private sector market?
•
Prices paid under the Plan may set a floor, over which private investors would be
unwilling to bid. This could further devalue the distressed assets. However, some
believe that the conditions imposed on sellers under the Act may give financial
institutions an incentive to take lower bids from the private sector. Though the
Secretary may offer higher prices, the contingencies that come along with the higher
prices may be a turnoff. Sellers will have to determine whether it is more effective to
sell on the open market or to the government.
Key Political Issues
When the Proposal was being considered by Congress, the Treasury, the Federal Reserve and President
Bush had stated their belief that the Proposal should be enacted without delay or substantial change in order
to minimize further damage to the financial markets. However, the Plan was reworked and contains many
provisions not contained in the Proposal that represent Congressional efforts to rework what it viewed as
flawed legislation. The following summarizes certain key issues related to the Plan and the extent to which
Congress’ reactions to the Proposal were incorporated in the Plan:
•
Lack of Transparency and Accountability:
As originally drafted, the Proposal granted the Secretary almost limitless discretion to
effectuate the bailout plan: the Treasury had asked for U.S.$700 billion with few restrictions
as to the purchase and sale process or the management of purchased assets. Furthermore,
the Proposal prohibited judicial or administrative review of the Secretary’s decisions. This lack
of transparency and oversight was one of the most troubling aspects of the Plan in Congress’
eyes. Speaker of the U.S. House of Representatives Nancy Pelosi spoke for many within
Congress when she stated that the Proposal, in effect, had appeared to be a request by the
Treasury for a blank check with few conditions.
Bipartisan support for additional oversight of the bailout plan led to the substantial number of
such features contained in the Plan, including the establishment of the Financial Stability
Oversight Board, appointment of an Inspector General and limited judicial review of the
Secretary’s decisions. However, as mentioned throughout this Briefing, the Secretary is still
granted broad authority and discretion with respect to many aspects of the Plan. Also, it
remains to be seen if the various oversight bodies are able to peacefully and efficiently coexist, despite their political nature and multi-layered structure.
Furthermore, in order to gain more influence under the Plan, many lawmakers pushed for the
Plan’s funds to be disbursed in installments, a key feature of the Plan. However, this
mechanism provides the opportunity for further political disputes and dissatisfaction down the
road.
•
Executive Compensation:
Strong measures relating to executive compensation had been proposed in the House and
the Senate and were supported by Democrats including presidential candidate Senator
10
Barack Obama; supporters of these measures believed the bailout program should not permit
corporate executives to be the recipients of taxpayer dollars. The presidential administration
and most Republicans within Congress had opposed many of these proposals, stating that
such measures may limit participation in the plan and thereby make it even harder to value
distressed assets. The Executive Compensation provisions of the Act, while the result of
bipartisan compromise, are really a victory for the Democratic point of view. It is noteworthy in
this regard that the “say on pay” provision that was under consideration by both the House
and Senate did not find its way into the Act.
•
The Mandatory Insurance Program:
Many within Congress, especially House Republicans, feel the Plan’s intrusion into the
private sector violates free market principles. The Insurance Program required to be set up
under the Plan represents a victory by such lawmakers, who feel the financial institutions
themselves should shoulder some of the burden, in this case in the form of their premium
payments. However, because the insurance premiums required to be charged will be market
rates, based on a credit risk assessment, very few entities may decide to participate in the
Insurance Program. This is because the cost of premiums will likely be extremely high, since
mortgage-related securities are currently a very high risk asset.
•
Assistance to Taxpayers and Homeowners:
The Proposal did not contain any provisions specifically designed to help troubled
homeowners or ease the burden on ordinary taxpayers. Both parties viewed this omission as
a serious flaw and sought to introduce measures that benefited their respective agendas.
Each party succeeded in incorporating certain items on their agenda in the Plan. Republicans
within Congress were able to ensure that the government’s profits from the resale of Troubled
Assets and sale or exercise of warrants are set aside to reduce the federal deficit. Many
Democrats preferred to see profits earmarked in other ways, such as for affordable housing
funds, but conceded on this point. However, many other homeowner and taxpayer protections
did make their way into the Plan, including: the requirement that the Treasury and other
federal agencies modify troubled loans to the extent possible to reduce the incidence of
foreclosure, the ability of the government to purchase troubled assets from pension plans and
small banks that serve low- and middle-income families, and provisions helping small
businesses that need credit by permitting small, local banks to deduct losses from
investments in Fannie Mae and Freddie Mac stocks.
On the other hand, the House Democrats were unable to succeed in having a “cramdown”
provision included in the Plan that would have given bankruptcy judges discretion to adjust
the terms of mortgages subject to bankruptcy court proceedings, due to strong resistance
from others within Congress that believe this measure would violate the sanctity of contracts,
encourage litigious behavior, and further complicate the mortgage-backed security valuation
process.
•
The increase in the FDIC guarantee is designed to calm consumer fears about the economy
and prevent bank runs, which have contributed to market turmoil, including the collapses of
IndyMac and Washington Mutual Inc. This provision particularly appealed to centrists in both
major parties.
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The Future
The bailout plan is certain to have wide-ranging effects, both domestically and on an international scale. It
will be interesting to see the extent to which the Secretary asks other countries to consider following the
United States’ lead (and if such countries take similar steps). The guidelines that the Secretary is required to
issue will also provide important details as to how some of the programs and bodies constituted under the
Act will operate in fact. Perhaps most importantly, financial market participants, and even average U.S.
taxpayers, will be watching closely to see whether and how quickly the Plan achieves its intended goal of
restoring confidence to the U.S. financial markets.
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Please address any queries to any of your usual Linklaters contacts on +1 212 903 9000, or to any of the
following:
Contact
E-mail Address
Structured Finance
and Derivatives
Gary Barnett
Caird Forbes-Cockell
Adam Glass
Stan Renas
[email protected]
[email protected]
[email protected]
[email protected]
Corporate/Capital
Markets
Joshua Berick
Jeff Cohen
Ray Fisher
Edward Fleischman
Jon Gray
Nick Rees
Scott Sonnenblick
Larry Vranka
[email protected]
[email protected]
[email protected]
[email protected]
[email protected]
[email protected]
[email protected]
[email protected]
Executive
Compensation
Bindu Culas
Heidi Schmid
[email protected]
[email protected]
Tax
Stephen Land
[email protected]
Litigation
Paul Alfieri
Larry Byrne
[email protected]
[email protected]
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