Corporate Governance

From the Pages of The Pomerantz Monitor: Bail Out Funds Have Yet to Unfreeze the Credit Markets

By Carolyn Moskowitz

As President Obama appeals to Republicans to pass his $825 billion economic stimulus package, called the "American Recovery and Reinvestment Plan," it?s worth re-examining the Troubled Asset Relief Plan (?TARP?) initiated by the Bush Administration (known in some circles as T-TARP: the Troubled Troubled Asset Relief Plan). Obama, as we outline later in this post, is already addressing TARP?s failings and moving it in a new direction. In the January issue of The Pomerantz Monitor, we described the TARP baggage that Obama inherited.

TARP authorized the Treasury Department to funnel $700 billion of taxpayer money to many of the institutions that got us into this financial mess in the first place. The Treasury Department directed all nine of the largest financial institutions to sign up for TARP, whether they needed a bailout or not. If only desperate institutions were given a bailout, it reasoned, they would be ?stigmatized? as weak, undermining the whole purpose of the plan. Secretary Paulson summoned the CEOs of the top 9 banks to a meeting in Washington on October 13, at which he announced that the Government would spend $250 billion of TARP funds to purchase preferred shares in each of their companies. This was an offer they couldn?t refuse. And they didn?t. 

Instead of lending, some bailout recipients have stuffed their TARP money into mattresses, where it can shore up their balance sheets. Others have used it to acquire other banks. For example, Bank of America received $15 billion from TARP, and a few weeks later announced that it would spend $7 billion to increase its stake in China Construction Bank. The Treasury Department has given its blessing to the use of bailout money to acquire failing banks, but the money is being used for other acquisitions as well. 

Some institutions have paid out much of the bailout money as dividends to their own shareholders. The Washington Post estimated that, if current trends continued, over half the bailout funds would be paid to shareholders as dividends during the next three years. The Bush administration has also defended this diversion of bailout funds, claiming that dividends are beneficial to the economy. By contrast, European governments have demanded that all companies receiving bailout money suspend dividends until the government loans are repaid.

Other institutions are reportedly planning to use a big chunk of their bailout money to pay lavish bonuses to management. TARP requires that executive bonuses not exceed those paid in the past. But given the extravagant spending by investment banks on year-end bonuses in past years, that hardly a limitation. Goldman Sachs and Morgan Stanley, which collectively received $20 billion in bailout money, disclosed after the third quarter that they had already set aside $11 billion for bonuses this year. Congress and the NYAG are investigating this year?s bonus plans at the nine biggest banks, which have collectively received $125 billion so far from the U.S. Treasury. If huge payouts are announced, there will be a backlash. Some of the banks argue that if they shut off all bonuses, top talent will flee to greener pastures. Given what wonders such talent has worked, however, some will be happy to say good riddance. The outcry over this issue got so bad that the chairs of Goldman and Morgan Stanley had to publicly forgo all bonus money and work for $1 per year, and there is pressure on others, such as John Thain of Merrill Lynch, to follow suit.

Making matters worse, people are only now starting to notice that there is a huge loophole in the limitations on executive compensation imposed by TARP. These limitations have some teeth, including, most significantly, the prohibition on companies who receive bailout funds from deducting more than $500,000 from their taxable income for the compensation of any executive. Just before the bill was voted on, however, the Bush Administration insisted that these compensation limits apply only to companies that sell assets to the government, and not to companies that receive bailout funds as investments or in other ways. Although Treasury originally planned to use the bailout funds to buy ?troubled assets,? it has subsequently done an about-face and decided to invest in the distressed companies instead. As a result, the TARP compensation limits are inapplicable. 

Finally, Citibank, which in late November received a $20 billion federal bailout, plus another $300 billion guaranty of its toxic debts, is refusing to cancel a $400 million deal to have the new stadium for the New York Mets named ?Citi Field?; and AIG, which received over $100 billion, is not trying to undo its agreement to pay $125 million to have its logo appear on the uniforms of the Manchester United soccer team. 

Not surprisingly, these developments have led to an outcry from Capitol Hill, the public and the press. "These loans must not be used to acquire healthy banks, hoard in their coffers, or pay shareholder dividends," Sens. Charles E. Schumer (D-N.Y.) and Robert Menendez (D-N.J.) wrote in a letter to Treasury Secretary Henry M. Paulson Jr. in early November. Since money is, of course, fungible, lawmakers are thinking that, until the bailout money is paid back, dividends, bonuses and acquisitions should be strictly limited or even eliminated. 

President Obama has pledged to continue with the TARP, but to re-focus it in a direction favored by congressional Democrats such as Barney Frank: to devote more TARP money to preventing home foreclosures; give small banks more TARP access; force more disclosure by TARP participants; limit use of TARP funds in bank buyouts; and standardize restrictions on the pay of executives employed by TARP recipients. We welcome the change of focus for TARP and will follow carefully, and hopefully, the progress of Obama?s new stimulus plan.

Full post as published by PomTalk on January 27, 2009 (boomark / email).