Congressional and Administrative Status Update Regarding Economic Bailout

September 23, 2008

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets.

What follows is our latest in a series of updates on key regulatory and legislative issues.

Senate Banking Committee Hearing

The Senate Banking Committee met today to hear testimony from Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke, Securities and Exchange Commission Chair Chris Cox, and Federal Housing Finance Agency Director James Lockhart.

Treasury Secretary Paulson continued to advocate for a narrowly tailored bill without additional corporate governance provisions which could slow down approval of the legislation.  Though he maintained that approval of the legislation needed to be quick and administration of the program efficient, he seemingly relented slightly to congressional demands for stronger oversight of the program.  He stated that Treasury is considering auctioning one asset class at a time.[1]  Finally, he called for economic structural reform to come after the country weathers this initial crisis.[2]

Federal Reserve Chairman Bernanke said the $700 billion dollar plan to purchase troubled mortgage backed assets would stabilize the financial markets, and offered a grim picture of the economy if Congress does not act on the legislation.  Bernanke urged that Treasury not buy the assets at "fire-sale" prices, but purchase them at "hold-to-maturity" prices.  Though the lower fire-sale prices would benefit taxpayers when the assets rose again, a massive government purchase of the assets at those prices would depress the market even further. He suggested that an auction mechanism would be the most appropriate way to determine the hold-to-maturity values.[3]

SEC Chair Chris Cox focused his testimony on the SEC’s role as a law enforcement agency and discussed the various investigations the SEC has undertaken in the subprime market.  He also urged Congress to give the SEC greater authority to regulate the national market in credit default swaps.[4]

FHFA Director James Lockhart discussed the market conditions that he believes led to Fannie Mae and Freddie Mac’s deterioration and the FHFA’s decision to place the government sponsored enterprises into conservatorship.[5]

Debate on the Hill

Reportedly, the Democrats are pushing for issues such as executive compensation and bankruptcy laws to be addressed in the bailout legislation, while Treasury is focused on producing a more narrowly tailored bill.  Secretary Paulson argues that such provisions could discourage small banks and credit unions, among other institutions, from participating in the program.[6]  At least one compromise option has been suggested, which would apply executive compensation limits only on those firms to which Treasury provides a significant amount of capital.[7] 

Republicans primarily are concerned with protecting taxpayers and many have expressed doubts about writing the federal government an enormous blank check to bail out private companies.[8]  Former Speaker of the House Newt Gingrich urged congressional members to vote against Treasury’s bailout plan and predicted that no plan would be passed if one has not been passed by Friday night.[9]

During the Banking Committee Hearing, Senator Schumer called for the $700 billion in purchasing authority to be given to Treasury in tranches to better protect taxpayer interests.

Congressional members from both parties have proposed postponing their election year recess to stay in Washington and devote more time to the legislation.[10]

Other Developments

Treasury has agreed to include stricter oversight of the bailout plan and assistance to homeowners facing foreclosure in the bailout plan, which have been two of the Democrat legislators’ main priorities.[11] 

The draft tax title of the financial package, released today, would reduce executive compensation deductibility from $1 million to $400,000 for the top five executives of participating corporations and would impose a 20 percent excise tax on golden parachute outlays above a limit set by Treasury. 

The tax title would permit many banks to treat their losses from their preferred stock holdings in Fannie Mae and Freddie Mac as ordinary losses which reduce the banks’ need to raise more capital.  The tax provisions also would prevent sales of bad mortgages to Treasury from Real Estate Mortgage Investment Conduits from triggering a 100 percent tax penalty, and would extend a provision from the July housing relief bill that allows homeowners to avoid paying taxes on forgiven mortgage debts.[12]

Both Republicans and Democrats have agreed to allow Treasury to take an equity stake in financial institutions that sell assets to the government, though the details of that plan have not been resolved.[13]

Yesterday, September 22, the IRS announced that Treasury and the IRS will not assert that the Treasury-initiated program to insure the holdings of money market funds violates any restrictions placed on tax-exempt money market funds.  Thus, eligible money market funds may participate in the Treasury program and still claim their regular benefits from tax exemption.

Yesterday, the FHFA announced new chairmen of Fannie Mae and Freddie Mac.  Former Chairman of Ernst & Young, Philip Laskawy, has taken over as the new chair of Fannie Mae, and John Koskinen, former President and CEO of Palmieri Company and former Deputy Director for Management at the OMB has taken over as chair of Freddie Mac.[14]

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                [1]  Bernanke Goes Off Script to Address Fire Sale Risks, Wall St. J., Sept. 23, 2008 at http://online.wsj.com/page/lexis.html ("Real Time Economics" Blog).

                [2]  Testimony of Treasury Secretary Paulson to the Senate Committee on Banking, Housing, and Urban Affairs, Sept. 23, 2008 [http://banking.senate.gov/public/_files/PAULSONTestimony92308.pdf]