Contents

History [ edit ]

The legislation had its origin in early 2008, Secretary of the Treasury Henry Paulson directed two of his aides, Neel Kashkari and Phillip Swagel. to write a plan to recapitalize the U.S. financial system in case of total collapse. The plan, which was also presented to Federal Reserve Chairman Ben Bernanke. called for the U.S. government to purchase about $500 billion in distressed assets from financial institutions. [ 4 ]

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 H.R. 3997. [ 5 ] The amendment was rejected via a vote of the House of Representatives on September 29, 2008, voting 205–228. [ 6 ]

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. [ 7 ] [ 8 ] The Senate accepted the amendment and passed the entire amended bill, voting 74–25. [ 9 ] Additional unrelated provisions added an estimated $150 billion to the cost of the package and increased the length of the bill to 451 pages. [ 10 ] [ 11 ] (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. [ 7 ] [ 12 ] [ 13 ] 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. [ 14 ] TARP was dwarfed by other guarantees and lending limits; analysis by Bloomberg found the Federal Reserve had, by March 2009, committed $7.77 trillion to rescuing the financial system, more than half the value of everything produced in the U.S. that year. [ 15 ]

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, [ 16 ] claimed that better alternatives were not considered, [ 17 ] and that the Senate forced passage of the unpopular version through the opposing house by sweetening the bailout package. [ 18 ]

Economic background [ edit ]

After 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 [ 19 ] 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. [ 20 ] The same day, CNN reported these worldwide stock market events: [ 21 ]

• Britain’s FTSE 100 Index was down 7.9%
• Germany’s DAX down 7.1%
• France’s CAC 40 dropping 9%
• In Russia, trading in shares was suspended after the RTS stock index fell more than 20%.
• Iceland halted trading in six bank stocks while the government drafted a crisis plan.

Paulson proposal [ edit ]

U.S. Treasury Secretary Henry Paulson proposed a plan under which the U.S. Treasury would acquire up to $700 billion worth of mortgage-backed securities. [ 22 ] The plan was immediately backed by President George W. Bush and negotiations began with leaders in the U.S. Congress to draft appropriate legislation.

President Bush meets with Congressional members, including presidential candidates John McCain and Barack Obama. at the White House to discuss the bailout, September 25, 2008. [ 23 ]

Consultations among Treasury Secretary Henry Paulson, Chairman of the Federal Reserve Ben Bernanke. 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. [ 24 ] [ 25 ]

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 markets 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. [ 26 ] [ 27 ] [ 28 ]

Throughout the week of September 20, 2008, there was contentious wrangling among members of Congress over the terms and scope of the bailout, [ 29 ] 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. [ 30 ]
• On September 23, the plan was presented by Paulson and Bernanke to the Senate Banking Committee. who rejected it as unacceptable. [ 31 ]
• 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. [ 32 ]
• Also on September 24, 2008, Republican Party nominee for President, John McCain. and Democratic Party nominee for President, Barack Obama. issued a joint statement describing their shared view that The effort to protect the American economy must not fail. [ 33 ]

The plan was introduced on September 20, by Paulson. Named the Troubled Asset Relief Program, [ 22 ] 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. [ 34 ] that was released on March 31, 2008.

The proposal was only three pages long, intentionally short on details to facilitate quick passage by Congress. [ 35 ]

Mortgage asset purchases [ edit ]

A 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 markets 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. [ 26 ] [ 27 ]

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. [ 36 ] [ 37 ]

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. [ 38 ] 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. [ 39 ] 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. [ 40 ] 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. [ 41 ] 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. [ 42 ]

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. [ 43 ]

Sweeping powers [ edit ]

The original plan would have granted the Secretary of the Treasury unlimited power to spend, [ 29 ] 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. [ 22 ] This provision was not included in the final version.

Potential effects [ edit ]

The 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). [ 44 ] 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. [ 45 ] [ 46 ] [ 47 ] [ clarification needed ] 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. [ 48 ] 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. [ 49 ] [ 50 ] [ 51 ]

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. [ 52 ]

Rationale for the bailout [ edit ]

Government officials [ edit ]

In his testimony before the U.S. Senate, Treasury Secretary Henry Paulson summarized the rationale for the bailout: [ 53 ]

• 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: [ 54 ]

• Investor confidence: Among the firms under the greatest pressure were Fannie Mae and Freddie Mac. Lehman Brothers. and, more recently, American International Group (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. [ 55 ]

Journalists [ edit ]

According to CNBC commentator Jim Cramer. large corporations, institutions, and wealthy investors were pulling their money out of bank money market funds, in favor of government-backed Treasury bills. 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. As a bank’s capital reserve of deposits evaporate, so too does its ability to lend and correspondingly make money. 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. [ 56 ]

Reaction to the initial proposal [ edit ]

Skepticism 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. [ 57 ] Alabama Republican Spencer Bachus has called the proposal a gun to our head [ 58 ] fear-inflicting policy of the administration to stifle proper debate and affect decision. [ 29 ] However, many sources have reported that for this crisis there are many alternatives and options, [ 59 ] 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 reactions [ edit ]

On 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. [ 60 ] [ 61 ] 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. [ 62 ] 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. [ 63 ] 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%, [ 64 ] still far below the average rate during the early 1990s recession. when it topped 9.0%. [ 65 ]

Potential conflict of interest [ edit ]

There 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 had hired Goldman executives as advisors and Paulson’s former advisors had 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. [ 66 ] [ 67 ] [ 68 ]

The treasury staff member responsible for administering the bailout funds was 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. [ 69 ] [ 70 ]

Views from the public, politicians, financiers, economists, and journalists [ edit ]