Bankruptcy

Senate Bailout Bill: Just a 451-Page Version of Paulson's Two-and-a-Half Pages

By Adam Levitin

For all the ink spilled about the bailout bill over the past week or so, there has been strikingly little media coverage paid to the actual terms of the bailout bill. A tremendous amount of attention has been paid to the politics of the bill, but it just doesn?t make a lot of sense to talk about the politics of the bill without looking at the substance of the bill. Legislation can be technical and it can be hard for reporters to know the significance of legislative provisions, but I?ve just read too many articles that regurgitate the blandishments about the revised (and rerevised) bill imposing oversight, limits on executive pay, help for homeowners, and now the FDIC deposit cap drivel. Any consideration of the substantive provisions shows that there's a lot of verbiage and very, very little in substance. Once one realizes this, the politics of the bill are even more bizarre and more fascinating.

The bill has been bloated up to 451 pages in the Senate version. The additional 341 pages in the Senate version have nothing to do with the bailout per se, but instead are an energy bill and a tax bill. In short, the Senate version is the same as the failed House version, but with the addition of (1) the irrelevant FDIC provision, and (2) other unrelated legislation. And the House version was just a 110-page expansion of the Paulson's original two-and-a-half page proposal that had lots of extra window-dressing, but little in the way of new substantive provisions that are actually mandatory, enforceable, and monitorable. This means that the Senate version of the bailout bill has the same flaws as the original Paulson bill. (Gotta hand it to Hank--he's concise.)

First, it has very, very weak oversight. No matter how many oversight boards and committees and inspectors general and GAO reports there will be, the essential oversight over $700BN is in creating a pricing mechanism for Treasury that limits Treasury's discretion. No one is going to question Treasury's business judgment. And that's the problem. Business judgment allows for a lot of malfeasance and mismanagement that simply cannot be proven. It is a very deferential standard, just like the "arbitrary and capricious" judicial review standards for Treasury's actions. Does anyone really think that Congress will dicker with Treasury over whether it paid 40 or 50 cents on the dollar for some bum MBS? And is an oversight board going to question the order in which Treasury helped out financial institutions? And who is really going to investigate whether Treasury overpaid in commissions to financial institution agents? These are all business judgment calls, and Treasury will get a pass in every case. That should concern us, especially when we're talking about $700BN.

If we?re worried about conflicts of interest and waste, we should just go with a simple, transparent, and fast auction process with mandatory equity-taking requirements. We?ve already established with AIG and Fannie and Freddie that the price-tag for a bailout is shareholder dilution. That price tag should not be discretionary as it is now. Treasury has no particular expertise in pricing these assets and frankly neither do financial institutions?if they did, we wouldn?t have a problem. There?s just no reason to pay billions in commissions and trying to calculate prices asset by asset will take time that the economy doesn?t have. Just hold a reverse Dutch auction on the steps of the Treasury on Friday and be done with it all.

Second, the executive compensation provisions are sheer nonsense. There are lots of ways to curb executive pay, but making another $500K not tax deductible for all of 3 employees and only for financial institutions that have $300MM in troubled asset dealings with Treasury excluding sales is just smoke and mirrors. This is a bs part of the bill. Its not hard to understand and the press should be all over it.

Third, the homeowner assistance provisions of the bill are also meaningless. Treasury just isn?t going to be purchasing very many mortgages directly and holding mortgage-backed securities doesn?t give Treasury the ability to modify mortgages. This bill will do little, if anything, to help financially distressed homeowners.

The whole problem with MBS is that no one is confident of their valuation because of high default and foreclosure rates. This lack of confidence either (1) depresses MBS resale prices, making financial institutions have to mark them to market very low, which raises capital adequacy issues in some cases or (2) means that there is no market whatsoever. If the goal of the bailout is to restore the MBS market to a more accurate reflection of the assets? values, the best fix is to modify mortgages so that there will be smaller MBS pool losses. Yes, there will be losses, but they will be (1) quickly known and (2) much smaller than from foreclosure. This is a really easy way to fix the market, without taxpayer dollars involved.

And as I noted earlier today, the idea that adding in a provision that temporarily raises FDIC insurance caps is just laughable. This helps a few rich, but stupid/lazy people (the smart ones can work around it easily) and perhaps some small businesses. But FDIC caps being too low just aren't the economy's problem.

Let me make clear that I have no ideological aversion to a bailout bill. But there?s a good bailout bill and there?s an incompetent and wasteful one. We?re facing the later and there?s no reason we couldn?t easily have the former?its not that hard to figure out what to do. Of course, getting Congress to agree to any provisions that might gore someone?s ox (mortgage industry, exec pay, banking lobby, etc.), however, is another story.

Full post as published by Credit Slips on October 01, 2008 (boomark / email).