After a week of tumult and tempest, Congress passed a significantly revised version of the Emergency Economic Stabilization Act of 2008 (the "Act"). Shortly afterward, President Bush signed it into law. So much changed between the original iteration of the legislation and the version that was signed into law that we offer a before-and-after snapshot and, more importantly, thoughts on how this might affect you.
In the beginning, there was a two-page document that provided little detail but gave Treasury Secretary Henry Paulson virtually unfettered control over $700 billion in bailout/rescue funds. What Congress passed was a 451-page bill that provides for some significant oversight and clarifies what the secretary can do. In both cases, the premise behind the legislation was that granting participating institutions with liquidity and price support for distressed assets would alleviate the crisis of confidence in the capital markets and trigger new lending.
One of the most significant changes is that the new legislation provides a staggered schedule of this staggering amount of money. Under the original plan, Treasury would fund $700 billion immediately. Under the legislation that became law, the immediate funding authorization is $250 billion, with the balance coming in two tranches: (1) $100 billion upon the president's certification to Congress that Treasury needs the additional spending authority, and (2) the final $350 billion if the President certifies Treasury's need for such funding and provides a written report on how Treasury intends to spend the final sums.
Covered Assets. In the version that passed, Section 101(a)(1) authorizes Treasury to purchase "distressed assets from any financial institution, on such terms and conditions as are determined by the Secretary." The Act's language authorizes purchases of many classes of assets, such as credit card receivables, auto loans or even corporate loans; most public discourse has focused on mortgage-related assets. Stay tuned to see how that shakes out. Meanwhile, keep in mind only distressed assets originated on or prior to March 14 are eligible.
Implementation. Neither version states how assets will be selected for purchase nor how the Treasury Department will set prices for purchase. Press reports have said that Treasury will likely use reverse auctions, in which purchasers offer securities in sealed bids and the government buys at the lowest offered price. One limitation on Treasury's authority is that it cannot purchase a troubled asset for a higher price than the seller paid for that asset.
The Treasury Department also has broad discretion on the management and disposition of distressed assets. Treasury is authorized to hold distressed assets until maturity or re-sell them. The Act's supporters hope that the government may be able to reduce the overall cost of the rescue by reselling at a profit some mortgage-backed securities it purchased. Whether that hope will be realized is one of many uncertainties regarding the overall cost of the Act.
The Act authorizes Treasury to use external contractors or advisors in the purchase, sale or management of the assets. The Act also directs Treasury to develop and publish regulations dealing with conflicts of interest in the operation of the program, including rules on conflicts of interest in: the hiring of asset managers, the purchase of distressed assets, management of distressed assets, post-employment restrictions and other ethical issues.
Oversight. One of the key weaknesses of the original Paulson proposal was its lack of oversight, a deficiency that Congress fixed. The revised Act directs Treasury to consult with the Federal Reserve, the Securities Exchange Commission, the Department of Housing and Urban Development and the Federal Home Finance Agency. The Act also creates a Financial Stability Oversight Board to be composed of the Chairman of the Federal Reserve, the Treasury Secretary, the Director of the Federal Home Finance Agency, the Chairman of the SEC and the HUD Secretary. The Financial Stability Oversight Board is to report to Congress quarterly. The Treasury Secretary must report to Congress monthly on the operation of the program, with the report to contain information on the assets purchased, the prices paid and a justification for such transactions. The first report to Congress is due 60 days after the commencement of the program.
Warrants in Participating Institutions. To counter widespread criticism that the initial proposal represented an unjustified, one-way bail-out of financial institutions that had made bad investment decisions, the revised Act provides that the Treasury Secretary shall receive warrants or senior debt instruments, respectively, from participating publicly traded and private sellers. Treasury is authorized to set the terms relating to these warrants or senior debt, and also to determine whether to exercise or sell these warrants.
Homeowner Protections. Fear that the Administration would do nothing to help homeowners avoid foreclosure—or even aggressively foreclose on delinquent residential borrowers—gave rise to provisions that encourage forbearance and workouts on mortgages, mortgage backed securities and other assets secured by residential real estate. Under the law, Treasury is required to:
The Act also directs the Federal Housing Finance Authority—as conservator of Fannie Mae and Freddie Mac—the FDIC and the Federal Reserve to maximize assistance for homeowners and minimize foreclosures.
Executive Compensation. As enacted, the law requires that participating financial institutions in which the government has received "a meaningful equity or debt position" must meet "appropriate standards for executive compensation and corporate governance." Even the version signed into law does not provide details to explain that directive. It requires, however, that institutions that sell more than $300 million in assets to the government include "claw back" provisions on bonuses for senior executives. Participating institutions are also barred from offering so-called 'golden parachutes' to executives so long as the institution is participating in the program. Finally, compensation over $500,000 annually for senior executives will no longer be deductible for tax purposes.
Default Insurance. The Act permits Treasury to guarantee distressed assets originated or issued prior to March 14. The guarantee program may, upon the request of a financial institution, guarantee the timely payment of principal and interest on a troubled asset up to 100 percent of such payments. Premiums will be set by the Secretary based on credit quality of the assets. Amounts insured under this portion of the Act will reduce—dollar for dollar—Treasury's authority to purchase distressed asset. Treasury must report to Congress the status of the insurance program within 90 days after the enactment of the Act.
Future Regulation. The Act requires that by April 30, the Treasury Secretary provide to Congress a report on the state of the financial markets, an overview of the regulatory system for the markets and any proposals for reform. The report is to address regulation of credit default swaps and other derivatives, the role of government-sponsored entities (such as Fannie Mae and Freddie Mac), and whether participants outside the regulatory system should become subject to regulation. This provision is the result of a year-long, inside-the-Beltway policy debate, the gist of which is how regulation of the financial system should be revised in light of current market conditions. The inclusion of this provision ensures that the broader issue of regulation of the financial system will be on the agenda in 2009, irrespective of the results of the presidential election.
What This Means To You. Passage of this legislation, by no means ends the debate or, necessarily, the credit crisis. Public discourse and debate will continue through November 4 against the backdrop of the presidential elections, and well beyond as our new chief executive takes office. Follow the action as reported in the mainstream media and trade journals, be on the lookout for further updates from us, and:
Please contact Stephen Selbst at (212) 592-1405 or firstname.lastname@example.org if you have any questions regarding this update.
Copyright © 2008 Herrick, Feinstein LLP. The Credit Crisis Update is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.