I want to focus on some incorrect and inflammatory statements by Dr. Goolsbee this morning:

Chris Wallace:  I also want you to talk about the clash between policy and profits.  The governments wants General Motors to make small cars, fuel-efficient cars, while all the indications are, that according to the market, the cars they make most profit on are SUVs and pickup trucks.  So which takes preference?  Profits for the taxpayer shareholders, or environmental policy?

Dr. Goolsbee:  The President made totally clear in his remarks, and he specifically said we are not going to be in the business of telling General Motors or anybody else what kind of cars to make, where they should open their plants, or anything of the sort.  The President made clear we want to get out of this as quickly as possible.  We are only in this situation because somebody else kicked the can down the road, and that’s really an understatement.  They shook up the can, they opened the can, and handed to us in our laps.  Senator Shelby knows that to be true.  When George Bush put money in to General Motors, almost explicitly with the purpose, how many dollars do they need to stay alive until January 20th, 2009?  There was no commitment to restructuring, to making these viable enterprises of any kind. They made none of the serious sacrifices.  And Republicans in the Senate attached a list of conditions, they opposed George Bush’s intervention, because they said the unions had not made the following sacrifices.  In the Obama plan, it asked more and received more from the unions and from the other stakeholders than the people that objected to the bailout last November asked for.  So we have finally put them on that path.

This is incorrect.  I will bite my lip, refrain from commenting on the tone, and focus on the facts.

History

At 3:30 pm on Sunday, November 30, 2008, a quiet meeting occurred at the Treasury Department in Secretary Hank Paulson’s office.  Present for the Bush Administration were Treasury Secretary Paulson and Commerce Secretary Carlos Gutierrez, White House Chief of Staff Josh Bolten, Deputy COS Joel Kaplan, White House Legislative Affairs chief Dan Meyer, Treasury Legislative Affairs head Kevin Fromer, and me.  Present for the incoming Obama Administration were Deputy COS-designate Mona Sutphen, NEC-designate Dr. Larry Summers, Dan Turullo (now a Fed Governor), and WH Legislative Affairs-designate Phil Schiliro.  We had requested the meeting.  They agreed and asked that it be held outside the White House.  It appeared to us that they were quite concerned about leaks, and about the risk of creating a public impression that they were working closely with us.

At that meeting, we (the Bush team) floated a proposal to establish an auto czar.  President Bush would create a new position called a Financial Viability Advisor (FVA) through an executive order.  The President would instruct the FVA, for any auto manufacturer that sought a “bridge loan,” to evaluate that firm’s restructuring plan for viability.  If after 60 days (which the FVA could unilaterally extend for another 30) the firm did not have a plan to achieve viability, then the FVA would produce his own plan to make that firm viable.  The draft executive order was explicit that the FVA could include a Chapter 11 bankruptcy in his plan.  We invited the Obama team to suggest names for the Financial Viability Advisor, so that it would be someone with whom the new President would be comfortable.

Under the Bush team’s proposal to the Obama team, the current Secretary of the Treasury (Paulson) would provide bridge funding from the TARP, and he would state that, as a matter of policy, no further TARP funding would be made available except in support of (1) a plan certified as viable by the FVA, or (2) the FVA’s own plan.

The key to success of this plan was that the Obama team would publicly link arms with us and agree that they would continue the Paulson policy statement when they took over after January 20th.  Thus, the auto company’s stakeholders would know that they had no wiggle room, and that they had no chance of getting additional funding from the next Administration.  The Obama team would voluntarily commit itself to be bound by the restriction self-imposed by the Bush team.

Remember that this was one of two huge issues going on at the time.  The bigger issue was the financial crisis, and we were nearing the limit on the $350 B of available TARP funds.  We were concerned that another too-big-to-fail institution might fail before January 20th without Treasury having the funds available to prevent a systemic collapse.  So our proposal to the Obama team was a package deal:  we will announce the above process for autos, and we will ask Congress for the second $350 B of TARP funding, if the President-elect publicly supports us on both.  They would join with us in convincing Congress to approve the last tranche of TARP funding, since we would need help with Congressional Democrats.

We saw two huge economic issues that posed grave risks to the economy and to a smooth transition.  We proposed to work together with the incoming Administration in a way that we thought minimized these risks and would have positioned the new President as well as possible on January 20th.  GM and Chrysler would not be in liquidation, and there would be a strict, tight, and enforceable deadline (of about March 1) and process for GM and Chrysler to become viable or to have time to prepare for an orderly Chapter 11 process.  We would have a cushion in case another major financial institution failed in the last eight weeks, and the next President would not have to be bothered with having to ask Congress for the last $350 B from the TARP.

The Obama team were polite and professional.  They listened carefully and gave little reaction in the meeting.  We concluded based on their questions in that meeting that they were leaning against the proposal, because they did not want to be bound by the judgment of a Financial Viability Advisor – they wanted the ability to make decisions in the White House.  They also appeared to want to avoid being bound by our strict definition of viability.  (We defined a viable firm as one that would, under reasonable assumptions, have a positive net present value without additional taxpayer assistance.)

Dr. Goolsbee was not in this meeting.  I do not know if he was aware of it, either back in November or this morning.

Despite multiple efforts to get the Obama team on board, they did not take up our proposal, nor did they suggest any modifications.  At the end of that week we gave up on that approach and began to negotiate a bill with Speaker Pelosi, Chairman Barney Frank, and Chairman Chris Dodd that would provide bridge loans from previously appropriated non-TARP funds.  Senate Republicans blocked that bill.  Congress adjourned for the year and went home.  In the last week of December, GM and Chrysler told us they would file under Chapter 11 in early January if they did not get loans from the TARP.  They also told us, as did countless outside experts, that they were not ready for such a filing, and that Chapter 11 would lead to near-immediate liquidation.  We estimated that about 1.1 million jobs would be lost if this happened.

Confronted with a choice between loaning TARP funds to GM and Chrysler, and allowing both to liquidate in the weeks before his successor took office, President Bush authorized loans from the TARP to GM and Chrysler.  We had warned Senate Republicans earlier that month that the President would face this choice if legislation failed.  This was (and still is) a politically unpopular decision, and was the least worst of two bad options.  Based both on his public comments and what I saw privately, President Bush wanted to give the firms a limited amount of time and a hard back end to prepare for and, if necessary, to force an orderly Chapter 11 process.  He also knew that President-elect Obama would be facing tremendous challenges in his first days in office.  Despite their different political parties and policy perspectives, President Bush stressed that we needed to provide his successor with the time and space he would need in the opening weeks of his Presidency.

Structure of the December loans to GM and Chrysler

In the last few days of December, Treasury loaned $24.9 B from TARP to GM, Chrysler, and their financing companies.

According to the terms of the loan (see pages 5-6 of the GM term sheet), by February 17th GM and Chrysler would have to submit restructuring plans to the President’s designee (and they did).

Each plan had to “achieve and sustain the long-term viability, international competitiveness and energy efficiency of the Company and its subsidiaries.”  Each plan also had to “include specific actions intended” to achieve five goals.  These goals came from the legislation we negotiated with Frank, Pelosi, and Dodd:

1. repay the loan and any other government financing;
2. comply with fuel efficiency and emissions requirements and commence domestic manufacturing of advanced technology vehicles;
3. achieve a positive net present value, using reasonable assumptions and taking into account all existing and projected future costs, including repayment of the Loan Amount and any other financing extended by the Government;
4. rationalize costs, capitalization, and capacity with respect to the manufacturing workforce, suppliers and dealerships; and
5. have a product mix and cost structure that is competitive in the U.S.

The Bush-era loans also set non-binding targets for the companies.  There was no penalty if the companies developing plans missed these targets, but if they did, they had to explain why they thought they could still be viable.  We took the targets from Senator Corker’s floor amendment earlier in the month:

1. reduce your outstanding unsecured public debt by at least 2/3 through conversion into equity;
2. reduce total compensation paid to U.S. workers so that by 12/31/09 the average per hour per person amount is competitive with workers in the transplant factories;
3. eliminate the jobs bank;
4. develop work rules that are competitive with the transplants by 12/31/09; and
5. convert at least half of GM’s obliged payments to the VEBA to equity.

If, by March 31, the firm did not have a viability plan approved by the President’s designee, then the loan would be automatically called.  Presumably the firm would then run out of cash within a few weeks and would enter a Chapter 11 process.  We gave the President’s designee the authority to extend this process for 30 days.

In another error this morning, Dr. Goolsbee claimed the “Obama plan, it asked more and received more from the unions and from the other stakeholders than the people that objected to the bailout last November asked for.”  As I wrote last Monday (Understanding the GM bankruptcy), I have seen no convincing evidence that GM workers will now be paid competitive compensation with transplant workers, nor that the work rules are competitive with the transplants.  The negotiations led by the Obama team did meet the Corker targets for the unsecured debt holders and the retiree benefits, but current workers still look to have received a relatively good deal.

Chronology

November 30:  Bush team proposes joint solution to Obama team.

The following week:  Obama team declines to respond.  Bush team begins negotiations with House and Senate Democrats.

Mid-December:  Bush team negotiates compromise legislation with House and Senate Democrats.  Senate Republicans block the legislation.  Congress goes home.

Late December:  President Bush authorizes the above-described three month loans to GM and Chrysler.

January 20:  President Obama takes office.

Mid-February:  GM and Chrysler submit their first viability plans, per the terms of the Bush-era loans.

End of March:  President Obama says GM and Chrysler have failed to develop viable plans, as required by the Bush-era loans.  He gives Chrysler 30 more days, and GM about 60 until the end of May.

End of April:  Chrysler files Chapter 11 with a pre-packaged plan negotiated largely by the Obama Administration.

June 1:  GM does the same.  Chrysler emerges from Chapter 11.

Responding to Dr. Goolsbee

Let’s again examine Dr. Goolsbee’s claim:

We are only in this situation because somebody else kicked the can down the road, and that’s really an understatement.  They shook up the can, they opened the can, and handed to us in our laps.  Senator Shelby knows that to be true.  When George Bush put money in to General Motors, almost explicitly with the purpose, how many dollars do they need to stay alive until January 20th, 2009?  There was no commitment to restructuring, to making these viable enterprises of any kind.  They made none of the serious sacrifices.

Even if Dr. Goolsbee was not privy to the quiet discussion we had with the senior Obama team last November, the public record refutes his claim:

1. The Obama team declined to respond to the Bush team’s offer to work together to create a joint process that would have resulted in a resolution by March 1st or April 1st, rather than by June 1st for Chrysler and maybe September 1st for GM.
2. We then worked with the Democratic majority to enact legislation that would have limited funds to be available only to firms that would become viable.
3. After Congress left town for the holidays without having addressed the issue, President Bush was faced with a choice between providing loans and allowing these firms to liquidate in early January, which would have further exacerbated the economic situation for the incoming President.  President Bush chose to provide the loans.
4. We provided GM and Chrysler with sufficient funds to get to March 31st, not January 20th, and in those loans we gave the incoming Administration the ability to extend them for 30 more days.
5. The loans were conditioned on restructuring to become viable, with a precise definition of viability, specific restructuring goals, and quantitative targets.
6. The Obama Administration followed the restructuring process laid out in the Bush-era loans.  They are now measuring that deal against the targets established in the Bush-era loans.  The only changes the Obama team made were that they extended GM for 60 days rather than 30, and the Obama Administration directly inserted themselves into the negotiations as the pre-packager.

Dr. Goolsbee’s comments this morning were both inflammatory and incorrect.

Dr. Goolsbee gets it wrong on the auto loans

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. Auto loans, part 3: the Bush approach
2. Auto loans, part 4: Chrysler gets an ultimatum, GM gets a do-over
3. Auto loans: a deadline looms

I wrote last November about the first G-20 Economic Summit, initiated and hosted by President Bush.  You can see some neat behind-the-scenes photos of the gorgeous National Building Museum and read about the accomplishments of that summit.  Last November the press tried to write the story “Lame duck President … not much accomplished.”  That storyline was incorrect.  Now we have a new American leader and one fundamental policy shift, but much of the agenda remains consistent.

There is a symbolically important change to watch for in the text of the leaders declaration, compared to that in the November text.  I fear that the word “free” may be absent in the successor statement to this sentence from the November leaders declaration:

12.  We recognize that these reforms will only be successful if grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively regulated financial systems.

Losing “free” would be an enormous step backward.  All G-20 nations agreed to the above statement last November, so there is no good reason to change it if the U.S. objects.  In the short run, it is easy to see how a negotiator might give this up for a more concrete immediate objective.  In the long run, few things are as important.  I hope the American team will insist on repeating this language, and in particular keeping the phrase “a commitment to free market principles,” as our negotiator did last fall.

Four of the five major topics of discussion at the summit are extensions and continuations of the November efforts.  There is one big difference, influenced greatly by our new President.  After reviewing the available press and talking with Dan Price, President Bush’s “sherpa” for the first G-20 summit last November, here are my expectations for the London G-20 summit.

1. Global macroeconomic stimulus — The big difference is the new #1 agenda item for the G-20, global macroeconomic stimulus.  President Obama’s first domestic economic policy effort was the enactment of a law that he argues will stimulate near-term macroeconomic growth.  He is pushing other nations to take similar actions, and for the G-20 as a whole to support similar global efforts.

   I expect the final G-20 statement will broadly support national actions for macroeconomic stimulus, but will not include any numbers.  It will say something like “Nations should do what is necessary…”  It may also emphasize the fiscal actions already taken by a large number of nations.  Reading between the lines of President Obama’s answer to a question in a press conference this morning confirmed this expectation.

2. Financial market stabilization — I expect this will be a continuation of efforts in November, but with some details fleshed out.  The final statement will likely highlight three subgoals to financial stabilization: restarting lending, enhancing the capital structure of financial institutions (aka recapitalizing banks), and dealing with toxic assets.  This is consistent with discussions from last fall, but I expect a greater American emphasis on the last item from the new team.

3. Regulatory reform – While financial market stabilization focuses on short-term actions the G-20 nations need to take, the regulatory reform section will focus on longer-term reforms to reduce the chance that these same problems recur in the future.  The negotiators and their staffs have spent a lot of time on these issues, and I expect the final product will continue to flesh out the construct created last November, with a lot of details now filled in.

   I expect an emphasis on improving oversight and greater cooperation among national regulators.  To my delight, I do not anticipate any mention of any sort of “single global regulator.”  There is a so-called “college of supervisors” that was part of the November and prior efforts, but my expert advisors on this subject assure me that this group is about coordination, not the creation of a supra-national sovereign group.  Participant nations appear interested in coordination of national efforts while maintaining national sovereignty.  This is a big deal for me.  Let’s work together, but Americans should have the final say in what America does.

   There is an interesting debate about “convergence” of national regulatory structures that underlies this question.  I expect the statement will emphasize the goal of “convergent” regulatory structures.  A tension exists between two goals.  We want a level playing field across nations so that government policies distort capital flows as little as possible.  In this respect, convergence of national regulatory structures can be a good thing.  At the same time, if they converge to a consensus position that is unwise, then that’s a bad thing.  My own instinct is to worry that, in a politically governed process negotiated by national governments and regulators, there will be a tendency to converge to a structure that is overly restrictive and burdensome.  This is a tension that will play out in obscure international regulatory fora over months and years, and can have long-lasting and important consequences on the international flows of capital.  I could be OK in theory with “convergence” language, if I knew what the final details would look like.  Since no one can know that in advance, “convergence” language makes me nervous now, as it did last November.

   I further expect that the regulatory reform section will talk about the importance of better oversight of “systemically important institutions” (read:  too-big-to-fail) in ways that parallel how Secretary Geithner, and Secretary Paulson before him, and Chairman Bernanke, have spoken about the issue.  This will send an international signal that the problem of regulation of institutions that are deemed to be too big to fail is a critical area for future policy development.  My own view is that this is the big enchilada.  I trace back much (most?) of our current financial pain, as well as almost all of the tension between Wall Street and Washington, to consequences from being on the back end of a too-big-to-fail problem, where all options are terrible.  I think it’s our primary long-term financial policy challenge.  I wrote about the causes of the financial crisis last October, following a speech by President Bush.

   There is an important follow-on question about the relative importance of strengthening the oversight of huge banks and insurance companies on the one hand, versus expanding regulation into hedge funds and private pools of capital on the other.  I am absolutely convinced that the former needs major reform.  I am far less certain that the second is as large of a problem.  I am in the minority in this view.  This is a topic for further discussion.

   I also anticipate that the final statement will say something on tax havens.  My views here on international convergence of taxation differ significantly from those expressed in the past by those who are now senior American officials.  I will refrain from commenting while they are overseas negotiating.  They have the ball for America.

   I expect the regulatory reform section will talk about the importance of moving the trading of Credit Default Swaps (CDS) onto organized exchanges, which parallels efforts that Secretaries Paulson and Geithner have pushed here in the U.S.  This is a good and important thing.

   I expect the statement will continue to flesh out work to harmonize accounting standards.  This is simultaneously mind-numbingly boring and incredibly important.

   There will also be some structural changes to the Financial Stability Forum – they will change the name to the Financial Stability Board and add more members from the G-20.  They will also have language, I think, similar to that in the November document on executive compensation.

4. Increased resources for the IMF and restructuring of the World Bank and IMF – One of the advantages of being Treasury Secretary is you get some leeway to push issues that are important to you.  Secretary Geithner has spoken of tripling the IMF’s budget, and Prime Minister Gordon Brown has spoken of doubling it.  We will see where the number ends up, but it’s clearly going to increase.  I am interested to see how willing Congress will be to fund the increased U.S. contribution.

   They will also change the governance structure of the IMF and World Bank.  I anticipate that China and other developing countries will get more weight in decisions of these international bodies, but only if they pay their share of the budgets.  There is an important thematic here for China and India that crosses a range of international economic policy issues.  In international negotiations, China and India sometimes try to have it both ways.  Their negotiators argue they should have the same say in international economic policy questions as major developed economies like the U.S., Japan, and major European economic powers.  At the same time, they plead poverty and argue that they cannot possibly sacrifice economic growth for the global good.  My view is:  in or out.  You decide.  If you want to be a first-tier economic nation, that’s fantastic.  You play by the same rules as everyone else, and you make the same sacrifices for the global good.  You cannot have it both ways.

   Finally, I anticipate the U.S. and Europe will give up what some call the “knightship rights” of choosing the leaders of the World Bank and the IMF.  I expect one result will be some kind of new (supposedly) merit-based selection process.

5. Fighting protectionism – This is the topic that I hope will make almost all of the G-20 leaders uncomfortable.  In November the G-20 leaders agreed to a fantastic strong statement that opposed protectionism, in which they said,
   

   We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports. Further, we shall strive to reach agreement this year on modalities that leads to a successful conclusion to the WTO’s Doha Development Agenda with an ambitious and balanced outcome. We instruct our Trade Ministers to achieve this objective and stand ready to assist directly, as necessary.

   And yet on March 17th the World Bank reported that 17 of the G-20 nations “have implemented 47 measures that restrict trade at the expense of other countries.”  The U.S. is one of the 20, and the World Bank highlighted “the US direct subsidy of $17.4 billion to its three national [auto] companies.”  President Obama’s Monday announcement extending the auto loans make this a challenging topic for him in London.

   I’d like to praise World Bank President (and former U.S. Trade Representative and Deputy Secretary of State) Bob Zoellick for this excellent and well-timed study.  We need more “name and shame” tools to highlight protectionist actions by governments.  The fragile world economy makes it even more important that everyone push for free trade and open investment.

   Dan Price was President Bush’s international economic advisor in the White House, and also the President’s “sherpa” for the November G-20 summit.  Dan suggests that President Obama could demonstrate U.S. leadership with a move that promotes both free trade and his clean technology agenda, by getting the G-20 nations to agree to eliminate tariffs on clean energy technologies.  President Bush launched this effort last November, and it would be a huge win on multiple fronts for our new President if he could bring this to a successful closure.  I strongly agree with Dan.

   I conclude with a warning from Dan Price, who says, “In the process of needed reform, there is a risk of political demonization of particular products or services, like CDS or securitization, that in fact perform a very useful function.”

   I wish President Obama and his team the best in their efforts to represent America at the G-20 summit.

A quick guide to the G-20 summit

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. What was accomplished at the G-20 Summit?
2. The G-20 Summit in pictures
3. President Bush’s speech on financial markets and the world economy

When President Obama took office, $387 B of the $700 B of available TARP funds had already been publicly committed.  Here’s the breakdown.

This meant that the Obama team had $313 B left to commit before reaching the $700 B limit.

Since January 20^th, President Obama has made the following new commitments:

$50 B from TARP into housing subsidies — Note that this is just the TARP commitment.  There’s other spending on housing, but it’s not from TARP.

$30 B more from TARP for AIG

$5 B from TARP for auto parts suppliers

$15 B from TARP to buy securities derived from small business loans guaranteed by the Small Business Administration

$80 B to further expand the TALF to consumer credit and mortgages

$75 B — $100 B for the new “Public Private Investment Plan” announced Monday, to purchase toxic loans and mortgage-backed securities from banks.  They call these “legacy loans” and “legacy securities.”

That’s a total of $255 B — $280 B in new commitments.

Add that range to the $387 B we had committed, and you come up with a range of $642 B — $667 B already committed.

That leaves them $33 B — $58 B before they hit $700 B.

Uh-oh.

There’s some uncertainty around the $80 B figure to further expand TALF, because the Administration has been ambiguous about how big the new TALF would be in total.  I’ll bet they’re scrambling this week trying to figure out what they actually meant.

They can create some wiggle room for themselves if they say that the $15 B for small businesses and the $5 B for auto parts suppliers are a subset of the $100 B (in total) for “consumer credit.”  This uncertainty and ambiguity should not obscure the critical point:  they’re almost out of money.

They have $33 B — $58 B before they hit the $700 B barrier.  Let’s assume they do some hand-waving:  “What we meant was …,” and redefine some of those previous commitments as overlapping and therefore non-additive.  It appears to me that their best case scenario is they could have $100 B of room.  My best guess is that they have less than $40 B of room.

Let’s look at what other needs they will face:

• The banking regulators are doing rigorous stress tests on the 19 biggest banks.  Some of those banks are going to need more capital.
• The auto loans we (the Bush Administration) issued expire March 31^st.  If they continue those loans, then that $25 B remains committed.  It looks like they will extend the loans, using at least a few billion more from the TARP.  Let’s be optimistic and call it $5 B — $10 B.  (If they instead provide debtor-in-possession financing, their initial outlay is probably more like $20 B.)  I’ve written a separate series of posts on the Administration’s auto loan options.
• They need “dry powder” for unexpected bad scenarios, which seem to crop up every few weeks.  You always have to worry about AIG needing more money, and unpleasant surprises could come from any direction.
• I assumed only $75 B for the direct costs of the Geithner plan.  If they want to go to the top end of their range, that’s another $25 B.
• The ambiguity on the size of the TALF is an additional $50 B — $100 B question for TARP.
• I think the Geithner plan risks being too small to have the desired effect.  Much of the informed commentary seems to agree with this judgment.  If it is successful, they will want and need to put more funds into it.  (I think this is their strategy.)

I would bet heavily against them being able to stay within the $700 B this year.  It’s easy to imagine them approaching the limit within a few months.  The auto deadline looms, and there will be pressures when the stress tests complete.

Recommendations

1. The Obama Administration should produce an accounting of TARP commitments similar to what I’ve done above.  It doesn’t have to be complex — a two-column table will do nicely.
2. This accounting should show how the various consumer credit and TALF commitments overlap, if at all.  It should also provide clarity to the markets about the sizes of various components of the TALF.
3. The Administration should explain how much room they have left within the $700 B provided by Congress, what possible demands they anticipate, and what their game plan is for allocating the remaining resources.  Secretary Geithner should be given tremendous flexibility to change this game plan as circumstances warrant, but should provide initial clarity.
4. Congress should take the Obama Administration’s previous warnings seriously, and incorporate the possibility of a new TARP request into next week’s budget discussions.  It makes no sense to build a budget and ignore that $250 B elephant over there in the corner.

I think the President will need more TARP funds soon.  If he does, he’s going to have to go to Congress to get them.  If this happens, it will overwhelm his legislative agenda.

In part two of this series I’ll show you that the Obama Administration has warned the Congress that this may be coming.

In part three (coming soon), I’ll give my views and recommendations.

Is $700 billion enough?

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. Is $700 billion enough? Part 3: Secretary Geithner says we have more room
2. Is $700 billion enough? Clearing up the confusion (or at least trying to)
3. Four unpleasant options for TARP funding

This is the first of a two-part note.  Part one will describe the mechanics of the Summit and show some photos.  Part two will describe the substance.

The action began in mid-October after the President met at Camp David with French President Nicolas Sarkozy and Manuel Barrosso, President of the European Commission:

A statement released after that meeting included the following:

[The three leaders] agreed they would reach out to other world leaders next week with the idea of beginning a series of summits on addressing the challenges facing the global economy.

World leaders will be consulted about the idea of a first summit of heads of government to be held in the U.S. soon after the U.S. elections, in order to review progress being made to address the current crisis and to seek agreement on principles of reform needed to avoid a repetition and assure global prosperity in the future. Later summits would be designed to implement agreement on specific steps to be taken to meet those principles.

Four days later, we released a Statement by Press Secretary Dana Perino, which included the following:

Today, the President is inviting the leaders of the Group of 20 countries to a summit in the Washington, D.C. area, on November 15 to discuss financial markets and the global economy.

… G-20 members are: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, South Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, the United States, and the European Union.

The Managing Director of the International Monetary Fund, the President of the World Bank, the United Nations Secretary-General, and the Chairman of the Financial Stability Forum have also been invited to participate.

Normally a summit like this takes at least a year to plan.  The work of an incredible team from the Administration built an incredible summit in only 24 days.

As you can see, the G-20 actually includes 19 States, plus the European Union.  The meeting also included the heads of the major international financial institutions (IFI’s, pronounced “IF-ees”):  the International Monetary Fund (IMF), the World Bank, the U.N. Secretary General, and the Financial Stability Forum.  In addition, the final summit meeting included the heads of Spain and the Netherlands.

Events began last Friday evening with the President spending almost an hour greeting leaders at the North Portico of the White House.

(Game:  Name that Leader.  Answers are at the bottom.)

After a reception in the East Room, the President hosted a dinner in the State Dining Room with the leaders.  Here he is offering a toast:

We are here because we share a concern about the impact of the global financial crisis on the people of our nations.  We share a determination to fix the problems that led to this turmoil.  We share a conviction that by working together, we can restore the global economy to the path of long-term prosperity.

Each nation had four representatives in the Saturday summit discussions:

1. The leader (for the U.S., President Bush);
2. the finance minister (for the U.S., Secretary Paulson);
3. the “Sherpa” (for the U.S., Dan Price); and
4. the deputy finance minister (for the U.S., Dave McCormick).

The “Sherpa” is an interesting position.  It’s derived from the annual G-8 meeting.  Each leader appoints a personal representative to carry his or her heavy load in the negotiations leading up to the leaders’ meeting.  For the U.S., the Sherpa is always the senior international economic policy advisor in the White House.  Dan and Dave led all the negotiations leading up to the G-20 summit (since the U.S. was a host), and they are key players in the success of that summit.  In the G-8 context, the Sherpa’s deputy is known as the “sous-sherpa”, and the #3 person is the “yak.”

The Saturday summit meeting was held at the beautiful National Building Museum in Washington, DC.  Our advance team did all this setup beginning late Thursday night.  Some White House staff showed up at 5 AM Saturday to help escort the delegates:

The meeting began with the traditional “family photo”.

The leaders then went to the summit session.  The inner square is the leaders with their finance ministers.  Behind each is a small table with the Sherpa and Finance deputy.

Here’s the President’s view:

Here are two different angles on the room:

And here’s a view from the U.S. Sherpa/finance deputy table:

After the “plenary session,” the Leaders broke for lunch:

The Leaders left after lunch (one report said there were over 400 vehicles in the motorcades combined), while the President made a statement to the press:

Part two of this note looks at what was actually accomplished at the summit.

Answers to Name that Leader:

1. Mexican President Felipe Calderon
2. Chinese President Hu Jintao
3. Australian Prime Minister Kevin Rudd
4. Indian Prime Minister Manmohan Singh
5. Russian President Dmitryi Medvedev
6. Brazilian President Luiz Inacio Lula da Silva of Brazil (aka “Lula”)

The G-20 Summit in pictures

© 2010 Keith Hennessey - Your guide to American economic policy

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2. What was accomplished at the G-20 Summit?
3. President Bush’s speech on financial markets and the world economy

This note is just a collection of primary source documents from today’s announcement.  Generalists will likely be interested in the first six documents, as well as #10.  The other documents will be of interest primarily to financial experts.

Here you will find:

1. The President’s remarks in the Rose Garden this morning
2. A joint statement by Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke, and FDIC Chairman Sheila Bair
3. A summary document that describes the package as a whole
4. Statement by Treasury Secretary Henry Paulson
5. Statement by Federal Reserve Chairman Ben Bernanke
6. Statement by FDIC Chairman Sheila Bair

Treasury documents

1. Capital Purchase program description
2. Capital Purchase program term sheet
3. Executive Compensation rules
4. Speech by Interim Assistant Secretary for Financial Stability Neel Kashkari on Implementation of the Economic Stabilization Act (delivered Monday 13 October)

FDIC documents

1. FDIC press release

Fed documents

1. Commercial Paper Funding Facility press release
2. Commercial Paper Funding Facility: Program Terms and Conditions
3. Commercial Paper Funding Facility: Frequently Asked Questions

President’s Working Group on Financial Markets documents

© 2010 Keith Hennessey - Your guide to American economic policy

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Good morning.  I just completed a meeting with my working group on financial markets.  We discussed the unprecedented and aggressive steps the federal government is taking to address the financial crisis.  Over the past few weeks, my administration has worked with both parties in Congress to pass a financial rescue plan.  Federal agencies have moved decisively to shore up struggling institutions and stabilize our markets.  And the United States has worked with partners around the world to coordinate our actions to get our economies back on track.

This weekend, I met with finance ministers from the G7 and the G20 — organizations representing some of the world’s largest and fastest-growing economies.  We agreed on a coordinated plan for action to provide new liquidity, strengthen financial institutions, protect our citizens’ savings, and ensure fairness and integrity in the markets.  Yesterday, leaders in Europe moved forward with this plan.  They announced significant steps to inject capital into their financial systems by purchasing equity in major banks.  And they announced a new effort to jumpstart lending by providing temporary government guarantees for bank loans.  These are wise and timely actions, and they have the full support of the United States.

Today, I am announcing new measures America is taking to implement the G7 action plan and strengthen banks across our country.

First, the federal government will use a portion of the $700 billion financial rescue plan to inject capital into banks by purchasing equity shares.  This new capital will help healthy banks continue making loans to businesses and consumers.  And this new capital will help struggling banks fill the hole created by losses during the financial crisis, so they can resume lending and help spur job creation and economic growth.  This is an essential short-term measure to ensure the viability of America’s banking system.  And the program is carefully designed to encourage banks to buy these shares back from the government when the markets stabilize and they can raise capital from private investors.

Second, and effective immediately, the FDIC will temporarily guarantee most new debt issued by insured banks.  This will address one of the central problems plaguing our financial system — banks have been unable to borrow money, and that has restricted their ability to lend to consumers and businesses.  When money flows more freely between banks, it will make it easier for Americans to borrow for cars, and homes, and for small businesses to expand.

Third, the FDIC will immediately and temporarily expand government insurance to cover all non-interest bearing transaction accounts.  These accounts are used primarily by small businesses to cover day-to-day operations.  By insuring every dollar in these accounts, we will give small business owners peace of mind and bring stability to the — and bring greater stability to the banking system.

Fourth, the Federal Reserve will soon finalize work on a new program to serve as a buyer of last resort for commercial paper.  This is a key source of short-term financing for American businesses and financial institutions.  And by unfreezing the market for commercial paper, the Federal Reserve will help American businesses meet payroll, and purchase inventory, and invest to create jobs.

In a few moments, Secretary Paulson and other members of my Working Group on Financial Markets will explain these steps in greater detail.  They will make clear that each of these new programs contains safeguards to protect the taxpayers.  They will make clear that the government’s role will be limited and temporary.  And they will make clear that these measures are not intended to take over the free market, but to preserve it.

The measures I have announced today are the latest steps in this systematic approach to address the crisis.  I know Americans are deeply concerned about the stress in our financial markets, and the impact it is having on their retirement accounts, and 401(k)s, and college savings, and other investments.  I recognize that the action leaders are taking here in Washington and in European capitals can seem distant from those concerns.  But these efforts are designed to directly benefit the American people by stabilizing our overall financial system and helping our economy recover.

It will take time for our efforts to have their full impact, but the American people can have confidence about our long-term economic future.  We have a strategy that is broad, that is flexible, and that is aimed at the root cause of our problem.  Nations around the world are working together to overcome this challenge.  And with confidence and determination, we will return our economies to the path of growth and prosperity.

Thank you.

Rose Garden Statement by President Bush on financial markets

© 2010 Keith Hennessey - Your guide to American economic policy

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THE WHITE HOUSE

State Floor

9:01 P.M. EDT

THE PRESIDENT:  Good evening.  This is an extraordinary period for America’s economy.  Over the past few weeks, many Americans have felt anxiety about their finances and their future.  I understand their worry and their frustration.  We’ve seen triple-digit swings in the stock market.  Major financial institutions have teetered on the edge of collapse, and some have failed.  As uncertainty has grown, many banks have restricted lending.  Credit markets have frozen.  And families and businesses have found it harder to borrow money.

We’re in the midst of a serious financial crisis, and the federal government is responding with decisive action.  We’ve boosted confidence in money market mutual funds, and acted to prevent major investors from intentionally driving down stocks for their own personal gain.

Most importantly, my administration is working with Congress to address the root cause behind much of the instability in our markets.  Financial assets related to home mortgages have lost value during the housing decline.  And the banks holding these assets have restricted credit.  As a result, our entire economy is in danger.  So I’ve proposed that the federal government reduce the risk posed by these troubled assets, and supply urgently-needed money so banks and other financial institutions can avoid collapse and resume lending.

This rescue effort is not aimed at preserving any individual company or industry — it is aimed at preserving America’s overall economy.  It will help American consumers and businesses get credit to meet their daily needs and create jobs.  And it will help send a signal to markets around the world that America’s financial system is back on track.

I know many Americans have questions tonight:  How did we reach this point in our economy?  How will the solution I’ve proposed work?  And what does this mean for your financial future?  These are good questions, and they deserve clear answers.

First, how did our economy reach this point?

Well, most economists agree that the problems we are witnessing today developed over a long period of time.  For more than a decade, a massive amount of money flowed into the United States from investors abroad, because our country is an attractive and secure place to do business.  This large influx of money to U.S. banks and financial institutions — along with low interest rates — made it easier for Americans to get credit.  These developments allowed more families to borrow money for cars and homes and college tuition — some for the first time.  They allowed more entrepreneurs to get loans to start new businesses and create jobs.

Unfortunately, there were also some serious negative consequences, particularly in the housing market.  Easy credit — combined with the faulty assumption that home values would continue to rise — led to excesses and bad decisions.  Many mortgage lenders approved loans for borrowers without carefully examining their ability to pay.  Many borrowers took out loans larger than they could afford, assuming that they could sell or refinance their homes at a higher price later on.

Optimism about housing values also led to a boom in home construction.  Eventually the number of new houses exceeded the number of people willing to buy them.  And with supply exceeding demand, housing prices fell.  And this created a problem:  Borrowers with adjustable rate mortgages who had been planning to sell or refinance their homes at a higher price were stuck with homes worth less than expected — along with mortgage payments they could not afford.  As a result, many mortgage holders began to default.

These widespread defaults had effects far beyond the housing market.  See, in today’s mortgage industry, home loans are often packaged together, and converted into financial products called “mortgage-backed securities.”  These securities were sold to investors around the world.  Many investors assumed these securities were trustworthy, and asked few questions about their actual value.  Two of the leading purchasers of mortgage-backed securities were Fannie Mae and Freddie Mac.  Because these companies were chartered by Congress, many believed they were guaranteed by the federal government.  This allowed them to borrow enormous sums of money, fuel the market for questionable investments, and put our financial system at risk.

The decline in the housing market set off a domino effect across our economy.  When home values declined, borrowers defaulted on their mortgages, and investors holding mortgage-backed securities began to incur serious losses.  Before long, these securities became so unreliable that they were not being bought or sold.  Investment banks such as Bear Stearns and Lehman Brothers found themselves saddled with large amounts of assets they could not sell.  They ran out of the money needed to meet their immediate obligations.  And they faced imminent collapse.  Other banks found themselves in severe financial trouble.  These banks began holding on to their money, and lending dried up, and the gears of the American financial system began grinding to a halt.

With the situation becoming more precarious by the day, I faced a choice:  To step in with dramatic government action, or to stand back and allow the irresponsible actions of some to undermine the financial security of all.

I’m a strong believer in free enterprise.  So my natural instinct is to oppose government intervention.  I believe companies that make bad decisions should be allowed to go out of business.  Under normal circumstances, I would have followed this course.  But these are not normal circumstances.  The market is not functioning properly.  There’s been a widespread loss of confidence.  And major sectors of America’s financial system are at risk of shutting down.

The government’s top economic experts warn that without immediate action by Congress, America could slip into a financial panic, and a distressing scenario would unfold:

More banks could fail, including some in your community.  The stock market would drop even more, which would reduce the value of your retirement account.  The value of your home could plummet.  Foreclosures would rise dramatically.  And if you own a business or a farm, you would find it harder and more expensive to get credit.  More businesses would close their doors, and millions of Americans could lose their jobs.  Even if you have good credit history, it would be more difficult for you to get the loans you need to buy a car or send your children to college.  And ultimately, our country could experience a long and painful recession.

Fellow citizens:  We must not let this happen.  I appreciate the work of leaders from both parties in both houses of Congress to address this problem — and to make improvements to the proposal my administration sent to them.  There is a spirit of cooperation between Democrats and Republicans, and between Congress and this administration.  In that spirit, I’ve invited Senators McCain and Obama to join congressional leaders of both parties at the White House tomorrow to help speed our discussions toward a bipartisan bill.

I know that an economic rescue package will present a tough vote for many members of Congress.  It is difficult to pass a bill that commits so much of the taxpayers’ hard-earned money.  I also understand the frustration of responsible Americans who pay their mortgages on time, file their tax returns every April 15th, and are reluctant to pay the cost of excesses on Wall Street.  But given the situation we are facing, not passing a bill now would cost these Americans much more later.

Many Americans are asking:  How would a rescue plan work?

After much discussion, there is now widespread agreement on the principles such a plan would include.  It would remove the risk posed by the troubled assets — including mortgage-backed securities — now clogging the financial system.  This would free banks to resume the flow of credit to American families and businesses.  Any rescue plan should also be designed to ensure that taxpayers are protected.  It should welcome the participation of financial institutions large and small.  It should make certain that failed executives do not receive a windfall from your tax dollars.  It should establish a bipartisan board to oversee the plan’s implementation.  And it should be enacted as soon as possible.

In close consultation with Treasury Secretary Hank Paulson, Federal Reserve Chairman Ben Bernanke, and SEC Chairman Chris Cox, I announced a plan on Friday.  First, the plan is big enough to solve a serious problem.  Under our proposal, the federal government would put up to $700 billion taxpayer dollars on the line to purchase troubled assets that are clogging the financial system.  In the short term, this will free up banks to resume the flow of credit to American families and businesses.  And this will help our economy grow.

Second, as markets have lost confidence in mortgage-backed securities, their prices have dropped sharply.  Yet the value of many of these assets will likely be higher than their current price, because the vast majority of Americans will ultimately pay off their mortgages.  The government is the one institution with the patience and resources to buy these assets at their current low prices and hold them until markets return to normal.  And when that happens, money will flow back to the Treasury as these assets are sold.  And we expect that much, if not all, of the tax dollars we invest will be paid back.

A final question is:  What does this mean for your economic future?

The primary steps — purpose of the steps I have outlined tonight is to safeguard the financial security of American workers and families and small businesses.  The federal government also continues to enforce laws and regulations protecting your money.  The Treasury Department recently offered government insurance for money market mutual funds.  And through the FDIC, every savings account, checking account, and certificate of deposit is insured by the federal government for up to $100,000.  The FDIC has been in existence for 75 years, and no one has ever lost a penny on an insured deposit — and this will not change.

Once this crisis is resolved, there will be time to update our financial regulatory structures.  Our 21st century global economy remains regulated largely by outdated 20th century laws.  Recently, we’ve seen how one company can grow so large that its failure jeopardizes the entire financial system.

Earlier this year, Secretary Paulson proposed a blueprint that would modernize our financial regulations.  For example, the Federal Reserve would be authorized to take a closer look at the operations of companies across the financial spectrum and ensure that their practices do not threaten overall financial stability.  There are other good ideas, and members of Congress should consider them.  As they do, they must ensure that efforts to regulate Wall Street do not end up hampering our economy’s ability to grow.

In the long run, Americans have good reason to be confident in our economic strength.  Despite corrections in the marketplace and instances of abuse, democratic capitalism is the best system ever devised.  It has unleashed the talents and the productivity, and entrepreneurial spirit of our citizens.  It has made this country the best place in the world to invest and do business.  And it gives our economy the flexibility and resilience to absorb shocks, adjust, and bounce back.

Our economy is facing a moment of great challenge.  But we’ve overcome tough challenges before — and we will overcome this one.  I know that Americans sometimes get discouraged by the tone in Washington, and the seemingly endless partisan struggles.  Yet history has shown that in times of real trial, elected officials rise to the occasion.  And together, we will show the world once again what kind of country America is — a nation that tackles problems head on, where leaders come together to meet great tests, and where people of every background can work hard, develop their talents, and realize their dreams.

Thank you for listening.  May God bless you.

Address by President Bush on financial markets

© 2010 Keith Hennessey - Your guide to American economic policy

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2. Statement by Treasury Secretary Hank Paulson
3. Rose Garden Statement by President Bush on financial markets

This is really important.

Good morning.  I thank Treasury Secretary Hank Paulson, Federal Reserve Chairman Ben Bernanke, and SEC Chairman Chris Cox for joining me today.

This is a pivotal moment for America’s economy.  Problems that originated in the credit markets — and first showed up in the area of subprime mortgages — have spread throughout our financial system.  This has led to an erosion of confidence that has frozen many financial transactions, including loans to consumers and to businesses seeking to expand and create jobs.  As a result, we must act now to protect our nation’s economic health from serious risk.

There will be ample opportunity to debate the origins of this problem.  Now is the time to solve it.  In our nation’s history, there have been moments that require us to come together across party lines to address major challenges.  This is such a moment.  Last night, Secretary Paulson and Chairman Bernanke and Chairman Cox met with congressional leaders of both parties — and they had a very good meeting.  I appreciate the willingness of congressional leaders to confront this situation head on.

Our system of free enterprise rests on the conviction that the federal government should interfere in the marketplace only when necessary.  Given the precarious state of today’s financial markets — and their vital importance to the daily lives of the American people — government intervention is not only warranted, it is essential.

In recent weeks, the federal government has taken a series of measures to help promote stability in the overall economy.  To avoid severe disruptions in the financial markets and to support home financing, we took action to address the situation at Fannie Mae and Freddie Mac.  The Federal Reserve also acted to prevent the disorderly liquidation of the insurance company AIG.  And in coordination with central banks around the world, the Fed has injected much-needed liquidity into our financial system.

These were targeted measures designed primarily to stop the problems of individual firms from spreading even more broadly.  But more action is needed.  We must address the root cause behind much of the instability in our markets — the mortgage assets that have lost value during the housing decline and are now restricting the flow of credit.  America’s economy is facing unprecedented challenges, and we are responding with unprecedented action.

Secretary Paulson, Chairman Bernanke, and Chairman Cox have briefed leaders on Capitol Hill on the urgent need for Congress to pass legislation approving the federal government’s purchase of illiquid assets, such as troubled mortgages, from banks and other financial institutions.  This is a decisive step that will address underlying problems in our financial system.  It will help take pressure off the balance sheets of banks and other financial institutions.  It will allow them to resume lending and get our financial system moving again.

Additionally, the federal government is taking several other steps to address the trouble of our financial markets.

The Department of the Treasury is acting to restore confidence in a key element of America’s financial system — money market mutual funds.  In the past, government insurance was not available for these funds, and the recent stresses on the markets have caused some to question whether these investments are safe and accessible.  The Treasury Department’s actions address that concern by offering government insurance for money market mutual funds.  For every dollar invested in an insured fund, you will be able to take a dollar out.

The Federal Reserve is also taking steps to provide additional liquidity to money market mutual funds, which will help ease pressure on our financial markets.  These measures will act as grease for the gears of our financial system, which were at risk of grinding to a halt.  They will support the flow of credit to households and businesses.

The Securities and Exchange Commission has issued new rules temporarily suspending the practice of short selling on the stocks of financial institutions.  This is intended to prevent investors from intentionally driving down particular stocks for their own personal gain.  The SEC is also requiring certain investors to disclose their short selling, and has launched rigorous enforcement actions to detect fraud and manipulation in the market.  Anyone engaging in illegal financial transactions will be caught and persecuted [sic].

Finally, when we get past the immediate challenges, my administration looks forward to working with Congress on measures to bring greater long-term transparency and reliability to the financial system — including those in the regulatory blueprint submitted by Secretary Paulson earlier this year.  Many of the regulations governing the functioning of America’s markets were written in a different era.  It is vital that we update them to meet the realities of today’s global financial system.

The actions I just outlined reflect the considered judgment of Secretary Paulson, Chairman Bernanke, and Chairman Cox.  We believe that this decisive government action is needed to preserve America’s financial system and sustain America’s overall economy.  These measures will require us to put a significant amount of taxpayer dollars on the line.  This action does entail risk.  But we expect that this money will eventually be paid back.  The vast majority of assets the government is planning to purchase have good value over time, because the vast majority of homeowners continue to pay their mortgages.  And the risk of not acting would be far higher.  Further stress on our financial markets would cause massive job losses, devastate retirement accounts, and further erode housing values, as well as dry up loans for new homes and cars and college tuitions.  These are risks that America cannot afford to take.

In this difficult time, I know many Americans are wondering about the security of their finances.  Every American should know that the federal government continues to enforce laws and regulations protecting your money.  Through the FDIC, every savings account, checking account, and certificate of deposit is insured by the federal government for up to $100,000.  The FDIC has been in existence for 75 years, and no one has ever lost a penny on an insured deposit — and this will not change.

America’s financial system is intricate and complex.  But behind all the technical terminology and statistics is a critical human factor — confidence.  Confidence in our financial system and in its institutions is essential to the smooth operation of our economy, and recently that confidence has been shaken.  Investors should know that the United States government is taking action to restore confidence in America’s financial markets so they can thrive again.

In the long run, Americans have good reason to be confident in our economic strength.  America has the most talented, productive, and entrepreneurial workers in the world.  This country is the best place in the world to invest and do business.  Consumers around the world continue to seek out American products, as evidenced by record-high exports.  We have a flexible and resilient system that absorbs challenges and makes corrections and bounces back.

We’ve seen that resilience over the past eight years.  Since 2001, our economy has faced a recession, the bursting of the dot-com bubble, major corporate scandals, an unprecedented attack on our homeland, a global war on terror, a series of devastating natural disasters.  Our economy has weathered every one of these challenges, and still managed to grow.

We will weather this challenge too, and we must do so together.  This is no time for partisanship.  We must join to move urgently needed legislation as quickly as possible, without adding controversial provisions that could delay action.  I will work with Democrats and Republicans alike to steer our economy through these difficult times and get back to the path of long-term growth.  Thank you very much.

Rose Garden Statement by President Bush on the Economy

© 2010 Keith Hennessey - Your guide to American economic policy

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Last night, Federal Reserve Chairman Ben Bernanke, SEC Chairman Chris Cox and I had a lengthy and productive working session with Congressional leaders.  We began a substantive discussion on the need for a comprehensive approach to relieving the stresses on our financial institutions and markets.

We have acted on a case-by-case basis in recent weeks, addressing problems at Fannie Mae and Freddie Mac, working with market participants to prepare for the failure of Lehman Brothers, and lending to AIG so it can sell some of its assets in an orderly manner.  And this morning we’ve taken a number of powerful tactical steps to increase confidence in the system, including the establishment of a temporary guaranty program for the U.S. money market mutual fund industry.

Despite these steps, more is needed.  We must now take further, decisive action to fundamentally and comprehensively address the root cause of our financial system’s stresses.

The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded.  These illiquid assets are choking off the flow of credit that is so vitally important to our economy.   When the financial system works as it should, money and capital flow to and from households and businesses to pay for home loans, school loans and investments that create jobs.  As illiquid mortgage assets block the system, the clogging of our financial markets has the potential to have significant effects on our financial system and our economy.

As we all know, lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing.  This simply put too many families into mortgages they could not afford.  We are seeing the impact on homeowners and neighborhoods, with 5 million homeowners now delinquent or in foreclosure.  What began as a sub-prime lending problem has spread to other, less-risky mortgages, and contributed to excess home inventories that have pushed down home prices for responsible homeowners.

A similar scenario is playing out among the lenders who made those mortgages, the securitizers who bought, repackaged and resold them, and the investors who bought them. These troubled loans are now parked, or frozen, on the balance sheets of banks and other financial institutions, preventing them from financing productive loans.  The inability to determine their worth has fostered uncertainty about mortgage assets, and   even about the financial condition of the institutions that own them.  The normal buying and selling of nearly all types of mortgage assets has become challenged.

These illiquid assets are clogging up our financial system, and undermining the strength of our otherwise sound financial institutions. As a result, Americans’ personal savings are threatened, and the ability of consumers and businesses to borrow and finance spending, investment, and job creation has been disrupted.

To restore confidence in our markets and our financial institutions, so they can fuel continued growth and prosperity, we must address the underlying problem.

The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy.  This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible.  The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars.  I am convinced that this bold approach will cost American families far less than the alternative – a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.

I believe many Members of Congress share my conviction.  I will spend the weekend working with members of Congress of both parties to examine approaches to alleviate the pressure of these bad loans on our system, so credit can flow once again to American consumers and companies.  Our economic health requires that we work together for prompt, bipartisan action.

As we work with the Congress to pass this legislation over the next week, other immediate actions will provide relief.

First, to provide critical additional funding to our mortgage markets, the GSEs Fannie Mae and Freddie Mac will increase their purchases of mortgage-backed securities (MBS).  These two enterprises must carry out their mission to support the mortgage market.

Second, to increase the availability of capital for new home loans, Treasury will expand the MBS purchase program we announced earlier this month. This will complement the capital provided by the GSEs and will help facilitate mortgage availability and affordability.

These two steps will provide some initial support to mortgage assets, but they are not enough.  Many of the illiquid assets clogging our system today do not meet the regulatory requirements to be eligible for purchase by the GSEs or by the Treasury program.

I look forward to working with Congress to pass necessary legislation to remove these troubled assets from our financial system.  When we get through this difficult period, which we will, our next task must be to improve the financial regulatory structure so that these past excesses do not recur. This crisis demonstrates in vivid terms that our financial regulatory structure is sub-optimal, duplicative and outdated.   I have put forward my ideas for a modernized financial oversight structure that matches our modern economy, and more closely links the regulatory structure to the reasons why we regulate. That is a critical debate for another day.

Right now, our focus is restoring the strength of our financial system so it can again finance economic growth.  The financial security of all Americans – their retirement savings, their home values, their ability to borrow for college, and the opportunities for more and higher-paying jobs – depends on our ability to restore our financial institutions to a sound footing.

Statement by Treasury Secretary Hank Paulson

© 2010 Keith Hennessey - Your guide to American economic policy

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The bill now heads to the Senate.  Today the President called for quick Senate action:

The temptation is going to be for the Senate to load it up. — We need to get this bill out of the Senate and on my desk so the checks can get in the hands of our consumers and our businesses can be assured of the incentives necessary to make investments.

The Senate Finance Committee is marking up an alternate version of this bill today.  There are some in the Senate who have ideas about how they would like to modify the House-passed bill.  Various Senators want to:

• add infrastructure spending
• add funds to subsidize housing
• add funds for low-income heating assistance
• extend unemployment insurance
• provide tax rebates to seniors
• eliminate the income cap in the House bill
• change the business provisions to provide relief to firms that do not invest in 2008

There are many lobbying the Senate this week to add additional provisions to this bill.  There are two risks: (1) that the bipartisan agreement in the House is derailed by changes made in the Senate; and (2) that the bill becomes a “Christmas tree”, on which everyone wants to hang an ornament, delaying Senate completion.

At the same time, there is a growing chorus calling for the Senate to quickly take up and pass the House-passed bill without amendment.

Treasury Secretary Hank Paulson:    “The key here is keeping the deal simple, keeping this simple.  Complexity is our enemy right here.  Once you start adding things, it’s a slippery slope, and the process could quickly bog down and screech to a stop here. … I don’t think the Senate is going to want to derail this program.  And I don’t think the Amreican people are going to be anything but impatient if we don’t enact this bipartisan agreement quickly.”

“Former [Clinton] Treasury Secretary Lawrence Summers testified that the plan — due to pass the House today — was appropriately targeted to achieve its short-term goal. While he said an expansion of unemployment insurance would help spur the economy, ‘there are no possible improvements to the package that would warrant delay.’”

“Former [Clinton] White House Budget Director Alice Rivlin concurred: ‘Quick passage, I believe, is more important than improvements.’ Rivlin urged Congress to resist the temptation to add construction projects to the package. She said that spending would proceed too slowly to give the economy a timely boost and would end up accelerating the deficit.”

“It’s important that this bill not get overloaded. I have a full agenda of things I would like to have in the package, but we have to contain the price,” Pelosi said. “We made a decision, because that’s where we could find our common ground.”

Q: “Senator McConnell is asking to do just that, put your bill on the floor, without any amendments. Should Reid just agree to that, to schedule this without slowing it down with a markup tomorrow?”

Speaker Pelosi: “All I would say is, I would hope that the Senate would take up our bill and pass it, so that this can be as timely as it needs to be.”

Senator McConnell:  “In the Democrats’ response to the State of the Union, Gov. Sebelius called on Congress to ‘work together’ quickly on a short-term fix to speed relief to families.  Speaker Pelosi and Majority Leader Reid previously called for a plan to be ‘implemented into law without delay.’  The best way to do this is for the Senate to take up and pass the bipartisan compromise crafted by the House and send it directly to the President’s desk — this week.  Adding extraneous provisions to this cooperative package will only delay, and possibly derail, relief to America’s famliies and job creators.”

Stimulus 2008: a need for speed

© 2010 Keith Hennessey - Your guide to American economic policy

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